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%

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%

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

Office supply in V4

Office demand i V4

Office market: Supply and Demand in V4

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

Higher investment growth in CEE – enlargement of production capacities, productivity/quality improvements, infrastructure project. Latvia and Estonia – outliers in the region. Excessive investments Source: Eurostat, Erste Group Research,Budash 26 Capital flows and growth in CEE

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. Highest imbalances Almost balanced Net lenders Source: Eurostat, European Commission, Erste Group Research, Budash 27 Capital flows and growth in CEE

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 arevulnerable 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 intermediariesare 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.