The Future of the Central and Eastern European Property Market

On 1st May 2004 eight Central and Eastern European countries (Poland, Hungary,
Slovakia, Slovenia, Latvia, Lithuania, Estonia and the Czech Republic) along with the island
states of Cyprus and Malta joined the European Union thereby drawing a certain focus to
a region that for so many years had been marginalized.

The EU factor

On 1st May 2004 eight Central and Eastern European countries (Poland, Hungary,
Slovakia, Slovenia, Latvia, Lithuania, Estonia and the Czech Republic) along with the island
states of Cyprus and Malta joined the European Union thereby drawing a certain focus to
a region that for so many years had been marginalized.

With Romania and Bulgaria on the brink of joining in 2007/2008 and several other
South Eastern European countries hoping to follow in their footsteps over the course of the
next decade there is also a sense of a defined future to the expansion of this club – a sort
of roadmap for Central and Eastern Europe which will bridge the gap between Russia and
Western Europe.

With the EU providing a solid base as well as a tangible future for the region it is
perhaps not surprising that the Polish property market, at its centre, is becoming one of the
world’s hotspots for international investment.

Capital as base

Most development in Poland at and around the time of EU accession was centred on
Warsaw which boasts the largest population and highest GDP per capita within the country,
the most significant demand for A-class office space and upscale retail centres as well as the
greatest need for new residential complexes. Warsaw also boasted the best transport links
(nationally and internationally) and crucially – with little competition for sites – investors and
developers had no need to look and travel any further.

Investment spreads across the country

Three years on, the fundamentals are still the same with Warsaw attracting the lion’s
share of investment but increasingly the gap is closing and development is spreading to
secondary cities and beyond. In fact in Poland, average residential prices in Krakow are now
neck and neck with those of Warsaw (1,500 EUR per square metre).

Early Growth

Residential prices, broadly-speaking, have doubled from an average of 750 EUR per
square metre to 1,500 EUR per square metre in Warsaw and Krakow in the three years since
joining in 2004 with the likes of Wroclaw, Poznan and the Tri-City incorporating Gdansk,
Gdynia and Sopot following close behind. Growing personal wealth locally, increase in
interest from foreign investors and more importantly the wider availability of cheap financing
(particularly in Swiss Francs), coupled with restricted supply thanks to the still time-consuming
planning procedures look set to fuel residential growth still further.

Office and retail yields have roughly halved over the same period from above 10% to as
low as 6%. Increasing demand, however, for quality office and retail space indicate a potential
for rents to rise further while at the same time the arrival of numerous blue-chip tenants and
Western chains (symptomatic of a maturing of the market and a minimizing of risk) should
also allow for investors to factor in the possibility of further yield compression.

Office and retail markets

A combination of relatively high levels of unemployment, a stock of highly-educated
and linguistically competent young workforces, a conveniently central geographical location
and forgiving tax structures are converting many of Poland’s cities into a Mecca for Westernbased
companies looking to outsource the likes of back-office operations and call centres.

As long as wage inflation (rising moderately but kept in check from any unwanted spikes
by the unemployment levels) keeps stable, Polish government tax incentives are maintained
and the workforce remains satisfied, foreign direct investment should continue unchecked
even allowing for generous hikes in rents and capital values of real estate.

The potential absorption of further increases in rents is admissible too with regard to
the retail market. As wage inflation steadily grows, so does the disposable income of Polish
consumers and so it is hardly surprising that foreign retailers are keen, at no insignificant cost,
to establish their brands and market position in this burgeoning region at an early stage in
the cycle.

Residential market

City centre residential property prices in Polish cities (particularly in those with growing
links to the international tourist market such as Krakow) should continue to rise steeply until
they meet the Western European average. The wealth of any landlords or tenants in these
locations is based primarily on international activity and largely independent of any local
considerations. Rents in such areas should see a strong rise too as the market readjusts to
the influx of the foreign (long-term) business and particularly (short-term) tourist tenants and
yields also gradually equalize with Western European norms.

It remains to be seen to what extent the region’s population embrace the notion of
home-ownership and the foreign culture of mortgage but early signs are promising for
developers and banks with exponential growth already – with a long way left to go before
personal debt reaches Western European levels. If this trend continues (and if interest rates
remain low), the mid to lower end of the apartment market also looks promising. Growth
at this level should be bolstered by further urbanization within the Poland – there is scope
for the capital and other major cities to double in population to reach the same urban/rural
population ratio as in Western Europe.

On the fringes of the cities, if another cultural divide can be crossed – envisaging the
move into a detached house as a step on the property ladder rather than reaching its final
rung – the popularity of the detached house in the suburbs (currently excellent value at less
than 1,000 EUR per square metre) as part of a housing chain and hence as an investment will
also become an important part of the Polish housing market.

Sustained growth

In terms of factors initially influencing foreign direct investment into Poland, the low
cost of property (cheap rents, relatively high yields or highly affordable entry-level residential
investments) was obviously significant. Whilst this is still an important factor, investors in the
region are seeing many other positives which should keep investment in the area high even
when yields compress and rents and residential prices rise.

Inflation, overheads and taxes look like remaining low, the area is now as politically
stable as any other, financing is relatively easy to obtain and tourism is booming thanks to lowcost
airlines. There are even an estimated 500,000 Poles in the UK and Ireland many of whom
are flying back and forth regularly to Poland (which may in part explain the 97% increase in
passenger numbers, for example, at Krakow’s Balice airport between 2004 and 2005). New
routes are continually being opened with a direct service between Krakow and Moscow due
to open in the New Year. The wealth being brought back from abroad is important in terms
of driving the residential and retail markets, whilst the inevitable breaking-down of social
boundaries and prejudices will also have more wide-reaching effects.

Conclusion

Even leaving the persuasive economic argument to one side, the current sociopolitical
climate of the region and the direction in which it is moving looks set to garner
more investment for the Polish real estate market. As capitals begin to saturate with foreign
investment, this investment focus will increasingly dilate and spread outwards to suburbs and
secondary cities.

Not to be underestimated, the work ethic and productivity of the average Polish
employee (whether employed abroad or in their native land) has made a huge impression on
employers – and it would not be fanciful to suggest that even with all other associated costs
of investing in Poland reaching parity – real estate very much included – this central tenet of
conscientiousness will keep a positive spin on Poland and foreign investment in the country
and in its real estate market very much alive.