Investment in residential projects is likely to slow as demand falls

After months of rocketing home prices, the first quarter of the year showed concrete signs of a long-expected slowdown on the residential real estate market in Poland. While a record number of units were completed in 2007, in the second half of the year developers had difficulty selling them as demand atrophied. As a result, developers seem to have lost the upper hand and the Polish residential market has become increasingly buyer-friendly.

Shriveled sales

The first quarter of 2008 generally corroborated that trend. Home sales in Q1 recorded a slight increase over the worst period of 2007, but they still remained low in comparison to the levels achieved in 2006, for example. That resulted from several factors, including the surplus of units currently available on the market as well as reduced demand for new residential projects.

Nearly 134,000 apartments and houses were completed in 2007 and permits for the construction of another 250,000 were granted, according to the Residential market in Poland. Q1 2008 report by real estate advisory REAS. In the same period, developers started construction on nearly 80,000 units. A considerable portion of the supply, however, included projects designed at the height of the residential boom and targeted at more affluent clients.

"Developers' current offers could be better tailored to the existing demand," said Maciej Dymkowski, real estate advisor on the board of directors of advisory redNet Consulting. "There is a lack of popular-segment apartments that would address rudimentary housing needs," he added.

Unsatisfied needs

Housing needs, for their part, remain largely unsatisfied in spite of favorable macroeconomic indicators, which include falling unemployment and rising wages. Due to high prices and growing interest rates, the purchasing power of potential buyers has decreased significantly.

The growing cost of mortgages has become particularly visible as banks have tightened their lending rules. Rising inflation has led the Polish Monetary Policy Council to increase interest rates several times in recent months. In turn, banks have introduced higher interest rates on mortgages which already amount to over seven percent and could, according to analysts, record further growth by the end of the year.

On top of that, analysts also predict a further decrease in the number of relatively cheap mortgages denominated in the Swiss franc. This is due to a Banking Supervision Commission (now the Polish Financial Supervision Authority) regulation from July 2006 which encourages banks to offer mortgages denominated in Polish złoty.

Apart from difficulties related to mortgage costs, new home sales have also been driven down by psychological factors. In the face of unclear market prospects, a number of potential clients who could afford bank financing have instead been postponing their home-purchase decisions in the hope of striking better deals in the near future.

Global influence

Real estate experts stress that events on international markets have also left their stamp on the Polish residential market. From 2005-2006, following Poland's accession to the European Union, the country saw a massive inflow of foreign capital.

This inflow was driven by a number of factors, including the large size of the market as well as strong demand for housing developments. International investors, both individual and corporate, recorded considerable yields even after the US mortgage crisis and market downturns in Spain, Ireland and the UK had occurred. Now, however, diminished demand on the residential market has led to the withdrawal of the majority of speculative investors, which has further affected new home sales.

Maximilian Mendel, a consultant at REAS, noted that Spanish and Irish investments in Poland may now be affected by poor conditions on the developers' home markets.

"Due to crises on their home markets, some developers from the two countries will need to sell their Polish investments in order to save the parent company at home," Mendel said in REAS's April Residential Market Review report. "Several Spanish and Irish developers will also have trouble developing profitable projects, since many land purchases were overpriced, based on unrealistic steady price growth assumptions," he added.

American crisis

Mendel also suggested that Poland's residential market has been indirectly affected by the American credit crunch. Although no similar crisis has occurred in the country, partly due to the lack of subprime mortgage products, Polish banks have kept a wary eye on international markets. The desire to avoid a similar situation on the domestic market is another reason they have become more selective in their lending habits, thereby dampening demand from home buyers.

The restrictions are hitting developers too, as they find it increasingly difficult to obtain capital backing to finance their residential investments. The problem particularly concerns less-experienced players on the market and projects which - due to their location, pricing and the amount of living space - are more susceptible to the effects of a slowdown.

According to Marek Poddany, deputy president of the board of the Polish Association of Developers, the residential market could now see a round of consolidation through the takeover of such projects by large developers.

Price stabilization

As supply has eclipsed demand, new home prices have inevitably stabilized. In Q1 2008, the majority of large Polish cities saw only slight price fluctuations after the period of spectacular growth came to an end.

In order to cope with the new market reality, developers have moved to embrace discounts and special offers. These include free-of-charge balconies, parking garages and kitchen fit-outs. A number of developers have also been selling selected apartments at reduced prices in order to draw clients' attention to their projects.

New home prices could drop even further if demand continues to fall or financing remains hard to come by. The large stock of residential projects still in the pipeline could also affect prices.

But developers maintain that a dramatic fall is not going to happen. According to Poddany, persistently unfavorable market conditions will prevent investors from launching new projects rather than force them to radically drop prices.