Poland in Pole Position

Big institutional investors are now targeting Polish residential property - and we can learn lots from them about how to time our investments and how we can apply this knowledge to ANY property market...

Plus, how tax laws can help you to refinance your Polish investments.

I want to talk about why the Polish property market offers investors the very next best thing to being able to refinance - the classic way to build a property portfolio.  But, first it's worthwhile taking stock of the property market right now in Poland, because it is becoming increasingly clear that, in order to maximise capital growth, the timing of your investment is absolutely vital.

And that really translates into, not just when you should invest, but WHERE you should invest in the country.

What is equally clear to me is that when I hear people talk about the risk of investing in a country such as Poland, what they are missing is that the risk lies not in the country itself, but in choosing the right location at the right time.

The real risk is that you will miss the period of property hyper-growth in Poland's key cities. Some of these cities have already experienced this kind of turbo-charged growth, some are still experiencing it and - most important of all - others are GOING TO EXPERIENCE it...and soon!

What strikes me is that there are very telling signs that the Polish residential property market is maturing and growing up - fast!

And one sign of a maturing market is that institutional investors are starting to move into the residential market in several of Poland's main cities, something they would certainly have avoided in the recent past.

So, what has changed?

Well, traditionally, big funds don't like residential investments, unless they are big enough to be economically efficient - simply because these funds are very expensive beasts to maintain they need to make multi-multi million pound investments to justify their fees...

And, in the past in Poland, individual residential developments of that size have been rare.

But because the residential market is showing rapid growth and fabulous returns, it is the funds themselves that are changing the scale of the development landscape - in order to allow themselves a piece of the action.

They are teaming up with a developer who has the skills and the local knowledge, examining the developer's projects, and then injecting a huge amount of cash to transform, let's say, a £5 million project into a £20-£25 million one.

We are also seeing funds offering a joint venture to developers - again, giving developers far more financial muscle, and at the same time using the developer's skills and market knowledge.

In particular we are seeing funds from Poland, the US, and the UK coming in - lots of pension funds.

OK, interesting, you might say, but what does this mean for the property market, AND, more importantly, for the private investor? After all, funds can't achieve the same leverage as private individuals. So, as an investment, buying into a fund will remain the poor alternative to those with decent credit - but a reasonable alternative for those without.

Well, what this tells us first of all is that the investment funds are targeting the residential market because they see the exceptional returns on offer.

It also indicates that residential projects are moving up a gear, from being basically relatively small scale to larger scale, or more ambitious and more strongly financed.

What's more it shows a maturing of the market.

Where once cash was the restriction on the scale of development, it's now land. And right now there is a bidding war for prime building land taking place in Poland.

And, naturally, this large cash inflow will drive up land and therefore property prices - by a very large amount and at a very rapid rate.

Fund manages see a window of opportunity in Poland of some four or five years. 

Not simply an opportunity for good, steady returns - no, that is something that will continue long into the future. 

What we are talking about here is the opportunity for hyper-growth.

Let me explain further...

It took 14 years or so for Spain to rebuild after Franco. And that was without the huge inflow of funds that we are seeing in Poland today.

Poland's demand for residential housing is immense. But it is going to take a lot less time to rebuild than it took Spain. And we are now four years into the Polish rebuilding programme.

This doesn't mean that the opportunity in Poland is running out - far from it.

But it does mean that in certain cities the opportunity for hyper-growth is entering it last phase, at least for now. This is true of Krakow, certainly. This makes right now, the last opportunity to plug into this phase in Krakow and experience perhaps a year more of really extraordinary growth. Look upon it as the growth spurt of the teenage years - it doesn't last long, but it is spectacular!

And, if you're an investor, you really want to be in the market during the teenage phase!

The point is that while an average of, let's assume a conservative 13% a year of capital growth may be achieved in a Polish city's property market over 10 years or more, the growth will not be smooth. There will be under-average years and way above average years.

And, what our research and experience elsewhere tells us is that we are going to see very, very strong growth for short periods of perhaps four years in each of the key Polish markets, before they settle down to the steadier trend growth.

After the hyper-growth we are going to see steady, more measured growth - just like adulthood, if I may continue with the metaphor.

Obviously, the opportunity for a property investor is to identify the next location to experience that teenage growth spurt - and, in truth, there are only so many cities in Poland that will experience this phenomenal price growth over the next few years. 

We are talking about the Berlin - Warsaw corridor. The north and east of the country do not really offer investment opportunities at this time aside from Tri-cities.

The string of cities in the first wave included Warsaw and Krakow, of course. And it has been Krakow that has experienced a short period of hyper-growth whereas Warsaw (due to its larger size) is experiencing a longer period of substantial growth.

Both cities’ appeal will continue, with Warsaw likely to become the region's capital as it grows exponentially. Imagine, one million people have been added to Madrid's population in the last five years - that is 50% of the population of Warsaw. Madrid is still growing at a staggering rate even after 20 years of growth and hence illustrates how a city can boom for a long time. And Warsaw has the same long term potential as Madrid.

Poland is a large enough country to support a second capital city and Krakow is clearly that second city - even a kind of virtual capital. It has undoubted, enduring appeal.

The next string of cities certainly includes Wroclaw, Poznan, Katowice and Lodz, as well as the Tri City area in the north.

This is where we are next going to see periods of exceptional growth next.

And these growth spurts then open the possibility of two investment options. 

We can time our investment correctly and ride the wave of initial super-charged capital growth...and then take that gain and re-invest elsewhere.

Or, we can do exactly the same, but not sell and hold instead for the long term.

All the evidence suggests that if we choose this route and we get our initial timing right, we will experience super-charged growth, then a period of slower, steady growth as the market cools, then another period of super-charged growth as people's borrowing power starts to make property look very affordable once again.

That is why timing is so important. If you miss one growth spurt and only manage to exploit the second, it's not the end of the world. But imagine the difference in ROI if you can plug into two phases of exceptional growth!

So, you can buy and hold. Or buy, then take your profits earlier and look for the next location heading for a super-charged growth.

When deciding on your strategy, it's worth bearing in mind that those second super-growth phases may come quicker in some locations than many people might imagine.

This is because salary stats coming out of Poland are misleading - salaries are actually rising a whole lot faster than we're seeing in the data.

Why? 

The reasons are twofold.

First, data tends to reflect the national growth and it's important to remember that this is distorted by the large rural population in Poland. Just under 40% of Poland's population is still classified as 'rural' and they are much poorer than their urban counterparts and their wages are not rising anything like as fast. 

The second reason is that Poland's top rate of tax - 40% - kicks in at a relatively low level (just over the equivalent of £13,000). So many higher earners are now turning themselves into freelancers or setting up their own companies and hiring themselves back to their former employers. Hence they pay a lot less tax. This then distorts data relating to salaries paid - these higher earners are no longer included as salary earners.

And, remember: salaries, plus mortgage availability and flexibility, plus interest rate level = affordability. 

So, what this means is that even in property markets that are entering the final stage of their first period of hyper-growth - like Krakow (although this last phase could actually last a year or more) - the next period of such super-growth may be nearer than the figures might lead us to believe.

But what is this about re-financing?

Well, for property investors in Poland, this is key.

One of the limitations with investing in central and Eastern Europe is that because the markets are relatively young, the finance packages available on the domestic market tend to be limited - certainly when compared with a market like the UK's.

This means there are two obvious drawbacks - one, no interest-only mortgages and two, limited or no opportunity to re-finance.

And, of course, re-financing is the classic way to grow a portfolio - because it only requires that initial deposit on your first investment property. Buy one property, wait for price growth, refinance to use that profit as a deposit for a mortgage on another property. Then do it again, and again.

Right now, there is no market in the CEE where this kind of refinancing is possible.

BUT, one very attractive aspect of the Polish property market that makes a form of refinancing possible is tax, as it relates to property.

It's not quite refinancing, as we would normally understand it, but it is as near as it gets right now. And it certainly is as effective.

Under Polish tax law, the most you will ever pay on real estate profits is 10% - but of the sale price. But, if you sell after five years of ownership, you don't even pay that low rate.

(Please bear in mind, with an off-plan deal, your period of ownership starts only when the unit is completed - prior to that you are technically only buying an undertaking from the developer, not a piece of 'real estate').

However, there's an even more important rule than the five-year one, at least for investors looking to finance turbo-charged growth. 

Even if you do sell within five years, so long as you undertake to reinvest your profits into more property, you will pay no Polish tax on your gain. And this can be applied indefinitely.

So, this is clearly a form of refinancing. And it allows an investor to get in at the start of a market's hyper-growth phase, reap the big profits and then sell and reuse the initial deposit, plus the profits, to expand a portfolio in a new location that has still to experience the turbo-charged growth phase.

Obviously, the associated costs will be a little higher than a simple re-mortgage in, say, the UK and it has more risk (i.e. you might get the timing wrong). 

But then that's the price you pay if you want to gear your portfolio for multiple periods of turbo-charged capital growth.