20-30-year-old office buildings no longer meet the needs of tenants

LHV’s commercial real estate financing statistics showed some slowdown in 2023, but cautious optimism is being expressed for the current year.

The performance of commercial real estate is strongly linked to the health and state of the economy. Considering the challenges in the economy and the uncertainty of businesses, it was fully expected that the financing of commercial real estate would slow down slightly in 2023. Fewer transactions were made, and they took longer to complete.

‘Although we concluded 35% fewer commercial real estate financing contracts last year, the total volume of contracts only declined by 7%. Over the year, the average loan amount increased by EUR 1.25 million, or nearly 40%. The higher loan amounts show on the one hand that price levels have indeed risen, but on the other hand, they point to the fact that in an uncertain market, it was the financially more stable and larger players who were more active and made larger investments,’ said Jürgen Raag, Head of Real Estate Financing at LHV.

The conditions for granting loans to businesses have remained broadly the same, but each project is approached individually. ‘Each client, their profile, and their business is different, and these need to be looked at separately. Companies appreciate our personalised and flexible approach and increasingly prefer to be in partnership with a local bank. For example, last year, 30% of all loans issued to Estonian companies were financed by LHV,’ said Raag as an example.

In the case of commercial real estate, however, attention is increasingly being paid to the energy efficiency and modernity of the property, from the point of view of both the financier and the tenant. Jürgen Raag noted that this is partly due to rising energy prices, but also due to energy efficiency requirements becoming stricter. ‘More energy-efficient buildings, which offer lower energy costs and a better indoor climate, are likely to be more economically beneficial and attractive for the tenant in the long term, despite the higher rental price. On top of higher upkeep costs, costly renovation works may be needed in the future to meet the tightening energy efficiency requirements. In addition to a competitive advantage, better energy efficiency also has a positive impact on the market value of the building.’

At the end of 2023, after nearly a decade, the vacancy rate of Class B office spaces in Tallinn once again exceeded 10%. Raag believes that 20–30-year-old office buildings no longer meet the needs of tenants and need to be made more energy-efficient and modernised.

‘The market value of these types of buildings has plummeted in recent years, and if the current owner does not have the financial capability to make significant investments in the modernisation of the building, it could create new opportunities for developers who have the resources and vision to do so. We also aim to support sustainable development and innovation in financing commercial real estate,’ he said.

In terms of the current year, LHV is cautiously optimistic and believes that 2024 could be a good time to start construction in new projects. ‘Our belief is based on the assumption that Estonia’s economy will return to growth in 2025 and that reduced construction volumes have made construction prices relatively cheap. By starting construction today, the developer will be able to take advantage of the more favourable construction prices and, given that the average construction period is 12–18 months, the outlook for market participants and the economy could be significantly more positive by the time the project is completed.’