Wanted A vision for Prague

Walking west along ancient cobbled streets, over the Charles Bridge with the castle rising up before us and the mediaeval market square a few hundred metres behind, you would think that Prague doesn't need a vision. Its vision is its history. But according to the panelists taking part in the recent Eurobuild CEE ?Executive Talks' evening debate, it most definitely does

Richard Stephens

On the panel:
Jan Kasl
the owner and director of the Best Development Prague architectural studio and former Mayor of Prague

Jan Sykora
chairman of the board and partner, Wood & Co investment bank

Markus Leininger
CEE head of corporate banking, Eurohypo

Omar Sattar
managing director, Colliers International Czech Republic

Pawel Graliński
president, Arch Magic Group architectural studio

Pavel Trenka
member of the board, HB Reavis

Richard Stephens
awards director, Eurobuild CEE (moderator)

Forget the development downturn. The biggest problem Prague's real estate market faces is the disinterest - or worse - of the city authorities in making the Czech Republic's capital a more attractive place to do business. "In other countries you find that the public sector acts as a conduit to assist and advance the city, but here it's actually a barrier," said Omar Sattar, Colliers International's new managing director for the Czech Republic. "People are disappointed and frustrated with the politicians, planners and bureaucrats". Jan Kasl, mayor of Prague from 1998 to 2002, went even further. "What needs to be changed in the system? Many would say everything. I think that things cannot continue without better legislation," he asserted.

Bridging the gap
Prague's business identity, or lack of it, took up a significant chunk of the discussion, but first things first. The panel kicked off with a presentation by Omar Sattar setting the scene. "Encouragingly, we're seeing a year-on-year increase in investment volumes," he said. "2010 saw slightly over EUR 0.5 bln transacted in the Czech Republic, while Poland saw EUR 1.8 bln. For 2011, we're predicting that Czech will comfortably reach EUR 1 bln and Poland about EUR 2 bln".
The two slides which provided most food for thought highlighted the funding gap, showing two scenarios, the first for investors who bought property in 2006 and the second for those who purchased in 2007. "The first (see first graph, p. 71) shows someone who bought a prime office building in Prague back in 2006 with capital values of around EUR 3,000 per sqm and loan terms set for five years, so this was up for refinancing in 2011. In that time capital values have luckily come back a bit, so you're not looking at a loss of value. Come 2011 you have a gap and you need to plug that gap - how do you do it? You can put more equity in, but in many cases this is rather challenging, or the bank has a conversation with you regarding amortisation, or you look at pricing your debt differently over the next few years," suggested Sattar. "The next slide (graph 2, p. 71) shows someone who bought a property in 2007 at the height of the market. Not only have you lost capital value, but you've got a larger gap to plug. Do you go to specialist debt funds or insurance companies to do that? In the next couple of years there's something like EUR 600 bln worth of refinancing coming up, and with the banks no longer kicking the can down the road, does that mean the yields in Prague will stop compressing as debt gets more expensive?" he asked, completing the presentation.
What did the lone financing representative on the panel, Markus Leininger of Eurohypo, think about the funding gap? "The slide shows exactly where we are and the question is indeed 'who is bridging the gap' Before the crisis our institution originated app. EUR 35 bln in new business. Now this is approximately the volume German lenders are allocating for real estate in total. On the one hand there is demand for product, which is high as investors need to invest their money. Supply is low, as there are not many developments happening across Europe and owners of income-producing assets are not really willing to sell, due to the favourable environment. Lending terms have and will change, with inflation driving up interest rates and higher margin requirements, due to ongoing regulation, for example Basel III. I guess it is going to be more expensive, so there are lots of question marks about the outcome. There is pressure on banks' balance sheets, with a large amount of assets to be rolled over. Correction is needed in order to attract investors putting their money into the financial sector, even in safe havens," he claimed.
It was Omar Sattar who raised the next topic in his presentation - who did he think would fill the gap? "There are some specialist funds who might like to pick up a piece of the financing, and some mezzanine players, but I think the depth of the market is quite shallow. There aren't any big enough deals. Axa has recently launched a specialist debt fund looking to pick up the slack, but I think there's been enough pressure put on by the banks. I mean, in these markets the bankers are saying that their portfolios are doing well and I find that hard to believe. There's got to be some pain out there. Are banks simply delaying and praying, sticking their heads in the sand? Banks need to understand and know what they're going to do, and some of them don't, nor do they have the resources to deal with these issues. But who's going to step in? So far there's not enough volume in the market to make it interesting. Borrowers may be reluctant to pay for a slice of junior debt as the prices make it prohibitive," he believes.
From Pavel Trenka of HB Reavis's perspective, it's the local banks which have stepped into the breach. "Last year we had quite a number of distressed asset investors and funds coming into the market. I think the market never materialised from our perspective. There weren't any fire-sale transactions. Concerning the junior debt question, we can see that local banks are picking up the slack. They are much more willing to increase the leverage, but on the senior level and selectively. I think the crisis differentiated the stronger players and the banks recognised this and are being selective with whom they do business. Local banks who know their clients have much stronger relationships than the international banks." So, with HB Reavis gearing up for deeper commitments in Poland, is the company leaving the Czech Republic and Slovakia behind? "We have a development pipeline in Slovakia for the next 15 years, so we aren't going to leave it behind, and we have just started to develop slowly in the Czech Republic. We are looking forward and in the next three or four years we will see Poland really growing, but there just aren't any really good opportunities in Prague at the moment, from our perspective. There is more land in Warsaw that can be developed into landmark projects. In Prague we can see only class ?B' locations." Omar Sattar was quick to interject: "I wouldn't necessarily agree with Pavel. I don't think they're all class ?B' locations." "What I mean," explained Trenka, "is that because of the unclear situation with the master planning, the locations which would be good to develop, like Rohanský Ostrov or Bubny, are just not being developed, while there is a real demand for office space. Take Warsaw's Mokotów district, for example. It wasn't a typical business district but now it's one of the largest in the CEE region." In this regard, Jan Kasl is of the belief that the authorities are not seeing the wider picture. "The protection of some of the details while concept decisions are being secured is too exaggerated" he said. At this point Paweł Graliński threw in a counter-weight to balance the comparisons between Warsaw and Prague. "I live in Warsaw and I want to correct this a bit. There is no comparison between the Czech Republic and Poland. On GDP per capita or whatever criteria we take, the Czech Republic is a much more developed country. The reason why Poland is undergoing such dynamic development is not because of some wise decisions or careful planning. Locally we are very critical. Poland has suffered a lot because of the lack of any masterplans, for example." According to Pavel Trenka, Prague is even losing out to neighbouring Slovakia's capital city. "Bratislava is in a better position for office tenants as it's close to Vienna. Service centres are being created, for example. Prague is a fantastic city, but there are just not the opportunities to develop and the city has to really change its culture.

Ringing Prague
Jan Sykora of the Wood & Co investment consultancy took a step back and looked at Prague from a broader perspective. "Prague needs powerful branding and I think this has been a huge missed opportunity. My wife and I were looking at good places to live, taking into account education, family, kids, security, quality of life, culture etc, and Prague comes high on these criteria. Combined with the benign tax regime - a 15 pct flat tax rate, no property tax and no capital gains tax - it's almost too good to be true. So the politicians have completely missed the opportunity to project it as a fantastic place to do business." Is it too late to change this? "It's never too late. Take Prague Airport - it should be a regional hub. They should give it for free to an investor committed to bringing up the passenger numbers to 30 or 40 mln a year. We don't have a world-class university, but we should have. And there are several outstanding spots to develop some excellent projects," claimed Mr Sykora. "This could be achieved," believes Mr Graliński, adding that "there are some very solid foundations here. Some countries don't have anything in terms of tourism and so have had to create something out of nothing, but the Czech Republic has a very successful tourist industry and this can be developed. The Czech Republic has fantastic opportunities." Jan Kasl was Mayor of Prague for four years. What did he feel he achieved in that time? "I managed to create an atmosphere that the city is there to serve the people, but unfortunately that atmosphere, which was growing, dissipated too early." And, if he was dictator of Prague, what would he do? "I would build an outer ring road and - sorry - I would introduce a congestion charge for the centre of the city to give it a chance to breathe and move. It is after all a medieval city." Is it practical to build a ring road? "Yes, there are well-prepared designs. Unfortunately they haven't been realised in the best way. Money is allocated without any sense of adding value for the future, so it goes here and there, and sometimes without any sense at all."
Jan Sykora returned the discussion to the macro perspective. "I'm bullish in general for the CEE region. Central Europe is impressively positioned, despite the uncertainties, the level of global growth that we still experience, and the rise of China,  India and even Russia. I'd be selectively bullish on certain investments and asset classes - and property should be one of these. Concerning Prague I think there are immense opportunities. There are very few cities in the world which have such a historical platform, and very few city airports that can add another runway. You have these great areas in the city centre which can be developed. Banks just have to clean up their balance sheets and investors will be happier."
With the subject of the banks now raised, Markus Leininger re-entered the discussion in dramatic fashion: "The banking industry is bankrupt and it will take a long time to digest the outcome of the crisis." What about the assertion that local banks, for example Czech banks, are full of liquidity? "All national banks in Europe and the US have flooded the market with liquidity," asserted Mr Leininger, "otherwise it would have totally collapsed, even in markets where local banks never directly invested into triple-A-toxics. It will take a long time to clean up the balance sheets, in particular in countries where risk has been perceived differently, the so-called triple-A countries, and not necessarily in Poland or the Czech Republic. Because of the perception of a higher degree of risk in CEE countries we were more cautious. Where we had a long track record we made mistakes. Now when we talk about filling the funding gap, we're talking primarily about the large markets. I agree with Pavel Trenka that local banks are funding projects, but they are unable to fill the gaps in the global landscape. The CEE region is not an investor destination yet - apart from Poland to some degree, which belongs to the core markets in Europe." "Then how do you explain that in surveys asking where real estate investors want to be, the CEE region comes next after Germany?" asked Mr Sattar. "I don't know, to be honest. I would think Poland, yes, but not the region as a whole. I don't really see it for the time being," ventured Leininger. Omar Sattar was more upbeat. "I think we are seeing the return of an increase in serious bidders in 2011, more than in 2010, and some of these investors are coming back to the Czech Republic because they're unable to find product in Warsaw, and, I feel, Prague pricing is still a bit cheaper than Warsaw."

Discredited ratings agencies
Markus Leininger talked about the 'triple-A' markets, but aren't the ratings agencies giving these triple-A ratings rather discredited now? "I'm very sceptical about all the different auditors and ratings agencies," said Jan Sykora. "They were signing off on things that they must have known were junk. I'm surprised these ratings agencies are still around. You have to use common sense. You need to look at the quality of education, the work force, etc. Yes we have slower growth rates than China and India, but we're starting from a much higher GDP per capita. We are an hour's drive away from Germany, but the average salary here is about a third of their average salary," he said. But couldn't China be viewed as a threat rather than an opportunity? "Thanks to China over the last fifteen years inflation has been kept at historic lows in the west. Except for the last 100 years or so, over the last 3,000 years they've been the single biggest economy in the world. In China and India there is so much opportunity. Over the next five years we are going to have something like 1 bln people joining the middle class." said Mr Sykora.
The final word went to Paweł Graliński. "We all have to find our new place. The strength of China's and India's economies lies in their production. Where do we create value? In my opinion research and development is where the money should be focused. Concerning Prague, I've seen Oslo develop over 30 years. It has undergone so many phases of development in amazing ways. We've heard discussions about the fantastic places in Prague that could be discovered and given value. This just proves the point - change never stops." ?

Omar Sattar's overview of the Czech real estate market in a snapshot: "Retail is saturated, until we see a growth in disposable incomes. We'll see the development of more boutique-style projects as well as projects more focused on leisure. In the office sector we're coming to a point where the balance is tipping back in favour of the developer, so the opportunity for rental growth is there. The industrial sector is a bit polarised, with some parts of the country having higher rental rates than in Prague due to market supply and demand dynamics. On the residential market, the many unsold apartments over the past two years is forcing developers to be creative in pricing and helping people to take out mortgages."