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The Warsaw Voice » Real Estate » June 11, 2008
The Real Estate Voice
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Loans for Construction Projects
June 11, 2008 By Michal Jeziorski   
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The revival of the market for mortgage and home loans granted to retail clients has been coupled with a considerable improvement in relations between banks and developers. It seems that in recent years, many banks have changed their approach to the residential sector and now appreciate the potential offered by the demand for housing.

Developers find it much easier now to work with banks than a few years ago. Bank practices used in analyzing a loan application, the procedures involved, the time needed to make a loan decision and the conditions offered no longer stir up as much emotion as before. The late 1990s was a time when developers' experience with banks was especially difficult. Initially, banks operating in Poland did not know how to deal with developers; instead of offering them working capital loans, they proposed investment loans. Meanwhile, Polish development companies operate like wholesalers; they buy "products" from construction companies and sell them to retail clients. Now, a majority of large banks have come to understand what it takes to build in this system.

Banks ranked
The Polish Association of Developers (PZFD) has published its fifth league table of banks providing loans for residential projects to developers. Questionnaires were sent to 117 development companies-members of the association-of which 56 responded. Developers could return one questionnaire for every bank they worked with in 2007. Eight members reported they did not work with any bank in 2007, versus 14 the previous year. In all, 95 questionnaires concerning 25 banks were returned. The league table includes only those banks for which respondents have returned at least four questionnaires. As a result, the table comprises eight banks ranked according to their average score.

The PZFD members have evaluated the banks in terms of services related to funding residential projects carried out by developers. Nordea Bank Polska SA topped the general league table for the second year running. Bank Zachodni WBK SA and Pekao SA ranked second and third. The latter was additionally praised for the most spectacular leap up the rankings from last year. And Polbank EFG, ranked for the first time this year, took a commanding fourth place.

The banks were evaluated against five criteria. Millennium Bank retained its top position from last year in terms of "quick response to loan applications." Nordea Bank scored best in two categories-"terms of loan contract" and "cooperation during project implementation." Bank Zachodni WBK moved from third to first place in terms of "flexibility and treating the borrower like a partner." And BPH moved from ninth to first place in the category of "conformity between initial declarations and actual procedures."

Compared with last year's survey, developers are now less satisfied with the conditions of their cooperation with banks, which provide far more mortgage loans to development companies' clients than loans to the developers themselves. This is a major constraint on the growth of the residential construction market and a threat to developers' projects. Additionally, the number of banks an average developer works with has decreased markedly from last year. This is reflected in the number of questionnaires returned per developer: only 1.69 this year compared with 2.16 last year.

The data indicate that developers' relations with banks are now more conscious and based on good experience and satisfaction with their earlier work. But it should be noted that scores in general declined significantly. Last year, the top bank scored 87.20 points and this year only 81.75 points. The banks included in the league table scored 17.93 points less this year than last year. The number of financial institutions involved in the fifth survey of developers may indicate that competition between banks is increasingly tough. But the lower scores show that developers are now less satisfied with the terms banks offer them. This should be a signal to banks, which should start treating the development sector as an important partner.

Tightening of policy
According to the PZFD, the conclusions drawn from the survey are worrisome. Developers view their work with banks increasingly negatively. There is a great disproportion between the volume of loans granted to developers and mortgage loans granted to developers' clients. The ratio is one to eight in favor of retail clients in Poland, compared to one to four in the European Union. This disparity is a major barrier to the growth of the residential construction market.

At present, only around 15 percent of developers do not use bank loans. Developers complain that loans are difficult to obtain. Around 50 percent of banks have promised to tighten their loan policy for developers. But strong and experienced development companies should not worry; banks will continue to provide funding for good projects not financed by buyers through installments.

Bankers expect consolidation on the development market and say that strong developers will be buying projects from weaker ones. Some development companies have already offered their projects, with land, for sale but the prices are unrealistic. According to the Reas consulting company, the developers' situation in terms of apartment sales is good. They have already sold some 50 percent of homes planned for completion in 2009 and in the entire country, there are now only 2,000 homes that have been completed but not sold yet. However, as mortgage loans become increasingly difficult to get and banks are unwilling to provide funding to developers, many investment projects may get blocked and never get beyond the preparatory stage.

In the second half of the year, the Infrastructure Ministry is to submit to the government a draft law on contracts with developers. Under the draft, consumer interests are to be protected by trust accounts in which money will be collected for projects carried out by developers. If the developer goes bankrupt, consumers would not lose their money because assets in the trust account would be excluded from bankruptcy and would be used to discharge buyers' claims resulting from the contract with the developer. Consumers would also be better informed about the project. Before signing the contract, the developer would have to give them a prospectus, similar to an issuing prospectus, with detailed information about the project. This is supposed to prevent development company staff, whose salaries often depend on the number of contracts signed with clients, from misinforming consumers.

Value growth
Banks like working with developers because of high returns in the sector. The housing boom of recent years meant that prices skyrocketed, bringing hefty profits to developers. Looking at the results of development companies listed on the Warsaw Stock Exchange, it is clear that 2007 was an excellent year. Average profits rose by nearly 50 percent year-on-year. Furthermore, all the developers listed-J.W. Construction Holding, Dom Development and Polnord-have also posted good first-quarter results. J.W. Construction's sales were higher by almost 12 percent and net profit higher by over 70 percent year-on-year. Dom Development reported a 9-percent increase in sales and a 21-percent increase in net profit.

This strong performance was underpinned by the housing boom witnessed in 2006 and at the beginning of 2007.

Now, however, development companies have to prepare for worse times to come. They will have to reduce margins to maintain demand, which began weakening in the second half of 2007. Wholesale buyers disappeared, many prospective clients were squeezed out from the market as prices rose sharply, and others started to delay purchases in anticipation of lower prices. At the end of 2007, Dom Development projected it would sell 3,500 homes this year. But in the first quarter, the company revised this projection downward-first to 2,500 apartments and now "more than" 2,000 apartments. Meanwhile, in the first quarter Dom Development sold 328 homes, or 150 less than in the same period of 2007.

J.W. Construction recorded an even sharper decrease, having sold only 200 apartments compared with 600 in the first quarter of 2007. The company plans to sell around 2,500 homes this year. Polnord reported the sale of 717 apartments in the first quarter, but these included a residential project in Gdańsk sold at a profit to another developer. As a result, banks are increasingly cautious in their dealings with developers. The past good performance resulting from the housing boom of more than a year ago does not count today. But developers insist that in the long run prospects for the sector are good because of the strong underlying demand for housing from Polish baby boomers of the 1980s, and due to the expansion of large cities.

Building on credit
All this does not change the fact that bank loans are still the most popular source of funding in real estate projects. Developers try to leverage by keeping external funding as high as possible relative to their own resources invested in a project. Bank loans are available to developers practically at every stage of the project. Developers increasingly seek loans for the purchase of land if they have an opportunity to buy it at an attractive price but do not have money to finance the purchase. Then they tend to fund construction projects from money contributed by clients.

Generally, developers only need money to maintain liquidity, which means what they need is a typical working capital loan. It is noteworthy that the first specialist mortgage banks have already appeared on the Polish market, including BRE Bank Hipoteczny and BPH Bank Hipoteczny. It seems they are better prepared for worse times than universal banks. If the market collapses, mortgage banks will not shift to other products, but will continue to deal with real estate. As a result, they are more strict and cautious than universal banks.

Recently, another quite popular source of funding has been investment funds. Some of them partially fund residential projects by buying apartments wholesale at an early stage of development and paying in installments according to progress on the construction site. An investment fund can also finance development projects through special-purpose companies, in which the fund is not only the lender, but also takes some responsibility for the ultimate success of the venture in exchange for profits after the project has been completed. But one of the cheapest ways to acquire money, a way developers tend to prefer, is project funding from regular installments made by clients. There are marked differences between funding commercial properties and residential estates, with classical project finance schemes used in the first case. A bank has to provide funding for the whole project and checks pre-let agreements with prospective tenants. These are long-term loans granted for 15-25 years.

To sum up, it is often said that construction is the driving force of the economy and that one job in the building industry generates from three to six jobs in other sectors. More housing loans tend to produce more consumer loans for the purchase of furniture, household appliances and cars. Banks should remember that if they want to earn money from retail clients, they should support developers first.
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