The Czech Republic is showing tentative signs of recovery after the most difficult year in its brief history. But what are the implications for construction costs? Miroslav Vasko of EC Harris reports
01 / The Czech economy
There is no doubt that the economy of the Czech Republic was severely hit by the global economic slowdown last year, and it remains in its deepest recession since the Velvet Revolution of 1989. The official figures from the Czech National Bank show that GDP shrank 3.8% in 2009, following record growth in 2008 of 6.3%. The outlook, however, has become more optimistic since then, as GDP is expected to increase 0.7% in 2010 and 2.2% in 2011.
The Czech economy relies heavily on its export market, which contributes 59% to GDP, and this continues to suffer from the decline in worldwide demand for capital and consumer goods. This has been exacerbated by the recent strength of the Czech koruna which has gone from 41 to the euro in 2007, to 29 at the end of last year and its continued strength relative to other currencies has made exports even tougher.
One major difference between the Czech Republic and some western economies, including that of the US, was that banks collapsed in the latter, resulting in government interventions. Governments around the world have amassed huge debts as a result of the structural support of their banks and instigation of stimulus programmes to revive economic growth.
In the US, this debt is currently 10.6% of GDP, in the UK it is 12.4%, in Germany it is about 8%.
The Czech government did not undertake any such programmes but a high budget deficit is expected for 2009, and this is estimated to have reached about 6.8% of GDP (192.4bn koruna, or £6.9bn), in comparison with a planned deficit of 1.5% of GDP (38.1bn koruna, or £1.4bn).
Despite the relative health of the Czech financial sector, the republic continues to endure a technical economic recession. Companies have been forced to reduce working hours and are finding that they have fewer and fewer opportunities to cut costs further. Unemployment is expected to continue to increase in 2010. The official average unemployment rate was 5% in 2008, but rose to 8.6% in 2009 and is expected to reach about 10% in 2010. This significant increase will likely further reduce consumer spending and will continue to affect economic recovery.
To aid recovery, the Czech National Bank cut its interest rates in December 2009 for the fourth time in the past 12 months and the rate now stands at a historic low of 1%.
This latest rate cut brought the interest rates in line with the European Central Bank main rate, which has remained at 1% for the past few months.
02 / Real estate
The strength of the Czech currency, alongside the ability to raise capital, has almost certainly contributed to the reduction of direct foreign investment. In 2009, the value of real estate transactions completed fell by more than 60%, with nearly 90% of them taking place in the last quarter of the year. In 2009 the value of transactions was £350m compared with about £900m in 2008 and £2.2bn in 2007. Forecasts for 2010 are now expected to be within the £350-550m range.
Office premises accounted for an 83% share of 2009 investment turnover. Industrial and retail transactions accounted for 13% and 4% of total volume. Prague remains the most attractive location, accounting for 94% of all investment turnover in 2009. In the residential sector the mortgage market also showed a significant decrease of 40% over the past year, confirming the fall in consumer demand for real estate.
03 / Sectors
At the end of 2009, the total area of offices in Prague was 2.7 million m2, of which 71% was newly finished and 29% refurbished. Class A accounted for 67% and class B, 33%. During 2009, 162,000m2 of new offices were put on the market compared with more than 300,000m2 in 2008, and only 33,700m2 is expected to be finished in 2010. Vacancy rates for offices went up to almost 12% at the end of 2009 and are predicted to increase to 14-15% during 2010; the current trend shows an increase in renegotiations of existing contracts with landlords. Office rents in Prague city centre are about £18-19/m2/month, falling to £13.50-16 in the inner city and £11-13 in the outer city. Prime yields in Prague were about 5.25% in 2007, 6.5% 2008 and 7% in 2009.
The residential and mortgage market is relatively healthy in the Czech Republic as it is based on local demand and currency and is therefore immune to currency fluctuation shocks. The effect of the global crisis has had only a minor impact on the residential market, primarily in the outflow of speculative investors. However, mortgages are not easy to obtain as the banks require at least 30% equity, and an apartment development must have sold at least 30% of the flats before a loan can be obtained.
The residential market in the Czech Republic is mainly the domain of the middle and upper middle classes, where the trend has been, in recent years, to improve their housing on their own account, without expecting help from the state. As a result, demand for new housing has not been as great as it could have been and the residential market has not developed significantly in the past 10 years.
In 2009 a total of 38,500 homes were completed, just 0.4% more than in 2008, which in turn was 8% down on the previous year. A total of 37,300 dwellings were started in 2009, 14.3% less than in 2008.
Although most retailers postponed their expansion plans in 2009, new entries to the Czech Republic were recorded – for example, Avex Baumarkt and KappAhl opened their first stores in the country. On the other hand, the Czech market experienced the closure of a modern shopping centre for the first time in summer 2009 when Prague’s Stodulky mall was closed, to be replaced by a single unit of the furniture chain Mobelix.
At the end of 2009, the total area of shopping centres in the Czech Republic was 2.6 million m2, of which some 858,000m2 were located in Prague. There are nearly 140 shopping centres across the whole of the Czech Republic. Currently, however, there are only around 60,000m2 of traditional shopping centres under construction.
On the up side, a number of retail parks are expected to come to the market in 2010. Despite the limited number of new shopping centres, a number of retailers have already announced their expansion plans for the upcoming year.
DM Drogerie Markt, Tesco, Kik, Euronics, Takko and Sportissimoand Kikaare are examples of retailers who are planning to expand in 2010. Decathlon is due to open its first store in Liberec. Shopping centre prime yields have risen from 5.5% in 2007 to 6.8% in 2008 and 7% in 2009.
The 2009 industrial market experienced a difficult year as it was affected by the global economic downturn. Whereas in the years 2006 to 2008 the average amount of space under construction in one quarter reached 549,000m2, in 2009 the average was only 83,000m2 and speculative development had almost disappeared – only 15% of space under construction at the end of 2009 was speculative development. However, signs of revival were witnessed in the second half of the year when demand for modern warehouse space picked up to exceed 100,000m2 and the vacancy rate started to fall by the end of the year.
At the end of 2009 industrial rents ranged from £2.50-4.50/m2/month, although there were wide regional differences. In terms of total leasing activity, the market in 2009 was dominated by three developers, which together held a 68% share of the market; ProLogis had 28% of market share (up 15% from 2008), followed by VGP with 20% share (a fall from 27%) and CTP with 20% (down from 22%).
In 2010 it is expected that developers will mainly focus on leasing their existing stock instead of constructing new schemes; it is expected that very limited new space will be built on a speculative basis.
Hotels and leisure
In 2008 several hotels opened, including luxury brands such as Sheraton and Kempinski. However, the global economic slowdown in 2009 caused a major turnaround and the hotel market is currently experiencing a slump of 15-30%.
In 2009 the average occupancy was 56% in Prague and 55% in the whole Czech Republic, down by about 20% compared with 2008. The average price for a room in 2009 was £84 a night in Prague and £72 in the rest of the Czech Republic. Hotel prime yields were 6.25% in 2007, 7.5% in 2008 and 8.25% in 2009.
04 / The construction market
The construction market has seen nearly 10 years of relatively stable growth, heavily boosted by foreign direct investment, private residential mortgages, public sector investment and EU funding, which have all grown sharply since 2002/03. Construction output has increased by 5-8% a year over a number of years, but the current situation is different. For the construction industry, 2009 was a difficult year, but for some 2010 could be even tougher. The construction market output actually increased in 2009 by 0.6%, largely owing to the completion of projects that were started in 2008; the current prediction for 2010 is that there will be a decrease of 1-2%. As the availability of capital for private investments is still restricted, analysts expect most construction projects this year to be financed by government or EU funds.
Material and labour costs
High commodities prices, exacerbated by higher import costs led to some spectacular increases in materials prices in 2008. This was led by the prices of bituminous and steel-related products, which rose by 20% in the first half of 2008. However, other materials also showed large increases including glass, processed wood and wooden elements, as well as ceramic sanitary fittings. The boom in commodities prices, however, came to an end in the second half of 2008 and since then we have seen a drop in the cost of materials used in the construction industry with, for example, rebar prices falling by about 40%.
Labour costs in the Czech Republic represent about 30% of construction costs, primarily because of the high social security contributions. This is still lower than in western countries (for example, they are about 40% in Germany). As unemployment continues to rise, there is evidence of labour rates falling, which is contributing to an overall decrease in construction prices.
As contractors and suppliers have responded to the impact of the recession, margins have been cut and commodities prices have fallen. In the private property sector especially, EC Harris expects investments to fall further during 2010. According to figures published by the Czech statistical office and based solely on government projects, construction costs actually rose 0.3% in 2009.
Nevertheless, EC Harris believes that average tender prices in the private sector are about 15-20% below their peaks of 2007/08. The EC Harris tender price index for the Czech property sector is as shown in the graph above.
05 / Looking to the future
The Czech Republic is due to go to the polls this month to elect a new government. As with all Czech governments formed after 2002, it looks likely at the time of writing that no single party will have a majority; as a result the government will continue to struggle to make the significant changes, such as the reform of the health and pension systems, which are needed to stimulate growth and gain control of government debt.
The global recession has reduced consumer price inflation from 6.3% in 2008 to 1% in 2009. It is expected by the Czech National Bank that in 2010 inflation will be 2.4%.
The outlook for the construction industry remains uncertain and construction prices can be expected to continue to fall owing to cuts in material and labour prices. However, market activity is expected to begin to increase before the end of 2010. Although it is unlikely to return to the boom of 2007-08, we can expect to see construction prices rise steadily from 2011.
The recovery of the construction industry is linked to the recovery of the economy as a whole and, since the country is small and export orientated, the recovery of the Czech economy will be consequent to the recovery in western countries, especially in Germany.