THE DAYS when anyone who bought a piece of land could become a developer are gone for good: the greatest challenge for today’s developers is how to secure funds to finance their projects, says Ivan Valent, the chairman of the board of directors of major property developer HB Reavis Group. Valent does not think that the current global economic downturn has yet reached the bottom, but he is convinced that the fittest developers with the strongest projects will survive.
The Slovak Spectator spoke to Valent about the specifics of the Slovak property market, the mood of developers, regional disparities and the main challenges that the market faces during the current global economic downturn.
The Slovak Spectator (TSS): How has the global economic downturn been affecting developers active in Slovakia? What are the main challenges that a downturn poses for players in the real estate and construction market?
Ivan Valent (IV): The greatest challenge is to secure financing for projects and then also customers for particular projects. Financing, which was relatively straightforward in the past, is now becoming complicated. Since banks worldwide have been seriously affected, bankers are now taking a more conservative view of the market. Today they seek not just a strong developer with an established reputation but also strong projects with a significant number of customers tied to each so that they can be launched. Before the crisis, entry to the property development market was relatively easy, which was not a particularly healthy situation. In fact the banking sector would finance essentially anything. One of the positive aspects of the current situation is that projects are now more conservatively and carefully selected. Another challenge, which is a more long-term issue and has not emerged with the crisis, is the process of obtaining construction permits for particular projects, since we have around 30 projects running, each at a different stage.
TSS: Some observers said that the era of speculative projects is over now. Do you agree?
IV: I would perhaps explain the terminology thus: a speculative development is a project which takes off without contracted customers or users but has only a small degree of ‘speculation’. We basically built most of our projects on this speculative basis. The banks were willing to finance such projects since we have a track record and we were able to accomplish and fill these projects. At the time of unveiling, all our projects were sold out. It was more of a philosophy for doing business: on one hand we were willing to take more risks but on the other hand we were able to fill the projects and the banks accepted this approach. Then of course, there are speculative deals in which someone buys up property only to quickly sell it on for a better price. But the time of these deals is definitely over.
Certainly, our approach will become more conservative, even though a relatively conservative approach has always been one of the main features of our business.
TSS: What are the upsides of the economic downturn, if you can see any?
IV: There were almost no barriers to entry into the property development market. It was enough for someone to buy a piece of land and take a look around: immediately they became a developer. Certainly, the market will be cleaned up somewhat, with strong players who are able to come up with strong projects surviving.
TSS: What are the specifics of the Slovak real estate market when compared to other European countries?
IV: Forty years of socialism have influenced the whole real estate and construction market in the central and eastern European (CEE) region, from the quality of housing up to the way administrative buildings were built. The CEE region basically inherited bad real estate infrastructure and has had to catch up in about 20 years with the logical development in western Europe stretching over many decades.
I think that this market will continue catching up for the next 20-30 years, until the market becomes saturated. Yet, it is not only the historical legacy of the CEE region: the construction and real estate market has been growing twice as fast as in western Europe. All this has created greater, less sophisticated demand.
I would offer an example from the residential sector: the gap between the quality of projects that are saleable in Slovakia and what could be sold in a western European city similar in size to Bratislava is huge. The market simply did not experience strong pressures on quality because it was relatively small. Besides, people had not been used to quality for about 50 years and even if they sought it out, it was significantly overpriced.
However, it’s really hard to speak about real estate as one homogeneous market. One has to look at specific segments and perhaps compare these. We are active in office space, retail and logistics. The traditional market also includes residential and hotels and then other marginal segments. Each of these segments developed in a slightly different way in different countries. If we look at the office-space segment, in the mid-nineties Slovakia experienced a certain international isolation and businesses started rushing in mostly after 2000: this was the time when the segment started catching up with other countries in which the office-space business had had an earlier take off.
TSS: How have the economic crisis and banks’ reluctance to lend affected the operation of your company?
IV: The crisis found us in a relatively good condition, thanks to which we have not had to modify the time schedules for our projects. I do not know whether this will happen by the end of the year, but even if it does it would be a sign of caution rather than an unavoidable step.
We have not made any significant changes and we are running in a regular regime. The ultimate goal is to preserve the company at its current size and with its current projects despite the more conservative behaviour of the banks. Our long-term strategy has been to keep considerable funds in cash, which has helped us through the tougher periods.
If we had kept even more cash, we would now be tempted to buy some other firms, which of course would have been an opportunistic approach.
TSS: You recently attended the world real estate fair MIPIM 2009 in Cannes. How would you describe the atmosphere and the moods of developers and investors there?
IV: They were concerned, of course. Nobody was clear whether we have already reached the bottom or are still sinking. Some are convinced that the crisis has already reached its bottom and property developers are not readying themselves for take-off. Others say that the downturn will last longer. There was no unified view. I personally belong to the second group and I expect that we will experience some more shudders and contractions and that the crisis will take some more months. But to be honest, I would not describe the atmosphere as depressed either.
TSS: In the CEE region, most real estate investment flows to the capital cities and much less to the regions, which are still dominated by investments by retail chains, for example. What could make the regions more attractive to investors?
IV: In the development business there is a relatively direct link between strong suppliers and strong customers. Developers simply go where they think there is a market and where they can smell demand. If we look at the strength of some CEE regions, we find that Prague and the surrounding region has reached about 160 percent of the average GDP of the European Union while Bratislava is somewhere at around 150 percent, and I think Budapest and Warsaw perform similarly – but regional differences are huge. In Slovakia, these gaps range from 150 to 40 percent. For example if we take the economic development of Bratislava and compare it with the poorest region of Slovakia, the difference is four-fold. Indeed there is a smaller difference between Bratislava and London than between the Prešov and Bratislava regions.
Unfortunately, this is how business works: at the end of the day we have to see some returns from the invested capital, thus we focus on the market which already exists. GDP is the best indicator for us to see where to build and develop. Many regions in Slovakia are still not reaching the economic strength which would sustain a larger boom. If you compare prices of apartments in Bratislava and in the regions, they indeed indicate the difference in purchasing power.
TSS: How do you assess the development of the market for commercial real estate? Do you expect the take-up rate of office space to drop?
IV: I will use the example of Vienna. Many assume that Vienna is full, with its 10 or 11 million square metres of office space, and that there is no need for more. But in reality, there is still new office space being built in Vienna and you cannot really see the end of the market. Bratislava recorded its peak last year: it is a sort of paradox that this happened in the first year of the crisis. The take-up rate was significantly over 100,000 square metres. I expect this number to drop. But it will fall to somewhere around half of this astronomical height. I think this year that we will be at the level of 2002 or 2003.
TSS: There is an observable trend of firms moving from downtown to the wider centre. What factors have been influencing this trend?
IV: We live in an era when firms are tightly controlling their costs and one of the ways of doing this is to regulate rental outgoings. Logically, these are much higher downtown than in the wider city centre. To the rental we can also add soft costs such as parking or the accessibility of clients, etc. For some firms their location is also about their visibility or the transportation situation, even the proximity of the airport. The long-term trend is that offices which strive for prestige do stay downtown. Usually these are law firms, consultants and auditors. However firms which employ a lot of people are likely to take a different approach. Besides, the buildings in the centre are often historical and the office standard they are offering is often lower than the one which clients can get in newly built spaces.
TSS: HB Reavis launched a campaign to establish specific standards for office space. What was behind the move?
IV: It is an educational campaign. Some markets simply do not have set standards and a shared understanding about parameters; almost every newly built building is being given non-existent AA or A+ tag, suggesting the highest standards. Since we are operating in several markets where these standards have been clearly defined, we used the standards valid in western Europe as a basis. We are talking not only about the design of the building or the way it looks, it is more about the “organs” of the building. Our clients often are not – nor do they have reason to be - experts on office space and in real life the ones who do not have consultants are not able to make the necessary comparisons. We have launched a website which features all the information. As for the responses from other developers, if we had launched the campaign a year ago there would have been a stormy debate about it. But today, the players in the market face different problems and it is obvious that everybody is now sitting in the bank negotiating money to cover their projects.
TSS: Some observers say that brownfield sites have huge potential for the economy while some others warn that they carry significant risks as far us unsettled ownership or their environmental burden is concerned. How do you asses this segment?
IV: Almost all the buildings we have built are brownfield sites. I personally do not see much difference between brownfield and greenfield as far as commercial buildings are concerned.
When it comes to industrial buildings, it is different and a very complicated issue opens up. As far as brownfields in the cities are concerned, cities logically are growing. If you take the location of the so-called Kablo (cable factory), in the past that was the edge of the city but today it is the centre. The same is the case with small factories which were built 60-80 years ago - logically, today the city is much larger. Besides, socialist planners stretched the city extensively rather than intensively. This is how places like the industrial part around the bus station - the site of the Twin City project - remained unique localities, whereas in cities which developed on the basis of market economics they would no longer exist. In Bratislava, there is a relatively large industrial area, which could potentially stretch the city centre - which is here quite small - in a very elegant way.
TSS: How is the Twin City project progressing?
IV: It is the largest project under preparation in Bratislava. At the same time it is a very complicated project since it is a former industrial zone with a large area and a number of problems that call for solution. Today we are in the stage of negotiations with the city regarding the master plan and preparing studies.