Jeff McGeehee of <a href="http://www.ssd.com">Squire, Sanders & Dempsey</a> -
How is the credit crunch playing out in CEE countries and markets?
Initially, the global credit crunch was slow to affect Central and Eastern Europe, and the market perception was that the region would not be hurt badly by events in the US. As the crisis expanded, however, it became obvious that the early view was wrong and that CEE property markets are now following the lead of their Western counterparts.
Most banks in the region have gone beyond enforcing tighter underwriting standards and now simply refuse to lend funding for property projects. Many are reviewing their existing real estate loan portfolios and looking for additional security as property values have stopped rising (and are, in some instances, in moderate decline). If a borrower is able to find financing at all, it is, of course, now available at a higher margin, and the bank requires a higher equity commitment. Since many development projects were relatively highly leveraged (or became that way, in the opinion of the banking sector, as prices and demand have cooled), development company values have dropped dramatically, and the stocks of those that are publicly traded have plummeted.
As financing dried up, uncertainty increased about whether the markets could sustain further yield compression. Since the CEE markets are positioned later in the cycle than the US and UK, and many sellers in those markets have begun to accept the reality that values are declining, in many instances it is cheaper to buy a Class-A office building in Manhattan or the City of London than in Prague or Warsaw. Because local markets are still adjusting to the new reality, a large disconnect between buyers' and sellers' expectations has led to a dramatic decline in property investment over the last year (investment volume in the first half of 2008 in the region is less than one-half what it was during the same period last year). In addition, residential properties that also rose dramatically over the last five to six years are now looking to be set for correction as well.
What kinds of investors are currently active in the CEE property markets and what kind of properties are they pursuing?
While the markets are not as strong as they were, some active investors still exist. Principally, these are entities using very little leverage, such as Germany-based investment funds and the few developers that are not cash poor. These funds are acquiring prime assets at better prices than existed a year ago (yields have risen approximately 50 basis points in some instances) and developers are picking up prime sites at discounted prices compared to their more highly leveraged competitors. A number of opportunity funds are also exploring the markets, particularly in the area of subprime assets, where the yields have risen faster, though most are waiting to see where the market is six months or a year from now. Because no one knows where prices will be next year, investors are worried about jumping into a deal now that may lose value in the coming months. It seems that in this sense, Central Europe has joined the West at last.
How has the expansion of the EU reshaped the real estate market in Central Europe?
Dramatically. Before the revolutions that occurred throughout the region in the late 1980s and early 1990s, the Central European states did not generally maintain real estate assets in good condition - certainly not the condition in which they would have been maintained in private hands - so existing stock across the spectrum was in very bad shape. The countries' roads and general infrastructure systems were also badly outdated. State and municipal governments built considerably less new product (and generally of an inferior quality) every year than in a market economy. This led to massive development opportunities opening along with the revolutions that transformed the political environments in these countries.
Changes began to occur immediately after the revolutions, but the markets really started to gain momentum and move toward maturity in the years just prior to EU accession (and once accession dates were known). All of the new accession countries have enjoyed construction booms across all industry segments, which accelerated upon entry to the EU. While a boost was expected from accession, we were frankly surprised by the amount of capital that poured into the countries in such a short period of time. Of course, this period coincided with the largest global property boom in recent history, so the combination made for a uniquely fast-paced property market here.
The benefits of EU accession (harmonization of laws in new member states, availability of cheaper labor in new markets, etc.) led to a dramatic shift in the way Europe operates. As heavy industry (such as car manufacturing companies) opened factories across the region and antiquated state-owned industries were privatized and revitalized, a need arose in these markets for, among other things, new commercial space, logistics facilities and generally an updated infrastructure. As incomes rose as a result of these changes, increased demand for consumer products drove development of shopping malls and improved housing options. Truly, it is now difficult to remember the region as it existed before accession.
Jeff McGeehee is a partner in Squire, Sanders & Dempsey's Prague office and co-leader of the European real estate practice
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