Trouble in paradise

As the financial crisis rages on, the real estate world is finally facing up to one question, which until recently had not even occurred to investors: Will the Bulgarian and Romanian markets be the next big bubbles to burst?

Mladen Petrov

Journalists all around the world are posed with the same problem: how to start yet another article about the financial crisis without repeating themselves. And all the while, as reporters, analysts, bankers and politicians are running out of words, the panic keeps unfolding, claiming more and more victims all the time. As it turns out, Iceland is not going to be the only European country that makes it to the front pages. The consequences of the financial crisis are already being felt in the CEE region.

The first victims

The Baltic states, particularly Estonia and Latvia, were the first which were tagged as “countries in recession”. Once booming, now these two countries are to face the consequences of their previous rapid growth, easy access to credit and overheated real estate markets. As the Ukraine and Hungary attempt to avoid the fate of Iceland, reports are also identifying Bulgaria and Romania as probably the biggest victims of the crisis in Europe. The latest report by Danske Bank goes further, predicting that Bulgaria might even go bankrupt for reasons such as the large number of improbable real estate projects that were announced and have failed to materialize. There is a real threat that Bulgaria will swing from boom to bust, the report warns. 

Other analysts seem to agree. The Royal Bank of Canada’s report names Bulgaria “the most threatened Balkan economy,” while Citibank is confident that along with Romania, Bulgaria has the greatest chance of entering a recession. JP Morgan estimates that the entire CEE region is in danger of negative growth in 2009, with the weakest economies also having a hard time in 2010. The president of Romania, Traian Basescu, and the head of the Romanian Central Bank, Mugur Isarescu, agree that the Romanian economy is already feeling the negative impact of the crisis.

Over the top

Now, the question is how is it possible two of the most rapidly growing economies are in danger? Over the last two years, Bulgaria saw record total investment of EUR 15 bln, with half of this money going into real estate and infrastructure projects, which together with financial services accounted for 55 pct of the country’s GDP growth. The figures speak for themselves. However, restricted access to foreign capital followed, with a decrease in the volume of international trade. Klaus Gugglberger, member of the managing board of the Austrian-based Investkredit Bank, part of the Volksbank Group, explains that: “Consumption in Bulgaria and Romania has been way over the top. If Romania, for example, can’t sustain its growth figures, we are going to see the currency’s value falling. In the long run, I don’t think these two countries are ready to cope with the impending crisis on their own. The good news is that they now are members of the EU.”

Premiumred, the real estate arm of the bank, is developing its portfolio in the two core markets outside Austria: Poland and Romania. The company feels confident about investing in Poland, but is very cautious when it comes to starting up new projects in Romania. “Despite the demand, right now I wouldn’t begin any new project in Romania,” Mr Gugglberger adds. “I think this is the case with all the Austrian banks, which are just waiting to see what will happen next,” he says. Investkredit Bank is not interested in entering the Bulgarian market, but its Austrian competitor Erste Bank announced this summer that through its Sparkassen Immobilien Fund, it is to invest EUR 300 mln in office and shopping centre projects in Bulgaria.

A pill for a chill

The Bulgarian government is currently issuing assurances that it is ready to combat the crisis, having already corrected the 2009 economic growth figures. While this year’s GDP growth will most probably be on par with 2007’s (7-7.1 pct), next year a slowdown to 5-5.5 pct is inevitable. However, the International Monetary Fund is less optimistic. According to the IMF, this year GDP growth will be 6.3 pct, while next year it will be around 4.8 pct – the same as in Romania. “If next year the GDP growth in Romania is around 2.5-3 pct, nothing will collapse. But things will become grim if the GDP growth drops below these figures,” Klaus Gugglberger warns.

Bank analysts also seem not to have a great deal of confidence in the government’s promises, arguing that the same factors that have led to the slowdown (or even recession) in Latvia and Estonia are also expected to come into play in Bulgaria and Romania. The bursting of the real-estate bubble poses a major threat to economic stability, along with rising inflation and the liquidity problems of some banks.

There are, however, some reasons for sleeping well in Bulgaria. The local currency, the lev, has a fixed exchange rate, pegged to the euro under the supervision of a currency board. A happy outcome of this is that the cost of household and business credit is not subject to constant change, as is the case in Romania, where a cheaper currency results in higher costs, the value of which is determined by the rate of the euro.

On the other hand, the amount of toxic loans, according to statements issued by the government, does not pose any threat to the stability of the whole economy. The main question that now needs to be answered regards parent-companies, which might start withdrawing capital from their Bulgarian subsidiaries. This was the case with AIG, which owns the leading telecommunication operator in Bulgaria BTK. In an attempt to solve its liquidity problems, AIG “restructured” BTK, which resulted in a significant withdrawal of capital. The general feeling on the market is that this is an isolated case and that European banks are not going to start pulling out any time soon, since in Bulgaria they can easily benefit from the high interest rate.

Can you feel it?

While most discussions swing between the theoretical chances of deep crisis and how exaggerated the fears are, there are investors in Bulgaria and Romania who are already feeling the effects of the crunch. In fact, they have been coping with it for a couple of months now. The holiday homes sector in Bulgaria was the first to suffer, when British and Irish buyers started to leave the country in 2007. According to a number of sources, around 90 pct of the foreign buyers are now coming from Russia; but is their number high enough to support the large supply of holiday homes? Looking at the current, post-boom, prices, the answer is no. The Russian buyers are also having liquidity problems themselves, as withdrawing a big sum from the bank in the current conditions becomes more of a challenge.

A quality project, located right next to the beach, still has a relatively good chance of being sold. It is the residential projects in the Bulgarian mountain resorts that are suffering the most, with prices falling in some places by almost 50 pct. The mountain town of Bansko, until recently the largest construction site in Bulgaria, is likely to remember 2009 as the first year when no construction activity occurred. The majority of real estate agencies in the town are now closed, while the ones paying with cash might buy new property at prices as low as EUR 600 per sqm, an almost 50 pct decrease over the last year. The reasons for the declining prices in seaside and mountain resorts are also to be found in the oversupply, lack of regulation, poor infrastructure and low quality of the final product. Developers agree that the crisis should actually have a positive impact on the market, laying bare the need for major reforms in the sector.

The land market is also suffering these days. A source in Bulgaria informed ‘Eurobuild CEE’ that: “We are hearing about land prices going down, but the truth is that there are actually no transactions taking place on the market. Land owners are not the only people in trouble – for a few weeks now we’ve been seeing a large number of retail, mixed-use and residential projects being put up for sale.” For example, Bulgarian Land Development, listed on the London stock market, is now selling two of its current projects: ‘July Morning’ in the Black Sea town of Kavarna and ‘Riverland’ in the skiing resort of Borovetz. The developer was one of the first to acknowledge the seriousness of the situation. Over the last year, the company’s stock has lost almost two-thirds of its value.

Game with new rules

Romania with its troubled residential market is no exception to this either. According to data provided by Colliers International Romania, sales of residential units have dropped by some 30-50 pct around the country. The other real estate agencies confirm these figures. “The main problem is the withdrawal of speculative investors. The situation on the market has changed and now we can’t simply wait for some investor to buy 50 apartments,” claims Shimon Galon, country manager of GTC Romania. The financial crisis made the relationship impossible between the banks and speculative investors, who are now in a hurry to sell their portfolios. Small developers are also in trouble, having to contend with an increasing number of rejections by the banks, who on the other hand are burdened with money from the inter-banking market being much more expensive.

So, what comes next? “The first step must be taken by the banks. Now they are trying to minimize the risks, imposing unrealistic financing conditions for both retail and corporate customers. The banks, however, need to answer an important question: If credit is so hard to obtain, how can the bank make a profit?” asks Alexandru Petrescu, president of the real estate consulting company Esop.

As the business climate worsens, developers are not terribly optimistic, while customers, both investors and end-users, are adopting a wait-and-see attitude. Due to the current market environment (stiff competition, difficulties in financing and the slow pace of sales), smaller developers are now less visible on the market, while larger developers have extended their portfolios, starting new projects in Bucharest and other regional cities. In spite of this activity, there have been a lower number of new projects launched in the first half of this year, compared to the same period in 2007.

Banks and the city

The increasing costs of financing, the rigorous conditions imposed by banks and only a slight increase in the disposable income of the population are all factors that have started to induce a downward trend in demand. Mortgage loans have remained the main source of finance for residential acquisitions by private individuals. “Customers will be seriously affected. Obviously, some of them won’t qualify for mortgages for new apartments and will be forced to buy old ones. If the banks stop financing projects, in 2009 we might see skyrocketing prices again due to the limited supply,” continues Alexandru Petrescu.

The developers present on the residential market of the major Bulgarian cities also have no reasons to celebrate. According to the latest data from Credit Center, the amount of credit for residential purposes is going down as the banks offer more expensive loans. Since the beginning of the year, the interest rate has gone up by 1-1.5 pct, with an additional rise of 1 pct being expected by the end of the year. The average interest now comes to around 10 pct for a loan in Bulgarian levs. Credit Center’s research also reveals another significant trend: as the interest rate goes up, the average amount of borrowed money is definitely going down. In September, the average loan was EUR 43,800, down by EUR 10,000 over August and September. The majority of customers are receiving some 50-80 pct of the sum necessary for the purchase.

Meet the new customer

In Romania, potential buyers are now in a position to analyze and compare the existing residential offers that have appeared on the market during 2007-2008 with an increasing interest in advanced projects – and this is also the case in Bulgaria. Customers in the two countries have become more demanding, expecting high-quality fit outs, security, additional services and exceptional design, preferably without paying extra for these features. “Nowadays, talking to buyers is no picnic. The good news is that the market is now becoming healthier,” believes GTC’s Shimon Galon. In H1 2008, a high demand for studios and 2- room apartments of up to 60 sqm usable area was recorded in Bucharest. Smaller flats are becoming very popular in Bulgaria, as young customers are reluctant to take out big loans with banks.

There is also some good news for those looking to buy. After a couple of years of steady growth, prices are now starting to drop – even in Bulgaria’s major cities, which experienced sky-rocketing prices last year (up by 30-45 pct). The real estate agency Address predicted an average growth of around 15 pct for the whole year, but the financial crisis, combined with the high inflation and decreasing purchasing power, proved the analysts wrong. An analysis of what is on offer on the major websites, the average sale prices in Sofia are down by 7.76 pct (average price – EUR 1,100 per sqm) and by 8.23 pct in Varna, the most expensive city in Bulgaria (around EUR 1,200 per sqm). The biggest drop has been recorded in Plovdiv, the second largest Bulgarian city, down 9.77 pct (EUR 700-750 per sqm). Less attractive districts of Sofia such as Tolstoi are seeing prices plummet by as much as 16 pct. In Budapest, despite the significantly smaller demand, average prices have remained stable (EUR 1,900 per sqm)

Crisis? What crisis?

The analysts who talked to ‘Eurobuild CEE’ for this story seem to agree that it is the retail sector that will be particularly affected by the crisis. The latest report by Cushman & Wakefield – the Pan-European Retail Update Q3 2008 – however, is rather positive about the future of these projects. According to the report, Bulgaria is significantly lagging behind in the development of modern retail, with around 300,000 sqm of retail space under construction in the country. This is to be delivered within the next 18 months, which will result in a 300 pct increase in the retail space stock in Bulgaria, while currently there are seven shopping centres operating in the country. “We remain positive that most of the retail projects in Bulgaria and Romania are going to be delivered. So far, we haven’t heard of cancelled projects and our own shopping mall projects are coming along according to plan,” says Nisan Cohen, deputy CFO of Cinema City International. His company, as a developer, is working on retail projects in the Bulgarian cities of Plovdiv (Mall of Plovdiv – 99 pct leased), Ruse (Mall of Ruse – 40 pct leased) and Stara Zagora (at the design stage). So far the company has invested around EUR 50 mln in Bulgaria, and this is not the end. The company is using both its own capital and bank loans for its Bulgarian projects. Bulgarian banks, despite their difficulties, are not backing out of financing completely. “The banks are just being more picky, but the big players with good projects in prominent locations should hardly be affected,” Mr Cohen claims. In October, UniCredit Bulbank and UniCredit Bank Austria, owned by the Italian banking group UniCredit, another troubled big bank, announced that they will finance Mall Bulgaria (33,000 sqm) in Sofia, a shopping centre project now being developed by LSProperty and the property management group Salamanca Capital. The centre is to cost EUR 220 mln. Prior to the opening of Mall of Plovdiv in 2009, it has already been sold to GE Real Estate. “We have been approached by investors regarding the project in Ruse. We are also constantly looking for new opportunities in Bulgaria, but we are going to be much more selective,” Nisan Cohen adds.

In Romania, as a cinema operator, Cinema City has already signed 30 deals and this, according to Nisan Cohen, is just the beginning of expansion on the local market. The company has recognized Romania as its second core market after Poland and is planning to operate over the course of the next 2-3 years over 290 screens, which are both already delivered or under construction.

C&W’s report, however, states that investors are taking a more cautious approach towards Romania due to the rapid depreciation of the local currency, among other factors. So far, there is no information about cancelled projects in Romania. Two of the projects under construction – Era Shopping Park Oradea, developed by the Greek company Omilos, and Sun Plaza in Bucharest, developed by the French-based EMCT – will be delayed; but according to market analysts, the main reason for this is the lack of a labour force.

Cinema City is also scanning the whole region for investment opportunities, with a few announcements to be expected. “All in all, I am rather optimistic for 2009. It is a known fact that when a crisis hits, everyone goes to the cinema. One can go to the cinema and escape for a while from the crisis or start learning some Chinese. It’s a great language in which the word for crisis has two meanings: danger and opportunity.” ν

With Matei Roman contributing for this story from Bucharest