My company, First Property Group plc, is an active investor in Poland, having commenced our operations there shortly after it joined the EU in 2004. Not many investors have successfully navigated the Polish property investment proposition. In a short series of articles I intend to set out some of the key aspects of doing business there.
After the recession of the early 1990’s it became virtually axiomatic that the yield available on UK commercial property should exceed the cost of borrowing. For the following fifteen years this broadly held true, creating the opportunity for investors to magnify the returns that could be earned by borrowing against income generating commercial properties. The “yield gap”, as it became known, was essential to ensure that a high rate of return could be earned from good secondary property in a mature market and economy. Like many other investors, we made a lot of money exploiting this gap.
But the market had changed by 2004 after international and domestic investors, in the pursuit of yield, had bid it up to silly levels. The yield gap was replaced by a funding gap. This was, in fact, the beginning of the bubble which led to the credit crunch.
Unable to ply our trade in the UK we searched for pastures new and alighted on Poland in 2005. The country had just joined the EU, it was destined to receive massive funding from it as well as benefit from foreign direct investment and a general increase in trade. The fashionable term used at the time for the emergence of Central and Eastern European countries was convergence. As members of the EU these countries also benefitted from the political protective blanket of the EU and, investors like us, could feel confident that property rights and the rule of law would be observed. Poland’s economy was set fair.
Equally important to us was that we could buy properties on yields of around 8% plus and borrow at all in rates of around 4% – a massive yield gap. The market was not as competitive as the UK’s, the banking sector was well capitalised, enabling us to raise good levels of debt and so we chose to focus on Poland and sell our UK assets.
Poland has not let us down. During the credit crunch it did not go into recession and we suffered very few tenant delinquencies. These sustainable high yields coupled with the cuts in interest rates which accompanied the onset of the recession resulted in the rates of return being generated by our portfolio going through the roof. Indeed, this phenomenon went on throughout the credit crunch, enabling my company to be largely sheltered from the storm raging in Western Europe and the US.
The Polish market is not, of course, without its drawbacks. First and foremost it is an illiquid market by UK standards. Whereas in the UK some £70 billion in commercial property may change hands in a year, in Poland the figure is only around €4 billion. So the higher yield available on Polish assets is required in order to allow investors to hold the properties for longer in case sales cannot readily be made. This is not a concern to long term investors but does pose a problem for private equity type investors seeking to exit positions within a short period of time.
The other drawback for investors is a rather fluid planning system coupled with a flat topography in most major cities. This has resulted in ever new office and retail schemes being developed and thereby keeping a lid on rental growth. The market can absorb quite a high rate of new property deliveries and tenant demand is high given the rate at which the economy is growing but without rental growth capital gains become unlikely. The high yield available on commercial properties makes up for some of this but it would be much more comfortable if we could be confident in rental growth.
More recently, with the election of a right of centre populist party to govern Poland, the legislative and fiscal landscape has become a little difficult. There have been a number of changes in the law governing, amongst other things, the oversight of the judiciary, the way it is appointed and control of the media. These changes have resulted in a public spat between the EU and Poland. Luckily for Poland, it cannot be sanctioned in any way or be stripped of its voting rights at the EU without all other 27 member states agreeing to it and Hungary, which has its own right of centre populist government, would always vote with Poland.
The current government has also mooted and, in some cases, gone through with some other less than investor friendly changes. To name a few, a new tax on banks was introduced, a tax on large format retailers was threatened and then withdrawn, reclaiming VAT of the purchase/ sale of property has become more difficult and minimum levels of corporation tax have been set for property owning companies. So far these changes have not had a material adverse effect on investor attitudes to Poland and the commercial property market is as buoyant as ever. But these sorts of changes are unsettling for the market and do necessitate constant vigilance on the part of the investor.
Notwithstanding these changes I remain confident in the Polish investment proposition. The convergence story continues, the economy remains healthy, the banking sector remains liquid, high yields can be found and there is certainly money to be made! More on this in my next article on the subject.
In my next article I intend to look at Polish property market in greater detail and some of the key differences with the UK.
