BRICKS & MORTAR: A lost property market soon to be found

By bne IntelliNews December 14, 2009

Nicholas Watson in Prague -

The financial crisis brought the Czech real estate market to a virtual standstill, but with no distressed deals to date, an economy out of recession and a shortage of good residential, commercial and retail space available, the sector should grind back into gear in the latter part of 2010.

The crisis impacted all the real estate market segments as banks tightened or even stopped development financing, while buyers hunkered down and adopted a "wait-and-see" strategy.

In residential, homebuyers stood back and waited (largely in vain) for big falls in prices, while many also worried over their ability to pay back the mortgage loans, the availability of which was one of the main drivers of the growth in the residential segment over the past few years.

Kamil Kosman, group head of real estate at Erste Bank, says the situation in the Czech market was exacerbated by the increase of VAT in 2008, which caused large forward buying and consumption of the future supply in 2007 - a similar effect to that seen before the country's accession to the EU. "The sales activity in following years would then naturally drop down even without the crisis," he notes.

Despite the fall, the cost of homes hasn't declined by much. Figures for the third quarter showed an approximately 10% year-on-year average fall in the price of residential units, with a range mostly between 5% and 20%. "These figures confirm what experts were saying all the time - that no huge discounts or real distressed price levels will be seen in the market, and what the media did not reflect in their headlines for a long time," Kosman says. "Overall, the role of the Czech media (mostly printed ones) in the crisis and their influence on expectations has been very negative."

In terms of next year, any market recovery will depend on macroeconomics, which for the residential segment is even more important than for other property segments due to the direct link between household purchasing power and home buying. "If the fourth quarter of this year and the first quarter of next confirm the positive trend and economic growth, the real estate market will follow it," says Kosman.

Office space

In the commercial segment, the two key areas that experts look at to assess the health of the market - leasing and investment from the capital markets - show at once the profound effects of the crisis but also the seeds of the recovery.

In the lead-up to the autumn of 2008, Prague's office space was expanding at an exponential rate, adding a record 322,000 square metres (sqm) in that year to reach a total of 2.6m sqm, 70% of that newly built and most on a speculative basis. "Everyone was so confident about the market, no one thought of any risks related to financing or leasing," says Tewflik Sabongui, managing director of Jones Lang LaSalle.

The collapse of Lehman Brothers and the resulting credit crunch put paid to that, causing an immediate halt to bank financing and investment. According to Jaromir Smetana, director of the consultancy DTZ, banks are now demanding the developer put 40-50% of the money up front, whereas before they were happy to finance 80% of a project, and have 40% pre-leasing in place, something that's incredibly hard to get when companies have put on hold plans to expand or move into new premises and are busy renegotiating their existing leases on more favourable terms.

At the same time, investment dried up. The volume of money coming into the Czech market between 2004 and 2008 averaged about €1bn a year, except for 2007 when it was more than double that. In 2009, Smetana reckons the amount will be €350m at most, which is "closer to 2003-2002 levels."

Even so, rents, which are similar to those of Berlin and Brussels, have remained remarkably stable despite the spike in the vacancy rate from 5.5% at the end 2008 to 11% today. Czech landlords are traditionally loath to lower rents to keep the space filled and prefer to see it lie empty, but industry experts say they may also be looking at market fundamentals that support a turn away from a tenants' market as soon as the second half of next year.

The amount of new office space taken up by the end of the third quarter was 142,000 sqm, whereas the amount of new space built in 2009 should be around 120,000 sqm, meaning demand for new space is outstripping supply. And this mismatch will grow. The only developments being completed are those that were under construction before the crisis hit; DTZ estimates in 2010 only about 70,000 sqm will come on the market, less than a quarter of that banner year in 2008.

Furthermore, the stock of good office space in the Czech Republic remains relatively low. In Prague, it's just over 2,000 sqm per 1,000 inhabitants, which is a far cry from Munich's 8750 sqm, a city comparable in size to Prague.

The retail market is also holding up well, even though the crisis is expected to cause 2009 retail sales to fall 5%. Sebastian Pawlowski, founder of the Prague real estate developer Copa, says he has pre-let virtually all the retail space in his 6,000 sqm Copa Center Narodni mixed-use development that's under construction. "There's a whole range of big, international retail names looking for space," Pawlowski says.

DTZ says many international chains are also looking at franchising to help them rapidly enter and expand in new local markets like the Czech Republic. New franchise concepts looking at the Czech market include the US' Athlete's Foot and Applebees, and France's Sergeant Major and Descamps.

Sabongui believes the biggest beneficiaries of the shakeout caused by the crisis will be the efficient mid-sized developers who have a proven track record of bringing good projects to market. The big question is what the future holds for the over-ambitious regional developers like Orco, which are drowning in debt after taking on too many projects.

A big test for Orco and the Czech real estate market as a whole will be its mammoth 27-hectare mixed-use project in downtown Prague - a "city within a city," it calls it - which the developer had hoped to break ground on this autumn, but which remains a desolate area of old railway sidings, second-hand car lots and other assorted shacks.

Orco says the reason for the delay was changes to the masterplan demanded by the city authorities, which must rezone virtually the entire area before work can begin. Some industry insiders doubt there's enough political will to push a huge rezoning effort through the notoriously bureaucratic process for a company in such financial trouble. Orco counters the project remains its top priority and the fact it already has everything in place to develop 5% of the land in the northeast corner that doesn't need to be rezoned proves this. "Our role will be as a 'master developer' - there will be about 30 developments and these will be done with different partners and different timetables over 10 years," says Ogi Jaksic, group development director of Orco.

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