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01 / The economy

Before 2008 a large percentage of investment in Romania came from sources outside the country, so it should not come as a surprise that when the global credit crisis struck, it was badly affected. The recession that has hit the country is quoted as being the worst in 20 years, and has wiped out the gains made in 2008 when the economy grew 7.1% - at the time the fastest pace in the EU.

Before the crisis, many of the investment houses in western Europe followed a well-trodden path to Romania, with Austria, France, Germany and the UK leading the field in terms of numbers. The previous growth was based on this investment, as well as a credit boom within the country.

The financial crisis created a tide of negative sentiment towards eastern Europe and obliged Romania to approach the IMF for a 鈧�20bn financial rescue, which included 鈧�5bn from the EU鈥檚 bail-out fund. Romania has, in part, been relying on this loan and, despite rumours to the contrary, the EU reports that it is a good payer, so the money is on its way.

Romania has always been keen to develop quickly, and during the boom times the market was saturated, but still attracting interest. One town with 170,000 inhabitants had seven large-scale shopping malls planned, and advisers were recommending that developers add more. This pace of growth was not sustainable, and some developers may have actually been lucky that the crisis happened when it did, as they would otherwise have been sitting on some unprofitable assets by now.

IMF funds and EU loans may not be enough, however, as the Romanian government has been in turmoil since it collapsed last October. A coalition government has been formed in recent months, which had hoped to restore confidence. However, budget cuts have been hanging over the nation and have undermined any serious movement in the economy.

On 6 May 2010 the president announced these cuts in public spending, which were needed to unlock more IMF money for the country, but they have not proved popular. State pensions have been cut 15%, and some public sector wages have fallen 25%. There are also proposals to sell off two large institutions, the state electricity company (Termoelectrica) and the state railways (CFR Marfa). It has yet to be seen how these measures pay off, but VAT and the country鈥檚 flat-rate tax may rise if these cuts not produce the right results over the next few months, and that could lead to a further destabilisation of the government.

So although there are some positive signals, in terms of money arriving, there remains the potential for future turmoil as Romania emerges from the crisis. That said, the basic economic and geographical characteristics that drew investment into this country in the first place still remain. These include:

• The availability of finance from the EU鈥檚 post-accession funds, which could be a magnet for many investment projects. Potentially, up to 50% of eligible costs are available for reimbursement.
• A 16% rate of corporate tax.
• It is close to other European countries that have strong and growing economies.
• A skilled and still relatively inexpensive labour force.
• A culture that is very close to that of western Europe. English, French and Italian are all widely spoken.

If the government鈥檚 difficulties were put to one side, these basic factors may still be able to assist Romania in drawing in the necessary investment to recover from the crisis that has hit Europe in the past couple of years.

02 / Sector overview

As with any market emerging from a crisis, a fall in workload means costs and margins are expected to follow suit. The need to perform has also stimulated us to help clients to look for innovative ways to deliver their projects as opposed to the strategies that were being proposed, and carried out, before the crisis.

Retail

Within the property sector, all types of schemes have suffered. In the retail sector, it has been possible to deliver a completed shopping mall this year, on time and to budget, but this story is not typical. There are many retail centres around that were developed and designed for a market that was buoyant, and the crisis has also affected consumer spending.

The result is that many large malls are experiencing low levels of occupancy and developers are struggling to attract new retailers to the market, or to find ways of expanding their existing businesses.

Some retail developers may have been poorly advised in constructing shopping malls, especially in Bucharest, where a 50,000m2 scheme opened in recent months, to add to four others of similar size within the city. A new 200,000m2 mall is also planned, and is expected to start on site soon. We wait to see how successful this addition will be.

Residential

Housing schemes have suffered, too. Prior to the crisis many schemes were designed to provide high-quality developments with high-end specifications, and these developments are now struggling to attract the type of clientele they had hoped for, as everyone tightens their belts. The introduction of the 鈥減rima casa鈥� loan scheme, in which the Romanian government is guaranteeing 鈧�1bn in mortgages for first-time buyers, was intended to boost the struggling residential sector. There are certain barriers to qualify for these loans, however, and the result is that existing housing stock, which often comprises former Communist developments, has been the main beneficiary.

Commercial

The demand for commercial office space was always sufficiently high and supply was low before the crisis, which supported prices. They soon fell when foreign investors pulled out, although not fallen as dramatically as other sectors. Although there was still a drop, some clients were able to charge a premium on deals made during the crisis, and there are many examples of schemes recently completed where occupancy levels are still high.

Logistic and similar commercial spaces have continued, although tenants are negotiating from a position of strength and the take-up in some prime areas has not been as swift as some had expected.

03 / The property sector

As with the wider economy, the real estate boom in Romania was largely funded by western European investment. Much of the built asset consultancy work being carried out by EC Harris was underwritten by lenders and investors from the UK, Austria, Germany and France, and, outside Europe, from Israel.

When the crisis hit, many of these funders left the country, and some preferred to take large losses rather than remain in the market. Local and international banks have inherited some of these assets, including partly completed schemes, after repayments could not be met and where investors and developers had failed to resolve their disputes.

Some of the smarter developers we are working with suspended their works in time and, with good strategies and sound advice, have been able to work through the crisis and should be in a position to deliver their projects just as an upturn in the economy is expected. These may prove to be the people who benefit the most from any upturn in the market.

There are many projects that were poorly planned, designed and executed during the boom prior to the crisis, and these have ended up in the hands of the banks, which are only now beginning to understand the magnitude of the task they face in selling these schemes. The models established by the western European banks to handle these 鈥渢oxic assets鈥�
are now being followed closely by Romania鈥檚 own banks.

04 / Construction workload

Infrastructure and public sector schemes have continued through the crisis, and some contractors and developers have been able to move into these markets to offset the fall of the property market. However, government work is especially difficult to win, and the entry requirements often bar outside companies and investors from getting involved.
That said, local partners can provide some of the experience and qualifications needed to enter this market, and we have seen some successes from international companies, in liaison with local firms, in winning work away from the property sector.

05 / Prices

Despite the willingness of some to diversify, there have been casualties in the contractors鈥� market, and a number of large international firms are known to be suffering. The continued existence of some firms remains at risk at this time, and we are noticing some low tender prices as firms try to reduce margins to unprecedented levels to keep their businesses afloat.
Material prices have, understandably, dropped as orders have dried up, although there has recently been a slight increase. This is largely the result of a fall in production, although it is not clear yet whether this is also an indication of tactical purchasing. Some firms, and developers, are considering this strategy as an option, as Romania always experiences a yearly increase in steel costs.

Those developers with alternative strategies may benefit from starting site works towards the beginning of 2011, and they may benefit from stockpiling materials now, while prices
are low.

06 / International investors

As with most locations in Europe, there are signs that things may be improving - alongside signals that caution should be exercised in predicting any growth.
Economists report that direct foreign investment in Romania halved in 2009 from $13bn to $6bn. The expectation is that in 2010 direct foreign investment will increase to 拢9bn, rising to 拢11bn in 2011. This prediction assumes a 1% growth in GDP for the Romanian economy in 2010.

Recent figures seem to undermine this forecast, however, with foreign direct investment in the first two months of this year halving to 拢395m compared with the same period in 2009.
In line with this view, there are few indicators that international investment is returning. Most of the construction workload we are seeing is related to works on existing 鈥渢roubled projects鈥�, and investors and funders are looking, firstly, to pick up what is available from a distressed market, while others are looking to revive struggling and failed schemes, now that funding is being released.

EC Harris is assisting a number of foreign investors, and there remains a good mix of projects that would benefit from a reworking to get things moving again. Our perception is, therefore, that most of the work being done is based on existing funds being rearranged, as opposed to a large influx of fresh money.

07 / Summary

The Romanian market has followed a path similar to most economies during the recession. But the country appears to be in a better position to succeed than some of its neighbours, and it could be argued that the economy has followed a trajectory more typically seen in western rather than central and eastern Europe. This may be due to the country鈥檚 strong business ties with France, UK and other Western European nations.

The strong growth in the economy in the period before the recession is fresh in many minds, and the desire to develop, as a country, is still felt. Many organisations are copying the strategies used by larger economies and European businesses to emerge from the market downturns.

There still exists some naivety that things can return to the levels of boom activity that were especially evident in northern Bucharest and other larger cities in the country. However, it is clear that the current market will not allow these times to return anytime soon, and the lessons that will inevitably be learned during a more prudent market resurgence may go a long way to sustain a period of growth for longer than before.