BMI View: The outlook for the occupational market in Bulgaria remains positive in the medium term in all three real estate sectors. We expect occupier demand to strengthen in line with an improving economy and rents to rise further. However, a lack of high quality stock and a constrained development market will continue to curb activity in the investment market, with much of the interest continuing to come from domestic and regional investors as well as opportunistic players .
The macro-economic outlook for Bulgaria shows a steady but modest growth in GDP over the next five years. Economic growth is expected to be 1.5% in 2015 and to average at 1.9% per annum over the period 2016-2019. Growth is likely to be driven by expansion in domestic demand. The external sector is expected to remain weak this year and next, but to rebound thereafter.
In the office sector, business investment is expected to remain weak in the short term, given companies are in a deleveraging mode. That said, the situation is expected to improve in the medium term. BMI forecasts show an increase in output of tertiary services, particularly from 2017 onwards and that will underpin growth in demand for office space. Rents have already increased this year and we expect this trend to continue going forward. As the capital city, Sofia is likely to benefit most from higher demand and rental growth, but we believe that the prospects for secondary cities are also favourable. In the past year we have seen higher levels of decentralisation to Varna and Bourgas as occupiers limited by high quality of space in Sofia and looking for more cost effective space have relocated. We expect the higher level of office requirements to spur further rental increases in these secondary cities as the market shifts from being tenant driven to becoming increasingly landlord driven.
Rental growth has also been a feature of the retail real estate market in Bulgaria this year and with household spending expected to rise and consumer affluence and purchasing power set to strengthen in the medium term, we believe that the prospects for this sector remain positive. All three cities covered in our report, Sofia, Varna and Bourgas, have experienced higher levels of retailer demand for space and we believe that they will continue to benefit from an improving economic outlook and see further uplifts in rental values in the coming months. With supply of prime space diminishing in all three cities, occupiers are likely to become increasingly willing to consider smaller towns in the regions in the medium term.
In the industrial real estate market, International companies are becoming increasingly interested in Bulgaria as a hub for outsourced production facilities, with the automotive sector expected to be a strong driver of occupational demand going forward. Changing market dynamics and consumer shopping trends, such as on-line shopping, will also play a key role in shaping future demand for logistics space. While demand is expected to remain strong over the forecast period, the poor availability of modern, good quality space remains a key constraint across the market. Speculative development is currently non-existent and the space that is under construction is being developed for owner-occupation. Rental costs have increased marginally in Sofia and Varna this year and are set to increase further going forward in response to the tight supply of Grade A space.
Net yields are expected to remain stable over the next few years, largely due to a more uncertain outlook for the investment market, particularly in the short term. Domestic and opportunistic players have been the key player in the market this year and we do not expect this to change in the short term. The office sector is likely to fare better in terms of investor demand than retail and industrial, given that more development activity is taking place, which will bring higher quality properties to the market. The retail market is likely to be constrained particularly by lack of large lot sizes in the shopping mall segment, where international investor demand is likely to continue to remain strong. Turnover in the industrial sector is also expected to remain low in terms of standing investments because of lack of new and high quality space. Until such time as speculative development brings more high quality stock to the industrial market, activity in this sector is likely to be focused on land for owner-occupation.