A million behind them, a million ahead of them

Ewa Andrzejewska, ‘Eurobuild Central & Eastern Europe’: This June we will be celebrating the 25th anniversary of the first free elections in Poland. This gives us an occasion to look at the history of the property market since 1989. What, in your opinion, were the turning points, and the key events for the modern real estate market and for Echo Investment, which has been growing together with the market since 1996.

Piotr Gromniak, the president of the board of Echo Investment: Over the 18 years of our presence on the real estate market we have been moving forward together with it, adjusting to the processes that have been taking place. We started out with the construction of apartments; next we built simple shopping centres, and then each successive generation of shopping centre; and then the office market started to develop. We have developed almost twenty projects on the hotel market. Echo Investment has not been changing the real estate market but creating it. Poland is now the number one market in the CEE region and we have played a part in this.

Could dates such as 2001 and the construction crisis, and 2004 and EU accession, be considered turning points?

EU accession resulted in us opening up to Europe. This was obviously a turning point when we consider that over 90 pct of investors who buy commercial properties in Poland are foreign ones. The majority of shopping centre tenants are also international corporations, while a huge proportion of office tenants, such as those from the BPO sector, are foreign firms. And so on.

And what about the most important projects for Echo Investment?

Each of our hundred projects was important in the course of their construction. Now we have 108 under out belt. It is not easy to pick out just one. However, judging by independent rankings, it turns out that our most unique project is Galeria Echo in Kielce, which received an award at the MAPIC fair in 2011 along with the prize for the best managed shopping centre in 2013.

And apart from those that have won prizes at competitions, which were almost non-existent a few years ago?

In that case it would be Galaxy,the third generation shopping centre in Szczecin that was opened in 2003. It was our first project on such a large scale. It had a completely new level of quality for the company and a completely new level for the market. As far as the office projects are concerned it would certainly be the Olympic Centre of 2004 and the accompanying Athina Park business complex of 2005 in Warsaw. When it comes to residential projects it is quite difficult to pinpoint the most important one – one that might have propelled us into the top league. Maybe Mondrian House in the capital city, which was built in 2005?

And what will the market look like in another 25 years? I know that a crystal ball would be useful right now, but unfortunately I don’t have one...

It is hard to talk about a prospect as distant as 25 years ahead of us, but I think that a five- or ten-year scale is much easier to discuss. For the residential market there will not be many differences. The demand for apartments will always be there because there is no alternative. The office market has the greatest development prospects in Warsaw and in some of the largest regional cities. Offices have become the factories of the 21st century. More and more processes and production, such as IT, take place in office buildings. The comfort of the staff has also become increasingly important, as well as the layout of the space, whether there is a canteen, a fitness club, a nursery school, plenty of natural light, and if it’s possible to pop outside for a break.

Will we reach the development level of, perhaps not London or Paris, but maybe Munich in 25 years?

We really could do with that crystal ball. Unfortunately, I do not know this. I guess that in five or ten years Warsaw could be today’s Frankfurt of this part of Europe. It is a realistic forecast. Millions of square metres of modern offices can still be built in the capital city. Most of the changes and the most question marks relate to the retail market. The reason is simple: e-commerce. Even though the changes resulting from this phenomenon are inevitable, the future of traditional commerce does not look pessimistic. Increasingly often we are coming to the conclusion that modern commerce is not about the product but the process of buying – and in this case the internet does not provide what can be offered by a shopping centre. This has already been identified by those people who are responsible for the development of chains: shops are being prettified and the staff are better trained. Such retail chains as Abercrombie & Fitch have even entered the scene, with whom it is not about the item you buy, but about visiting their boutiques and the whole experience and emotions you go through when making a purchase. This gives me the confidence that traditional commerce will never be replaced by electronic commerce, which, I have to admit, does provide a full choice and a good price. Some time ago people were saying that cinemas would be replaced by large TV sets, films on video cassettes, and then by DVDs. Cinema, however, even though it is more expensive than those alternatives, has survived and is doing well.

How will Echo change over the next few years? Just a few years ago the company was building hotels, but now you have no plans in this area. Warehouses are one of the segments of the real estate market where you have been absent so far. Will Echo try its hand in the competitive warehouse market?

Last year we finished the construction of our last hotel – out of around twenty we have carried out – for the Accor chain (Novotel in Łódź). We believe that the days when you could generate good enough margins on this market are over. The warehouse market, on the other hand, is a difficult sector – with low margins, divided up between strong players, but still offering some development prospects. There is a chance that we will launch our first small project on a plot we already own. But I admit that we still have to gain much experience in this field.

Can you let us in on a few more details about this first project?

It will be a facility with an area of a few thousand square metres for a few tenants. It will not be a huge hall like the one for Amazon. It is too early to reveal any more. After its completion we will be able to assess the level of difficulty and the possibility of generating good margins, as well as the complexity in terms of the construction. However, I know that it will be extremely difficult to enter the premier league of warehouse developers.

The warehouse will be built on a plot in the company’s land bank. How much land does Echo now hold?

I think what we can build on a plot is more important, because this defines the value of the land. Our land bank includes enough hectares to build 80 projects – that is, another million square metres. Half of this amount will be in office projects, while around 25 pct is going to be in retail and residential projects.

You built your first million within 18 years. How long will it take you to build the second one?

We want to implement our development plans within seven years. According to our estimates, the expenditure on these projects will amount to PLN 4.5 bln, excluding the land, which constitutes app. 20 pct of the costs on average – its value is estimated at PLN 9.5 bln.

You mentioned that 25 pct will be earmarked for residential projects. Is this a lot or little? It seems that such projects have now become the mainstay of the company.

Indeed, this will be a record year for us – we will sell almost 500 apartments and this is a level we want to maintain over the next few years. We are focusing on mid-range projects because we care about higher margins, of around 25–30 pct, as is also the case in our commercial projects.

Will your company, which entered the Budapest market in 2006, Romania in 2007 and Ukraine in 2009, be expanding its operations abroad?

We are not looking to start projects in new countries or in those we have already invested in, such as Romania or Hungary. On the one hand, these markets have been a little disappointing to us, and on the other, it is Poland which offers the greatest development opportunities in this part of Europe. We are mainly focusing on Warsaw and the six major regional markets in terms of office projects: Wrocław, Poznań, the TriCity, Kraków, Katowice and Łódź. The reason for this is simple: in these cities the supply of modern office space has exceeded 250,000 sqm, which means that foreign investors might now be interested in them. Perhaps in three or four years these cities will be joined by Szczecin, and later by Lublin. As far as other cities are concerned, it is possible that there are potential tenants of modern offices out there, but selling such projects could be a problem. Coming back to the foreign projects we have already invested in – we are planning to implement them and are working on them. We have only suspended our project in Kyiv, where we have a large plot where it is possible to build 100,000 sqm of office space. We are currently waiting to see how the situation develops before resuming any operations there. However, we believe that the capital city of Ukraine will be a good market one day.

Several months ago (in January 2013) the founder and majority shareholder of Echo, Michał Sołowow, announced that Echo would become more of a real estate fund than a development firm. Is the company still heading in this direction?

Even if we consider buying some assets, it would always be in order to generate a margin, which is done through an improvement in the quality and a sale at the best possible moment. This means that the value of the cash flow acquired should be comparable to the price of the land we would like to build a new project on. But the market is not at the right stage of the business cycle in terms of the cash flow to make it profitable for us to buy a facility in operation and subsequently demolish it in order to build a new project.

Moving from the whole operation to Echo’s particular projects: one issue that has been stirring up a great deal emotion is the project for the former Cracovia hotel, on the site of which you wanted to build a shopping centre. The city of Kraków objected to your plans. I understand that offices are now going to be built there?

We were not able to convince the Kraków authorities that it should be a place accessible to all the city’s residents, such as a shopping centre. So instead we will try to implement an office project. We hope that a local zoning plan will be passed this year and we will be able to apply for a building permit next year.

Many office buildings are being planned for Warsaw, where the vacancy rate is currently growing.

I think that the worst period for the sector was 2013. Out of almost 300,000 sqm of newly completed facilities, only 127,000 sqm was leased. This year another 300,000 sqm is to enter the market,

app. 200,000 sqm of which is secured by leases. This means that the vacancy level is growing. However, the forecasts for the next few years indicate that supply will be edging closer to the demand. Tenants have higher expectations all the time, so they are getting more eager to move out of their current offices and into new buildings. They mostly want to improve their working conditions, which will result in a growing number of vacancies in older facilities.

When will we hear about the first lease in Echo’s flagship project – the Q22 skyscraper in the capital city?

There is a chance for a contract to be signed before the summer holidays. This is good news because the building will come into use in around two years’ time and on the current market the majority of contracts are signed less than twelve months before the completion. The first tenant is of course significant – it gives market credibility to the project.

Which projects are still planned for this year?

We actually started the construction of the Tryton Business House complex in Gdańsk last year, the construction of the first stage of Opolska Business Park in Kraków got underway in May, and we are continuing with the A4 Business Park in Katowice and West Gate in Wrocław. We also want to begin a project near Pasaż Grunwaldzki in Wrocław and one on ul. Taśmowa in Warsaw. And we have not ruled out returning to our uncompleted Aurus development in Łódź.

And which projects will be leaving your portfolio this year – what has been put up for sale?

Theoretically, all the finished projects could experience a change in ownership. Nevertheless, it needs to be remembered that in the case of shopping centres, facilities that have operated for at least a year are especially ready to be sold. Will any transactions be closed soon? The process for selling a property takes a minimum of six months nowadays.

Perhaps one of the projects will change hands in Q4, but it is hard to predict which one because no sales process is advanced enough to talk about an actual schedule. But we are considering selling a number of assets, such as Galaxy in Szczecin, Galeria Olimpia in Bełchatów, Galeria Veneda in Łomża, Pasaż Grunwaldzki in Wrocław and Park Rozwoju in Warsaw.

Echo’s rivals have been expanding their property management operations lately. Will Echo also be focusing on offering property management services to external companies?

We manage our properties because, firstly, we generate good margins, and secondly, because it allows us to stay in touch with the market, to know what to improve in our future projects, and to get to know tenants’ expectations. However, we are not planning to offer the service outside our company. Of course, following the sale of a property the facility can be managed by us for one or two years due to, for example, the guarantee. However, this is not our key activity.

For a few years the growth of the market has been held back by the banks, who have been less willing to provide loans for development projects. Bonds now make up a considerable proportion of Echo’s liabilities.

We have three basic pillars in terms of financing and are currently working on a fourth one. The first involves wholesale bonds, which we offer to institutions. We pay the lowest margins among developers, which is evidence of how secure a company we are. Our current programme is worth PLN 1 bln. The second line involves securing loans for commercial projects – and in this case the banks have been eager to finance our projects. The third pillar is our current overdraft facility. And the fourth, which we are currently developing, will be a retail bond issue. Unfortunately, I cannot disclose any details about the issue. Some decisions will be made in the next few weeks, including whether the issue will take place before or after the holidays.

Will this represent a significant source of financing?

I think that it will in a few years, but much depends on the first issue. I am aware of the fact that Echo is not as well-known in every circle as it is in the property sector.

Echo does not publish financial forecasts, but could you please give us some kind of evaluation for this year?

Our quarterly, semi-annual and annual results are always close to analysts’ estimates, and if we do surprise the market is it always for the better. In the first quarter we did indeed give the market a pleasant surprise. We have always been conservative in the valuation of our properties, to allow them to provide us with a suitable profit when sold. We have recently been obliged to carry out a valuation of our property portfolio due to a bond issue. Knight Frank, which carried this out, applied a less conservative, market-based approach. This is where the high net profit came from.

A CAREER THAT MIRRORS THE MARKET

Piotr Gromniak is a graduate of the faculty of civil engineering at the Kielce University of Technology. He started his professional career after finishing his studies in 1990, gaining experience in the construction industry working as a site engineer, a master builder and tendering specialist for Exbud and Betonchem. In October 1997 he started working as a project manager for Kielce-based Echo Investment and in September 1998 became the director of the construction department. In October 2000 he was appointed to be a member of the management board. He has been the president of the management board since the June 27th 2008. Piotr‘s seventeen-year career at Echo closely follows the development of the company. Echo Investment has now chalked off over 100 projects in four sectors of the real estate market (residential, retail, offices and hotels). It has developed an area in excess of 1 mln sqm. The total assets of the company are worth more than PLN 4.75 bln (residual market value – RV).