Alternative asset classes are increasingly desirable investment products in Poland. Can they mean good news for investors in difficult times?
Polish developers have traditionally focused on building apartments for sale to individual buyers. Changing preferences (especially of younger generations) and an increasing trend for renting rather than buying have led to growing interest in alternative asset classes, including lease apartments, and privately-owned and operated student halls of residence. Let’s examine these real estate investments in turn, and assess their promise in a challenging economic climate. Institutional lease The number of apartments for rent in Poland has been increasing in recent years, but the needs of the market are still far from being met. Demand for rental apartments is still growing as a result of, among other factors, the increased mobility of a younger workforce and rising real estate prices.
Young people are less willing to make financial commitments to buy their own apartments, and instead are looking for new,flexible forms of living in attractive locations. Moreover, in Poland’s largest cities, the demand for rental accommodation has increased significantly in recent times, mainly due to the influx of workers from the east. What’s more, Poland’s growing popularity as a tourist destination has meant that many property owners have switched from traditional long-term rents to seemingly more profitable short-term rents to tourists, which has reduced the supply of apartments for ordinary tenants.
To date, private individuals have constituted the largest providers of long-term rental services. However, given the ever-increasing demand for rental apartments in large cities and their profit-making potential, it’s no wonder that large developers and investors are becoming attracted to building entire residential complexes for rent. The question is whether an institutional lease can be attractive enough for potential tenants and if entire housing complexes for rent can generate profits.
Institutional leases constitute a simplification of a typical lease agreement and bring specific benefits for a tenant. Above all, this type of lease gives the tenant a greater sense of comfort and stability compared to leasing an apartment from an individual. The tenant doesn’t have to worry about typical problems such as a difficult landlord, the risk of the apartment being sold (which means an early end to the lease) or a lease period not being extended.
Indeed, relations between the tenant and landlord are clearly regulated in a written agreement, which eliminates some potential conflicts resulting from misunderstandings between the parties (these are common when leasing from an individual). The location of institutional lease accommodation is also an advantage. Most investments are located in key parts of cities, characterized by the proximity of transport connections, schools and offices, as well as public and commercial service outlets. It’s easy to see why more and more people choose to live in such developments and why the increased interest from tenants is translating into the construction of new ones.
Currently, the main supplier of apartments for rent in Poland is the state Housing for Rent Fund (Fundusz Mieszkań na Wynajem) that manages some 1,800 apartments. In the private sector, companies leading the way include Catella from Germany, Golub GetHouse, LRC Group and Mzuri. Resi4Rent, which wants to create a portfolio of several thousand flats within a few years, has the greatest ambitions. Apartments-for-rent projects are carried out in the forward deals model.
If adopted, the Act on Real Estate Investment Trusts (REITs) currently being discussed in our Parliament will come into force and apply retroactively from January 1, 2019. In Poland, the activity of REIT companies will be limited to only investing in rental properties located in the country. Investors will be encouraged to engage their capital in such companies and investments mainly due to the tax and legal preferences that are provided for in the Act.
Private student accommodation
In Western Europe, private student accommodation is commonplace. In many countries, they are the backbone of a residential base for students. The first private student dormitories are currently being built in Poland, mainly in cities with large academic centers where student numbers are growing fastest.
One reason for this growth is the increasing number of foreign students in Poland while the number of places in student accommodation run by universities is decreasing. According to the Central Statistical Office, Poland had 1.3 million students in the academic year 2017-18. Student numbers have been steadily decreasing since 2007-08 and are currently the lowest since 1999-2000. However, the number of overseas students in Poland is growing, and will number as many as 100,000 by 2021.
According to Savills, there are almost 450 student dormitories operated by Polish universities, offering more than 120,000 beds, and 35 halls of residence belonging to non-state universities, which offer fewer than 4,000 beds. Student halls owned by private investors that are not related to any particular university currently offer 6,500 beds. This means only 15% of students can count on securing accommodation in such facilities.
The number of student dormitories owned by public and non-public universities, and so the number of beds, is decreasing for various reasons. These include demands of students for better quality living conditions: that is, poorer standard facilities are closing. An alternative to student halls are rooms or apartments for rent, which only private student accommodation can compete with in terms of higher standards. Private investments here are characterized by additional amenities and architectural solutions that draw on the culture of co-living.
The growing interest of students in private accommodation translates into an increase in the attractiveness of these properties for entities that might purchase them as an investment product. According to Savills, in 2018 the total worldwide volume of investment transactions in the private student dormitories sector exceeded USD 17 billion.1 The five-year average for the value of transactions in 2014-18 was three times higher than 2009-13, which shows a strong trend of growing interest from investors in this asset class.
Poland’s private student accommodation sector is at an early stage of development. However, in its favor is the global preference of investors to invest in this sector, thereby diversifying their portfolios, and thus reducing their risk exposure through products that are more resistant to short-term economic fluctuations. Demand for this class of assets exceeds supply, both from investors who expect more projects to be purchased, and from students who want somewhere to live.
Financing construction of buildings for rent and student accommodation
The specifics of financing projects to develop apartments for rent and private student dormitories are different from how you finance commercial facilities.
For a bank, one of the most important questions in issuing a credit decision is the borrower’s (investor’s) source of income. As regards investments in commercial properties, such source is the rental and the increased value of the property as such. Both questions are tightly linked: stable cash flows from rentals cause the property value to grow as well as increasing the attractiveness of the property to prospective investors. The stability of rental-linked flows is warranted by reliable tenants and long-term lease agreements containing specific terms that secure the investor’s interest. With projects to develop apartments for rent and student dormitories, the source of income for the borrower is similar to that for commercial properties. However, lease agreements are most frequently concluded for a short term, even for a couple of days. Short periods of lease do not guarantee for the bank as great stability of rental-linked flows, as in the case of commercial property, which is why the bank creates a charge on the entire enterprise.
The principal measure of the stability of the borrower’s cash flows for the bank is the debt service coverage rate (DSCR). This is understood as the proportion of the income from the property to the principal and interest rate of the contracted credit. In calculating the predicted DSCR rate for projects to develop apartments for rent or student accommodation, the period of testing is shorter than for commercial property projects; due to short terms of lease, it’s usually three months. For testing periods of 6-12 months, it’s necessary to apply alternative methods of calculating the predicted income as compared to the income under lease agreements concluded for the date of testing. Furthermore, in calculating the predicted DSCR rate for private student accommodation projects, a summer vacation period must be taken into account.
“Investing in apartments for rent and private student dormitories could be a great success.”
In addition to bank financing, the investor has three other options to obtain funds for this type of investment: forward commitment, forward funding or joint venture. Forward commitment is a commitment to purchase a property to be developed on the condition of being granted a building permit. Forward funding is a commitment to purchase an already developed property as well as financing the construction in progress. Joint venture is a financing structure in which the ultimate investor would like to create a joint venture in the form of a company with the developer and, ultimately, would take over the finished product on certain conditions.
Investing in these alternative asset classes: Is it worth it?
The first institutional lease and private student accommodation projects in Poland are at an early stage, and the level of profitability of these types of investments will become apparent in the coming years. However, the current unprofessional rental market characterized by a dispersed ownership structure, poor quality and the inability to meet the requirements of modern students – plus the fact that it covers less than 10% of demand – indicates that apartments for rent and private student dormitories could be a great succes
