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19 May, 2014

‘The Perils of Real Estate development’

A quick perusal of any online real estate forum will show that Krakow property developers are much-maligned – often seen as ‘fat cats’ turning an easy profit from poor-suffering individuals who have no option but to buy apartments from them. What is the reality?

Home Blog ‘The Perils of Real Estate development’

A quick perusal of any online real estate forum will show that Krakow property developers are much-maligned – often seen as ‘fat cats’ turning an easy profit from poor-suffering individuals who have no option but to buy apartments from them. What is the reality?

 

Whilst Krakow has had its fair share of unscrupulous property developers during the past decade (more of that in next month’s article!), the vast majority of companies operating within this sphere are now professional local, national or international businesses with a long-term approach which engenders a great deal more transparency than once was the case. These days it is often the developers themselves who are being stretched by arcane planning laws, new financing realities and legislation that favours the end-buyer…

 

A property developer’s first issue is having enough cash to ‘freeze’ in a land/property purchase – a typical Krakow city centre plot on which to build 50 apartments could cost well over a million Euros. The value of the plot will be highest if it comes with full planning (i.e. a valid detailed building permit) as the developer will almost immediately be able to proceed with construction. Only around half of Krakow is covered by basic outline planning though (in the form of a valid masterplan) and so a developer may also place a much lower value on a piece of land in the expectation that such a masterplan will come into force – or that separate self-initiated planning ‘warunki zabudowy‘ (WZ) can be arranged for a piece of land not covered by an existing or proposed masterplan. A development company will have to weigh up the potential amount of time they estimate will be required to receive outline planning in the former of masterplan or WZ – and then also the cost and time of arranging the full building permit – during which period the cash invested in the plot of course sits idle.

 

The most trouble-free scenario is buying a plot with valid build permit as this provides an element of certainty for the developer. Any other permutation can lead to an extended version of Paper-Scissors-Stone. A WZ can be quoshed by a valid new masterplan entering for a specific area whilst a masterplan can sometimes just plain disappear (as has just happened in Czyzyny in Krakow). The WZ procedure to arrange outline planning itself can be protested by any neighbour to the plot which can mean hundreds of individuals having their say when you are applying for planning next to an inhabited apartment building. Quite often a pressure group (who may not officially be a neighbour to the proposed scheme) will apply to become a party to the planning procedure on the grounds that it has some interest in the general area – thus a developer may end up with a protest from a ‘virtual’ neighbour even when all seems to be running smooth with the ‘real’ neighbours.

 

Once the planning process (which may have taken several months or many years) has been concluded, a developer will either use their own cash reserves to build or – more typically – arrange construction finance from a bank. Banks will typically want to see a strong track record of development and also want the safety of a certain percentage of apartments pre-sold by the developer before they will release any funds for construction as well as a strong commitment from the developer in terms of cash invested. The value of the development plot itself will suffice in most cases but some banks may ask for developers to provide additional equity depending on how cheaply/expensively the developer bought the land and/or if the bank deems the developer should increase their ‘skin in the game’ where the bank is less sure of the location or market fundamentals. Of course during the credit crisis banks were very wary of lending at all and many developers who had managed to break through the planning process were then stymied by the banks for several years more until the finance situation cleared up.

 

In former times it was legally permissible for developers to use clients’ funds towards the construction of the development but since the inception of the so-called ‘Developer’s Act’ this is being phased out with developers obliged to use their own cash to construct or to take construction finance (with the funds from clients safely blocked on an escrow account). This, of course, has increased the cost of financing for developers and there are several other obligations now placed on the developers – not least the onus on the developer to deliver the apartments exactly according to the sizes proscribed in the original plans/contracts allowing the end-buyer to withdraw even if there is some tiny error in measurement.

 

Aside from these rather specific potential issues emanating from the planning process, the financial wherewithal to purchase and build out the plot and the stricter legislative requirements, the developer also has to be aware of the marketplace. There is always the risk of supply of apartments outrunning demand from potential buyers leading to a crash in prices and eliminating any profit margin the developers may be aiming for – or potential unforeseen game-changers such as the financial crisis sapping the appetite from apartment-buyers. Besides extracting a gross profit from the rather basic ‘sales price – profit margin = land cost + ancillary and direct construction costs’ equation, a development company must cope with typical overheads such as office rental, staff costs and technical expertise such as external architects and marketing/sales budget. In short, residential property development is not for the weak-hearted and despite the attractive potential upsides is a field likely to appeal to just a few brave investors.

 

Have you recently purchased an apartment in Krakow? What was the experience like for you? How did the developer behave throughout the process? Did they deliver your apartment building on time? Are there any areas of Krakow that residential developers are missing which could benefit from regeneration?

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