Praying for salvation

It might seem like financiers have behaved like skinflints, doing a runner instead of paying for a slap-up dinner in a classy restaurant. But the owner has found the solution: make all the other diners pay for it. The trouble is that almost all of us dine in the same eatery

Emil Górecki

The world has gone topsy-turvy, for here you have a situation in which the central bank in the world’s most liberal country pumps USD 700 bln into the economy to save the financial system from collapsing; a system that has lost stability almost entirely because of the utterly reckless behaviour of its bankers. European Union countries, too, are to be allowed to relax the restrictions on granting public assistance to banks and so have had to raise the ceilings of their budget deficits. In contrast to the US government, which let Lehman Brothers go bankrupt, the EU refuses to allow any bank to collapse. The plan to save the Old World’s finances will cost a combined sum of EUR 1.8 tln, made up of government guarantees for interbank loans and injecting additional capital into the banks. To this let it be added that stock exchanges seem to have gone crazy throughout the world, with sharp slumps in October being followed by dramatic upswings. In the situation we now find ourselves in, it is quite impossible to predict what lies even around the corner.

Banks have to pay the bills

Greed is what drives markets, closely followed by fear – something which those working in real estate seem to have forgotten. But they are now having to pay for their excess, and in some cases even the ultimate price: bankruptcy, with the prime example being Lehman Brothers. In Poland this bank is intimately connected with residential developers such as Angel Poland Companies (one of its shareholders was a fund managed by Lehman) and also Robyg (investment funds connected with the bank own 20 pct of the company). Both of these companies are insisting that the collapse of Lehman will have no negative impact on the implementation of their projects. Jarosław Wnuk, director and head of the capital markets department for King Sturge in Poland, puts it this way: “If Lehman Brothers held a small part of an efficiently operating company, then that company should not suffer too much from the bank going bankrupt and should be able to continue operating. Such companies may look for an investor which will buy the bankrupt’s shares to avoid the official receiver acting to sell their assets. I have checked out the commitments of the American bank in Poland and it is clear that there are no companies or projects which could find themselves in dire straits as a result of its collapse.”

Brothers in adversity

Hypo Real Estate, the Munich-based mortgage bank whose daughter company Depfa has lost a lot of money in Irish mortgage loans, is another institution operating in Poland that has got into difficulties. The German finance ministry has drawn up a EUR 50 bln rescue plan for Hypo Real Estate. The company is still drifting, although now with a lifebelt attached. In our part of Europe, the bank is focused on property financing in Poland, the Czech Republic and Hungary, although now it is also operating in Russia, the Baltic states and Slovakia. It has financed projects by players such as AFI Europe, Raven Russia and aAIM Europe.

Several other European banks are also going through worrying times. Italy’s UniCredit, the owner of Poland’s Pekao, has had to raise its working capital by EUR 6.6 bln. In order to rescue the distressed Benelux-based Fortis Bank, its French rival Paribas has bought a controlling stake in the former for EUR 14.5 bln. Prior to this the Benelux countries had injected EUR 11.2 bln into Fortis to prop it up. This proved insufficient to calm its shareholders, with Fortis losing 64 pct when trading  in its shares recommenced after several days.

The Dutch have thrown their support behind the ING Group, after the company’s shares lost more than 27 pct in the first three weeks of October. At the end of Q3, the company is expecting its first ever loss of EUR 500 mln, which is why the government has earmarked EUR 10 bln to rescue what Wouter Bos, the Dutch finance minister, has called “a fundamentally healthy enterprise”. American International Group, the owner of AIG Lincoln, which operates in the Czech Republic, Poland, Russia, Romania and Hungary, has also been hit by the turmoil on the American market.

Saying prayers for the banks

Theoretically, at least, the contagion spreading to foreign banks should not reach Poland and any problems handed down by parent-companies should only result – at the worst – in changes in ownership. Should such agonies be felt on the domestic market, no help will be given by the “parents”. However, in practice, no data has come to light about the extent of “toxic” American securities held in Poland’s financial sector. Polish banks have probably not invested in such sophisticated-but-risky financial instruments. Prof. Jacek Laszek, an advisor heading the real estate market group of the National Bank of Poland, remarks that: “If the crisis drags on and gains momentum, only then will there be an impact on the Polish economy and its financial and real estate sector.”

Norbert Jeziolowicz, the director of the Polish Bank Association is also unconcerned: “You should not worry about banks operating on our market, which are owned by foreign institutions and experiencing anxious times. Here they are separate units which have no similar problems. The Polish credit market is healthy and the level of bad loans is at its lowest for more than ten years. Polish banks will continue to grant mortgages, since they have to generate profits for their shareholders.”

Countries with no cover

Regrettably, Eastern European markets have not turned out to be havens from the storms ravaging the West. Although they are still putting on a brave face, the Russians have a great deal on their plate to contend with, with an estimated USD 180 bln already being pumped into their banks, and foreign debt exceeding their gold and foreign currency reserves. The Russian Settlements Chamber put the foreign debt at USD 560 bln – USD 30 bln more than the country’s international reserves, and these are diminishing by the day. International analysts are also expressing fears of a painful situation developing in Ukraine and Hungary, an opinion that persists despite the promises of the substantial support these countries have been given by the European Central Bank.

In spite of the political chaos in Ukraine, the country’s central bank has pumped USD 2.2 bln into the financial system, the majority of which has gone to the 27 most endangered and important financial institutions. Some Ukrainian banks have limited the amount of withdrawals from cash machines – equivalent to a USD 350 maximum limit. The British ‘Daily Telegraph’ newspaper has claimed that there is an 80 pct probability that the Ukraine is heading for an economic catastrophe. In Hungary, the exit of capital is so huge that the government wants to halt it by issuing government treasury bonds. But these are not attracting many buyers, with the likely result of an increase in interest rates leading to a rise in the cost of the national debt, currently amounting to 67 pct of GDP.

Powerless strategy

The reply which almost every expert on the real estate market gives when asked about what the future holds is: “If I knew that I would be rich and live on Bora-Bora.” Even so, estate agencies are still endeavouring to estimate what the volume of investment transactions will be by the end of 2008. Jones Lang LaSalle believes that it will be only slightly higher than half of the global figure in 2007, which set an all-time record, with a total of USD 759 bln invested. In the first quarter of 2008, the volume of European transactions slumped 38 pct when calculated in dollars and 44 pct in euros, with the total sum invested being USD 105 bln. End of the year predictions made by European consultants are similar to those being made for the whole world, that volumes are likely to be half of that of the previous year, i.e. probably slightly more than USD 166 bln.

According to DTZ, German open pension funds have proved to be the most active purchasers on the Central and Eastern European market in the first 8 months of the year. Their commitment rose from 16 pct in the same period of 2007 to today’s 39 pct, the reason being the proximity of the home market and the weakening competition. Spanish, UK and Irish operators have all been getting out since the beginning of the year, whereas Germany’s problems only set in later.

DTZ’s analysts are also predicting a growth in yields in almost all the major cities in the region and in all sectors, with the greatest occurring in Moscow. Yields should rise in all sectors at the end of 2008 and remain on a stable level throughout 2009 – 9 pct in the office sector, 10 pct in retail and 11 pct in logistics. Yields will also grow in Poland, as DTZ expects the rates for Warsaw office buildings to reach 6 pct at the end of 2008 (5.5 pct in 2007), retail properties by 6.23 pct (5.5 pct in 2007) and for logistics up to 7 pct (from 6.5 pct). These rates should also remain steady throughout 2009.

Since what happens on the financial market is a determining factor for the real estate sector, investors are rehashing their plans and waiting to see what will happen. Waiting has become an almost obligatory strategy practiced by the majority of operators, as long as things do not become too unbearable. Those who cannot take any more are left with selling off their assets as their only option.

Keep smiling

Russian banks have almost completely ceased mortgaging home purchases as well as granting development loans. With an eye on the residential shortage, the government decided to purchase so-called ‘economy class’ flats from developers, that is half of all those constructed. In addition, developers will be able to receive preferential 16 pct loans in roubles from state-owned banks. Russia is to spend up to RUB 100 bln (around USD 3.84 bln) next year on the purchase of such homes in this manner. Yuri Luzhkov, the mayor of Moscow, has also promised to assist city developers, with around USD 2 bln earmarked for this purpose.

It seems, however, that the violent storm raging on the Russian market and the promise of government assistance is not making any impression on Group PIK. In H1 2008, the company completed buying up its land bank in the country’s major cities, such as Moscow, St Petersburg and Krasnodar, enabling it to develop projects for the next 10 years. The company insists that the land was not bought at exorbitant prices, but they are looking for partners with whom they want to establish joint venture companies to carry out more projects. Up until now, this has proved possible only once, in partnership with a Singapore government fund. The group plans to raise USD 1 bln for other projects in a similar fashion. For some operators, the turmoil on the market does not only signify problems, but also opportunities to be snapped up. The greater the storm, the greater but also the more risk-prone are the possibilities. Mikhail Prokhorov, the owner of development and investment company Open Investments, is counting on this. He intends to purchase projects at – of course – crisis prices. Alexander Samonov, ex-owner of the Kopieika shopping chain, has another idea. He is establishing a new investment fund for the real estate market with a value of USD 500 mln, a third part of which will be channelled into residential projects. The tycoon is convinced that now that the banks have practically stopped financing properties, investors will have to go to the funds for loans, even if this form of financing is not exactly cheap.

Another developer, Sistema-Hals, which has a debt of USD 1.2 bln, is another case in point. This huge amount is one of the reasons why it is losing capital from it and for the fall in its share price on the London Stock Exchange and the two Russian exchanges (RTS and MICEX). In the first three months of the year the company’s share price slumped 90 pct, more than 67 pct on the RTS exchange and on the Russian interbank currency exchange MICEX, by more than 60 pct. The company’s board insists that, today, only 20 pct of its debt remains to be repaid in the short term, but the situation is grim and the company is drawing up a special survival strategy to be announced in mid-November. Sergey Shmakov, Sistema-Hals’ president, remains convinced that: “Our foundations are strong: a well-diversified project portfolio, a variety of sources of finance, a secure loans portfolio and also experience.”

Who, if not a bank?

Access to loans has been substantially restricted everywhere. The outcome will be a drop in house prices, while those developers who paid over the odds for properties are going to suffer badly, up to and including bankruptcy. The number of projects being started will also fall. The way projects are planned may also change, with more inexpensive homes being built further out of from city centres. Prof. Jacek Łaszek of the National Bank of Poland stresses that: “We have reached the peak of the boom cycle on the housing market in Poland’s largest cities and its natural downward movement is not related to the situation on world financial markets. Such a convergence of factors is happening for the first time and the problems may complicate the situation somewhat.”

Since the financial storm blew up, rumour has it that the banks have been reluctant for some time now to finance the purchase of homes by individual customers. Norbert Jeziolowicz rubbishes this claim. According to him: “Banks are for turning over money, earning this by giving out loans and not by keeping their money in safes. Loans to purchase homes are and will be granted, only with greater requirements being laid down with regards to deposit contributions. The criteria for giving out mortgages have become much stricter, but loans will continue to be taken out. The panic in this respect is artificial and is being generated by those market operators which have been raking in huge sums of money almost without any risk.”

It is easy to notice that a large number of residential investments have been put on hold. Rafał Renduda, a partner in the FYI consulting company, thinks that: “We may return to the situation of having an overheated market in 2-3 years from now, although this may not be as intense as it once was. For the moment, however, one can expect a small price fall per sqm and a greater divergence of pricing between better projects in good locations and those of less quality.” He also expects a temporary increase in housing rents over the approaching year, by as much as around 40 pct in some cases. But some time from now, he remarks, rent may become too expensive and the possibility of being given a loan will be greater.

For the moment at least, companies are refraining from taking any decisions whatsoever. Property developer Polnord has been receiving several offers every month, over the last few months, to purchase projects that have already been started. Land owners, who had been convinced until recently that the value of land would never depreciate are also now looking to sell – but for the moment, with little success.

Jan Wagner, Polnord’s sales and marketing director, remarks bluntly that: “We are not being hasty in making purchases, for we have a land bank which is sufficient for our purposes for several years. Land owners who want to sell will have to wait a bit. Land prices will have to drop below the present level of PLN 1,200 per sqm of residential development space.”  

Piotr Cyburt, BRE Bank Hipoteczny’s president also gave us his opinion on this matter: “I do not think we are heading for a crisis,” he declared. But he is concerned however with development projects that are not financed by banks but by individual purchasers taking out their own loans. He believes that: “This is a less expensive way of financing for the developer, but is much more risky. There are a lot of these projects and their developers will be the first victims of the turbulence on the financial market.”

All clear on the commercial front?

It is still too early for any meaningful data to be published on the scope of restrictions in property financing, although this is surely in the offing. Banks are giving preference to the best and most secure projects. BRE Bank Hipoteczny’s president puts it this way: “Our bank has already decided to toughen loan granting criteria and to bring them into play. We now demand a 35 pct deposit contribution and 30 pct residence pre-sales, while the loan is much more expensive, starting from 3.5 pct above WIBOR,” reveals Piotr Cyburt.

He also does not expect any real slowdown on the Polish market, citing the same indices as other experts, as well as the government: growth will continue at the same good speed, while the demand for real estate in Poland is very great. But the supply of housing will soon fall away, while a boom situation still continues on the commercial property market.

Mr Cyburt also adds that: “It will be a long time before we will return to the situation which prevailed on the financial and real estate market a year ago. The market may cool down at the end of Q1 2009 and investor confidence will gradually reappear, but under a number of conditions: that the decisions taken by institutions and government, such as the Paulson plan, will take effect; that Europe will exhibit more sense in rescuing banks experiencing problems; and that no more shocks on the market occur for the next three months. I would say Europe’s economy is much less flexible than America’s and that the latter will drag itself out of the abyss much quicker. So it will take around 3 to 5 years to put the financial sector in order. And it is really very difficult even to guess the depth to which the recession in the real economy will fall.”

The demand for office buildings and warehouses is a function of the economy’s growth, particularly in the processing industries which generate the need for such projects. There should be no problems in this regard in the future, since the rate of growth of the national economy will continue to be positive despite the slowdown of the economy. European finance will keep flowing into Poland for infrastructure growth and that will boost the demand for logistics centres. On the other hand, demand for shopping centres is a determinant of consumption and the general health of the economy, which means that a market collapse should be out of the question, for the moment at least, all the more so that a large part of this investment is done by companies guided by long-term policy. Wojciech Pisz, of Cushman & Wakefield’s capital markets department, is one person who sees things this way: “Changes are already being felt by developers and investors of commercial properties. These are, first and foremost, the reluctance of the banks to provide finance for both new projects and to purchase existing ones. This is the reason why the overwhelming majority of negotiations have been suspended or even broken off. However, I do believe they will restart in a few weeks once the situation on the financial markets cools down.”

Happy ending for the few

In Prof. Łaszek’s opinion it would be hard to find anyone who is benefiting from the crisis. Those who were looking to cash in have already done so. He takes a sombre look at current developments: “We are having, today, to pay for the mistakes of careless investors, managers, monetary and supervisory policies and also of irresponsible politicians who managed to inflate the speculation balloon by lowering interest rates, unshackling control of the financial sector, selling worthless securities at high prices, and buying everything that came their way. Opportunities may open up today for those who will make sensible purchases of bankruptcy assets, but here too a degree of risk exists.”

Companies which buy up attractive assets sold off by investors can also cash in, but will have to see whether there is a skeleton in the cupboard, since it is sometimes difficult to check the foreign-market related operations in which the sold companies are engaged in. It is safer to purchase existing properties. Their owners are having to reduce prices and probably will have to reduce them further to give the buyer a risk discount. “Obviously finance is required in all such operations and this is hard to come by today,” Jacek Łaszek concludes. ν