Each square metre worth its weight in gold

According to data published by credit market monitoring agency BIK, May 2022 saw the lowest demand for mortgages in the last 15 years. Applications were fewer than half of those of the previous year (June 2021 to June 2022), while the average size of a mortgage increased by 2.9 pct. Due to the fact that the NBP has set inflation targets that are very different to what’s happening on the market and on shop shelves, it’s very likely that interest rates will continue to rise and that this will further sharpen banking policies and reduce the creditworthiness of buyers seeking mortgages to help them to buy real estate. In addition to this, in April the Financial Supervision Commission in Poland (KNF) recommended that banks should take measures to reduce their credit risk. One of the conditions that future borrowers are going face is that their monthly payments cannot exceed 40 pct of their earnings if they are in a low-income bracket (previously it was 50 pct) and 50 pct if they are in a high-income bracket (previously, 65 pct). One further condition is that monthly payments will come with an interest charge of 5 pp (rather than the 2.5 pp previously). Both of these recommendations have reduced the creditworthiness of those applying for such loans. The number of home buyers is now continuing to fall due to the restricted access to mortgages. And it’s not only the demand for them that is going down, but also the supply.

Construction prices and increased development costs have resulted in much lower returns on investment than before the Russian invasion of Ukraine. Construction and development companies, when reassessing their costs, often realise that breaking contracts could result in harmful losses, and so they agree to finish the construction work even on less profitable projects. It’s highly probable that projects will be delayed until market conditions and prices improve. We are not predicting bankruptcies on the residential development market, given the very strong results generated by developers in recent years, but smaller local players – especially those that have only started investing recently, enticed by the profits to be made on the residential market – and those with investment loans could have problems. This could lead to further consolidation of the development market.

Possible bankruptcies among general contractors could pose a problem for the sector as well as potential problems with handing over projects. At the moment, no large-scale issues are evident in this regard, either, but the situation could change by the end of the year if the prices of building materials and labour continue to rise.

Paying through the nose for bricks and mortar

According to Statistics Poland, construction and installation prices in May rose by 12.2 pct y-o-y. Since March 2022, the trend has been for installation and construction prices to continue to rise on the previous year. Since January 2022, the highest price rises have been for building construction, which has gone up by 15.4 pct.

Since the beginning of the year to the end of May 2022, developers launched the construction of 55,900 apartments (23.2 pct fewer than last year). This year they have had to limit the number of new homes, not only due to the fall in demand but also because of the unprecedented rise in development costs, which the entire sector has had to contend with since H2 2021. According to PSB Group, for each of the first five months of this year the prices of primary materials increased on average by 30–35 pct y-o-y. At the end of the second quarter of this year, steel and plastics were twice as expensive than before the pandemic, while wood-based materials were 50–80 pct more expensive and fuel prices reached their highest ever level in the 21st century. As a result, in May and June this year almost 80 pct of construction firms surveyed by Statistics Poland considered the price of materials to be a barrier to their activities – as they had reached their highest level ever recorded. Additionally, construction companies are facing rising wage pressure from their workers as a result of soaring inflation. In response to the extraordinary growth in construction costs, companies are increasingly raising their prices, as reflected in Statistics Poland’s record-high figures for the prices of production for construction and instalment, which are up by 8–12 pct. As a consequence of these record price hikes, many developers are putting their projects on hold, at least until prices in the construction market stabilise. “Such decisions are dictated by simple economic calculations, where developers can see that the cost of building 1 sqm of apartment space in most regions of the country is more than, or close to, its sales price. The slowdown in apartment construction in comparison to the record year of 2021 is clearly evident in Statistics Poland’s figures, which show that between January and May 2022, developers launched the construction of 23.2 pct fewer apartments compared to a year ago,” points out Damian Kaźmierczak, the main economist at the Polish Association of Construction Employers (PZPB).

A crisis around the corner?

The slowdown in the launch of new projects is obvious, particularly when viewed in light of the seemingly endless boom on the residential market of the last few years. Demand in many cities was then so high that supply simply could not keep up. According to NBP, the home prices offered over the last five years in Poland’s seven largest cities (Gdańsk, Gdynia, Kraków, Łódź, Poznań, Warsaw, and Wrocław) rose by 63 pct and over the last year alone they rose by 15 pct on the previous year. Over a five-year period, the highest rise in offer prices in those cities, 76 pct, was seen in Gdańsk. Among all the cities examined, the leaders were actually Szczecin and Zielona Góra, where five years ago the offer price was 88 pct lower than it is today but despite this the demand for apartments has not waned. Poles have been investing in apartments en masse due to the common belief that this is low risk. Above all, this has been an attractive investment especially with the rise in property prices and the record low interest rates.

Is it possible to talk of an apartment investment bubble – and if so, is it about to burst? The late economic historian Charles P. Kindleberger characterised bubbles as a “a sharp rise in the price of an asset or a range of assets in a continuous process, with the initial rise generating expectations of further rises and attracting new buyers – generally speculators interested in profits from trading in the asset rather than its use of earning capacity.” Such a situation can be described as self-perpetuating.

The last crisis on the residential market hit us 15 years ago (in Poland 14 years ago). In the first half of 2008, 27 developers went bankrupt in Poland and the number of construction companies facing insolvency rose by 40 pct. The crisis particularly impacted the residential sector and was preceded by rising prices between 2004 and 2007, which in some cities amounted to 200 pct over the period. Then, the first signs of a crisis emerged when subcontractors faced problems related to late payments, rising energy prices and other costs. The crisis was triggered by extremely cheap loans in the US and by speculative investment in real estate when there were no other attractive investments. Additionally, the country was pursuing a policy of a home for every American and subsidised interest payments for the least wealthy. All of this caused property prices to increase and in many cases this was purely speculative. The genesis of this situation was obviously far more complicated and largely depended on the overuse of rating agencies, banks and often valuers too. However, in Poland at the time the demand for real estate purchased through mortgages was largely due to the interest rate relief that was in place until 2006 – you could deduct interest payments made on loans from your income (this is still possible provided the loan was taken out before 2006). The subsequent demand drove up the price of real estate to high levels and as a result fewer buyers were able to afford an apartment. Sounds familiar?

Different times

The current situation is, however, different for a number of reasons. The fact that many of the apartments under construction have already been purchased is important. As a result, there’s no reason for their prices to fall. Moreover, the rising costs of development, land, construction materials, fuel and energy as well as the high level of inflation and the diminishing supply of new apartments, suggest that the situation is the complete reverse. On top of this, developers face additional costs due to legal reforms aimed at protecting the buyers of apartments and single-family homes. The reforms came into effect on July 1st 2022 and mandate that payments are put aside in a ‘developer guarantee fund’ to protect buyers in such cases as when a developer or a bank faces problems.

The situation is also clearly different because an important new set of players has emerged on the market – institutional investors. Developers are now offering entire buildings for sale as a rental apartment project, which may turn out to be an excellent alternative when the demand from private individual buyers is limited due to the current cost of loans.

It has to be remembered, though, that the rental market was impacted at the beginning of the pandemic. Cities that had many short-term rental apartments saw rents plummet as well as suffering from the further disruption that ensued. On the other hand, all cities did see rent rates go down.

The current rising rents for available apartments is undoubtedly a result of inflation, increased heating costs, the rising cost of mortgages that are borne by the tenant, and the arrival of a large number of refugees from Ukraine. In Warsaw, this increase can be as much as 19 pct y-o-y (14 pct in comparison to Q1 2020, before the pandemic). Additionally, long-term contracts are index-linked to the average yearly inflation rate to allow rents to go up further. For one-year contracts, which are the most common type in Poland, the lessor can adjust the rent level to the situation on the market, which with the current high level of demand will certainly result in rent hikes.

With such high inflation and uncertainty on the market, and with the increased price of loans and falling levels of creditworthiness, many who would like to buy their own apartment are set to put off the decision to do so and turn their attention to the rental market. If further rapid rent rises occur, there is the possibility that the government could regulate future increases (which is what happens in Scandinavia and Germany). Additionally, the influx of refugees from Ukraine has caused a sudden decrease in the availability of rental apartments in Poland’s largest cities, where there was a lack of flats available even before the war in Ukraine and despite the record high supply.

Rents still heading upwards

We have to assume that rents will continue to rise due to the high demand and the costs that landlords have to bear. Once again, we can see the room exists to manoeuvre for PRS operators that are looking to build up their rental apartment portfolios and invest capital in the sector as well as those who are looking to invest their cash as a hedge against inflation. Here it is worth considering the role of REITs, which are funds that invest in real estate but are still not regulated under Polish law. These could be an excellent alternative to long term investment for those that do not have enough capital to buy an entire property. But the bill that would bring REITs into the legal framework has still yet to be drawn up. Many of those who would prefer to buy a home are likely to opt to rent instead, due to mortgages becoming harder to obtain. To compound the situation, Ukrainian refugees and companies that are relocating from the east are generally going to make use of rented accommodation. With such a huge lack of homes available in Poland despite the record levels of supply over the last few years, which has been unable to satisfy the demand from the Polish population itself, the worry exists that there is set to be a serious long-term shortage of homes and especially of rental apartments. Much depends on the situation in Ukraine, on government policy and the ideas that local authorities come up with to resolve this situation. Unfortunately, the state Mieszkanie Plus programme has not been successful in its aims and has had no effect on solving the housing problem. The new bill on SIMs (otherwise known as Community Apartment Initiatives), which were to replace Community Building Societies (otherwise known as TBSs, with TBSs continuing to operate along the same lines) has not had made much difference either, although the launch of the Government Fund for Apartment Development seems to be a step in the right direction. Many developers may hold back from starting construction work due to the current high costs and are also unlikely to do so until the market stabilises. Our prediction is that the market for new homes over the next few quarters will remain lethargic with supply and demand falling to much lower levels until interest rates are reduced and construction costs return to a more acceptable level.

Financing post-pandemic

With inflation continuing to rise, some banks are nevertheless still prepared to finance residential projects. The clients of the residential debt market can be divided into the following groups:

1. a) individual investors buying for their own needs or as an investment
2. b) institutional investors buying entire buildings or projects
3. c) developers building homes to sell to individual or institutional investors

Individual investors are running up against the barrier of their own creditworthiness, which has dramatically fallen due to the continual growth in interest rates. The rise in base interest rates from 0.25 pct p.a. to 6.88 pct p.a. over the last four months has meant that the monthly payments on a 20-year loan with an average value of PLN 400,000 have gone up over this period from around PLN 2,700 to PLN 3,800. When you take into account that the average net salary in Warsaw is around PLN 6,000 net, the credit burden per income has jumped from 45 pct to 60 pct of the average net income. Such high rates significantly increase the risk of insolvency to levels that are unacceptable for banks. Assuming that WIBOR is to climb higher, which with the current rate of inflation seems unavoidable, we can assume that an increase of 0.5 pct will result a rise in monthly repayments of around PLN 150 on a PLN 400,000 loan. Some banks are still trying to offer individual investors mortgages but as long as far more collateral is provided. Previously, borrowers had to put up 20 pct, but now it comes to 40–50 pct of the total cost of the investment. The government’s ideas on subsidising loan repayments or on introducing repayment holidays might provide temporary support, but the important thing is how long the price of loans remains at such high levels when the soaring prices of utilities and food are also squeezing household budgets. This could result in a fall in consumer spending or households becoming even more indebted to lenders.

The institutional investors in rental apartments currently operating in Poland are mainly from abroad. Rental revenue is denominated in złoty as is the financing for their projects, while the cost of financing comprises the WIBOR base rate (one-, three- or six-month) and the bank’s margin. A flat rate is used much more rarely – and when it is it is normally limited to a period of five years. Banks are highly selective when they offer financing to PRS institutional investors. The crucial thing is that the investor has to be experienced and has a respected operator, that revenues provide a debt service ratio of at least 1.4, and that interest rate risks are appropriately hedged (with IRS or CAP). Additionally, due to the costs of maintaining real estate and of utilities, banks are demanding that money is put aside to meet operating costs and that stress tests are performed to assess how vulnerable projects are to sudden price rises. Such demands and cost assumptions are currently reducing project profitability – even as rents continue to rise. In order to meet the banks’ demands, the maximum available LTV has fallen from 60 pct to around 50 pct. Often the cash-on-cash return under these circumstances is a few dozen percent and the estimated IRR hovers at around 10 pct, which might mean that a project is not profitable. So why are investors still attracted to this sector? The capital value of PRS buildings in Poland is still way below the value in Western Europe and, taking into account the huge demand for apartments and the rising rents, the chance is still there for revenues to grow. Developers, in turn, when they deliver buildings to sell to individual investors, mainly use the money accumulated in the open development accounts of their clients. Bank financing is only an addition to this, since using the money in development accounts is almost costless. However, purchasing sites has mainly been done with their own money and through issuing bonds, which have either been repaid through apartment sales or renewed for repayment in the next period.

When the demand from individual home buyers is limited by the lack of availability of loans or due to clients cancelling their contracts with developers after having lost their creditworthiness, developers that want to complete their projects have to turn to overdrafts on their current accounts or make use of revolving loans, which obviously due to the high interest rates significantly increases costs. Another issue is the need to buy back bonds as they eventually reach maturity along with the much higher interest rates for these, since bonds are mainly based on the WIBOR rate. The additional galloping growth in the costs of materials and energy have also significantly reduced developers’ margins, which might lead in some cases to insolvency.

As a result of all this, in order to avoid such problems, some developers are holding back on launching their projects when they still do not have any pre-sales, while some are trying to sell land to free up the funds they need to complete their current projects. The banks are aware of the risks and are thus demanding more collateral and being very selective about the development projects they finance.

Karolina Furmańska, senior residential analyst, consulting and research, capital markets, Cushman & Wakefield

Mira Kantor-Pikus, partner, equity, debt and alternative investments, capital markets Poland, Cushman & Wakefield