Vulnerabilities of Visegrad real estate markets – lessons from the past.

Vulnerabilities of Visegrad real estate markets – lessons from the past.

Koloman Ivanička, Andrej Adamuščin, Július Golej

Institute of Management

of Slovak University of Technology

BRATISLAVA

Introduction

The Visegrad group of countries (V4) :

– Slovakia,

– Czech Republic,

– Poland

– Hungary

Economic overview – CZECH REPUBLIC

The population of the Czech Republic (2009): 10.3 million inhabitants

National currency : Czech crown

Capital city: Prague (1,249,026 inhabitants in 2009)

strongest economic sectors : industry and services

main export partners : Germany 28%, Taiwan 8.5%, Slovakia 8.4%, Poland 5.9%, France 4.9%, UK 4.4%, Austria 4.3%, Italy 4.3%

* May 2010

source: www.cia.gov

Economic overview – POLAND

The population of the Poland (2009): more than 38 million inhabitants

National currency : Polish Zloty

Capital city: Warsaw (1,711,466 inhabitants in 2009)

main industries: machine building, iron and steel, coal mining, shipbuilding, chemicals

main export partners: Germany 24.4%, France 6%, Italy 5.9%, UK 5.6%, Czech Republic 5.5%, Russia 5.2%

source: www.cia.gov

* May 2010

Economic overview – SLOVAKIA

The population of the Slovakia (2009): 5,463,046 million inhabitants

National currency : Euro

Capital city: Bratislava (428,791 inhabitants in 2009)

main industries: automotive industry, electrotechnology, engineering and wood processing.

main export partners: Germany 20.1%, Czech Republic 12.9%, France 7.8%, Poland 7.2%, Hungary 6.3%, Italy 6.1%, Austria 5.8%, UK 4.8%

source: www.cia.gov

* May 2010

Economic overview – HUNGARY

The population of the Hungary (2009): 10.01 million inhabitants

National currency : Forint

Capital city: Budapest (more than 1,800,000 inhabitants in 2009)

main industries: mining, metallurgy, construction materials, motor vehicles

main export partners: Germany 25.4%, Italy 5.2%, Romania 5.1%, Austria 4.7%, Taiwan 4.5%, Slovakia 4.5%, France 4.5%, UK 4.4%

source: www.cia.gov

Vulnerability

Social vulnerability refers to the inability of people, organizations, and societies to withstand the adverse impacts from multiple stressors to which they are exposed. These impacts are due in part to characteristics inherent in social interactions, institutions, and systems of cultural values

Vulnerability

Vulnerability is a set of prevailing or consequential conditions, which adversely affect the community's ability to prevent, mitigate, prepare for or respond to hazard events

These long-term factors, weaknesses or constraints affect a household's, community's or society’s ability (or inability) to absorb losses after disasters and to recover from the damage

Vulnerability precedes the disaster event and contributes to their severity, impedes disaster response, and may continue long after a disaster has struck

Vulnerability has two interacting forces: the external force, which is exposure to shock, stress and risk; and internal force, which is defenselessness, in other words a lack of means to cope with problems

Crisis triggers

The crisis trigger can be for instance, terms of trade, political turmoil, contagion from other countries

Or as in the last crisis the collapse of the subprime market

The triggers are quite random in their nature and we usually do not know to predict them

Most of the analysts at the beginning of 2008 were thinking that the V4 countries can withstand the financial crises without major impact

Their banking systems were at that time judged as not being directly linked to the subprime mortgage and securitisation processes which had initiate the financial crisis in the United States and in other financial centers

They were wrong.

Vulnerabilities and early warning systems

The underlying sources of vulnerabilities should be described, possible shocks that may unwind these vulnerabilities

It is necessary to understand, how these shocks could propagate through the sectors

Then the early warning systems could be prepared

The warning had to be accompanied by the set of the policy options that may enable to address the various types of risks and also the recommendation of the international policy cooperation

Neglect for early warning signals

When the business goes fine, most of the members of the politic and business community are blind and neglect the early warning signals –it was really true in V4

otherwise they would probably analyze the vulnerabilities and would try to prepare and to realize the measures that would protect the economy against major shocks in advance.

This could be difficult, when the broader community may not understand the need for the protective measures in the times of prosperity.

Thus in future the effort should be oriented on the ways how to address the policy makers in the way that they would be willing to react on the underlying vulnerabilities instead of trying to predict the crises triggers.

Investment property market

Property in Central and Eastern Europe (CEE) boomed before the crisis, with investors driving prices close to west European levels, believing the region was rapidly converging with the wealthy west

With banks offering cheap finance, investors flooded into the less developed markets of the Baltics, south east Europe and Ukraine.

But in mid-2008, when the global financial crisis erupted, panic hit CEE and its property market. Prices collapsed, yields soared, banks cut credit lines and investors ran into trouble. In Austria, the IATX property stock index, including companies with heavy CEE exposure, fell almost 90 per cent from peak to trough in early 2009.

Prime office rents in V4

Prime Office Rents

0

5

10

15

20

25

30

35

Q4/2006 Q3/2007 Q1/2008 Q4/2008 Q1/2009 Q4/2009 Q1/2010

€/sq

m/m

th Praque

Budapest (CBD)

Warsaw

Bratislava

Office supply in V4

Supply "V4"

0

50000

100000

150000

200000

250000

300000

350000

2005 2006 2007 2008 2009 2010(forecast)

Year

Sq

m

Praque

Budapest

Warsaw

Bratislava

Office demand i V4

Office demand in V4

0

50000

100000

150000

200000

250000

300000

350000

400000

450000

500000

2005 2006 2007 2008 2009 2010(forecast)

Year

Sq

m

Praque

Budapest

Warsaw

Bratislava

Office market: Supply and Demand in V4

0

50000

100000

150000

200000

250000

300000

2005 2006 2007 2008 2009 2010

(forecast)

Prague (supply)

Prague (demand)

0

50 000

100 000

150 000

200 000

250 000

300 000

350 000

2005 2006 2007 2008 2009 2010

(forecast)

Budapest (supply)

Budapest (demand)

0

50000

100000

150000

200000

250000

300000

350000

400000

450000

500000

2005 2006 2007 2008 2009 2010

(forecast)

Warsaw (supply)

Warsaw (demand)

0

20000

40000

60000

80000

100000

120000

140000

160000

180000

200000

2005 2006 2007 2008 2009 2010

(forecast)

Bratislava (supply)

Bratislava (demand)

Boom period before the crisis in Central Eastern Europe

Rapid growth

Growth often unbalanced.

Capital inflows were large, but to a great extent went to the “non-tradable” sector—in particular, real estate, construction, and banking.

Capital flows boosted domestic demand rather than supply—leading to a surge in imports, current account deficits that widened to unprecedented levels, and overheating economies.

Economic crisis

The international crisis was “imported” into the CEECs economies through external demand and foreign lending.

Many of the CEECs’ industries rely to a considerable extent on foreign demand, both directly and indirectly, though their participation in international production chains, and this is especially true for the new EU members. (ex. Slovakia 80% of GDP realized by export)

Last quarter of 2008 (export volumes contracted between 5% and 15%), that became even more severe in the first quarter of 2009, with drops in exports reaching 25%

Decrease of lending

The financial crisis raised risk perceptions in the international financial markets and international capital movements slowed down, so that many countries in Central and Eastern Europe saw a sharp drop in the amount of lending available, as capital inflows into the region stopped or in some cases reversed

The crisis raised the issue of the appropriateness of a transition and growth process heavily dependent on economic (both trade and financial) integration

The mostly hit countries

Among the countries most severely hit by the crisis are those with a high external debt already in 2008, such as Hungary and the Baltic states (close or above 100% of GDP), that made these countries very vulnerable to the problem of credit crunch and confidence loss that characterized the international financial crisis.

It concerns also the countries that are lagging in transition (Bulgaria and Romania)

Eastern European Real Estate

Capital flows and growth in CEE26

Higher investment growth in CEE – enlargement of production capacities, productivity/quality improvements, infrastructure project. Latvia and Estonia – outliers in the region.

0

2

4

6

8

10

12

15.0 20.0 25.0 30.0 35.0

Investments as % of GDP (2005-2007 average)

Rea

l G

DP

gro

wth

(av

erag

e 20

05-2

007,

%)

Estonia

Latvia

Spain

SlovakiaLithuania

CzechRep

Croatia

Bulgaria

IrelandRomania

Slovenia

Poland

Cyprus

UK

Sweden

Germany

Netherlands

Malta

Finland

ItalyAustria

Greece

HungaryPortugal

Denmark

France

High investmentsLow investments

Source: Eurostat, Erste Group Research,Budash

Excessiveinvestments

Capital flows and growth in CEE27

Countries with the greatest gap between investments and national savings - Latvia, Estonia, Bulgaria and Greece run the largest C/A deficits. Romania, Portugal and Spain almost at the same level. The lowest deficits were in Poland and Czech

Republic.Germany, Netherlands, Austria, Sweden were net lenders.

-10

-11

-12

-15

-18

-19

5

10

15

20

25

30

35

40

5 10 15 20 25 30 35National savings (% of GDP, average 2005-2007)

Inve

stm

ents

(%

of

GD

P,

aver

age

2005

-200

7)

Bubble size = Current accountbalance (as % of GDP)

Current accountsin deficits

Current accountsin surplus

Latvia

Estonia

Bulgaria

GreecePortugal

Romania

Lithuania Slovakia

Ireland

Malta

HungaryCyprus Poland

France

Italy

Czech Rep

Netherlands

Germany Sweden

Slovenia

line of balanced investmentsand national savings

Spain

Source: Eurostat, European Commission, Erste Group Research, Budash

Net lendersAlmostbalanced

Highestimbalances

REVERSE FLOWS OF MONEY

One unusual feature of the current crisis in CEE has been the apparent “reverse flows” from emerging market subsidiaries to advanced economy parent banks.

The countries that experienced the sharpest reduction in cross-border banking inflows, such as the Czech Republic, Poland and Slovakia, were in fact the ones with the strongest fundamentals going into the crises.

The reason for lower inflows was not the loss of confidence in these countries’ policies or banking systems, but apparently, the need of parent banks from advanced economies to maintain high levels of liquidity at home during the most acute phase of the crisis

Disastrous imbalances in foreign currencies

Imbalances in foreign currencies are disastrous for economic agents who do not have the means to cover the currency risk such as foreign exchange earnings, hedging

The share of foreign currency credit varied significantly from country to the other and is:• very high in Latvia and Estonia and largely exceeds the deposits currency;• high in Hungary, Lithuania, Bulgaria and Romania in relation to deposits;• high but lower deposits in Croatia;• increasingly strong in Poland;• low and equal to deposits in the Czech Republic

Slovakia and Slovenia are in EURo zone, so they are exposed to the different types of risks (growing internal public deficits plus deficits in some southern european eurozone countries)

Vulnerability of small economies

Small, open economies are in a number of ways particularly vulnerable to the types of shocks which the international financial crisis generated.

They are vulnerable to shocks which lead to a reassessment of emerging market risks. This was especially the problem for South Eastern European countries and Baltic States with fixed rate regimes they are more prone to a fast increase of private sector debt levels (plus potential real estate bubbles) prior to the crisis.

The other problem - the rescue operations in the fiscally stronger European economies that had the spillover effect on the smaller CEEC countries

Diversification of economies and impact on real estate

The regions, cities and states may be more vulnerable in period of economic crisis if their economies are not enough diversified. The low performance in one sector has negative influence on the region, city, state. This problem is often more acute in case of small opened economies that are heavily dependent on exports.

When the importing countries lower the demand for goods because of the internal problems, the exporting country is also in trouble. (As with automotive industry in Slovakia).

Creation of one new job places in base industry creates often two another places in the service sector. The destruction of one job in base industry can just opposite effects. Growing unemployment then reduces demand for real estate whether it is for business or for household purposes

Some countries, especially the Baltic countries, did not develop the base industries strong enough, and as the result the impact of crises was heavier then in V4 countries

The positive aspects of crises

The necessity to reduce the rents and prices of the real estate may help the businesses to reduce the costs and thus become more competitive

It may also enable the people to move to the areas were there is higher needs for the labor and the housing prices would act as reduced barrier for the labor mobility

I spite of crises: the opportunities for real estate development in V4

The region of V4 is still not well enough supplied by modern, high quality commercial and residential real estate

The large real estate stock built thirty - forty years ago does not meet modern criteria and its economic life is often close to the end

The new more modern buildings were built in last twenty years only in the most dynamically developing areas

There is the need for the replacement of many buildings in close future

Critical consideration, such as climate change and energy efficiency were not often taken into account even in the newly built buildings

Conclusions: Main vulnerabilities

Economic structures without well developed base economic sectors

The substantial amount of loans denominated in foreign currency

Low transparency of the real estate markets

Strong dependance on exports

Dealys in development of the green buildings

Conclusions: How to eliminate the vulnerabilities

Better macroeconomic regulation

By catching and analyzing the early warning signals coming from changing economic conditions, and adapting the economic, housing and real estate policies in advance

More strategic thinking in banking and real estate companies

Adapting the strategies of real estate sector, and looking for future market niches – especially the developers

By cleansing of market, which is actually taking place

Conclusions: how to overcome the vulnerabilities

The more professional real estate companies with the longer-term vision and client orientation will survive and some of the speculators will be forced to leave the market

Many especially the smaller real estate intermediaries are already leaving the market

The real estate prices may help to standardize the behavior of the actors on the market. The developers will become more responsible, and that the successful could become only the projects located in the best localities. .

The considerable market consolidation is expected by the developers and construction companies. Financially weaker companies had to leave the market, sell their distressed properties for a lower price

We expect that the new behavioral norms and market processes will emerge from the recession

The recovery may depend on the government policies (there is not a large margin for government that is restrained by the necessity of the fulfillment of Maastricht criteria, and by the rising public deficits)

Thank you for your attention

Vulnerabilities of Visegrad real estate markets – lessons from the past.

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