Börsiteade

Pealkiri

Arco Vara Interim Report (unaudited) for the 1st Quarter and 3 months ended 31 March 2014

Teade

General



Arco Vara AS (hereafter also ‘the parent company’ or ‘the Company’) and other
entities of Arco Vara group (hereafter together ‘the group’) are engaged in
real estate development and services related to real estate. Until the end of
year 2013, the group’s three business lines – services, development and
construction had been organised into corresponding divisions. Since year 2014,
the group has two continuing business lines: Service division and Development
division. The group has no plans on independent construction activities in next
few years. 

The Service division is engaged in real estate brokerage, valuation, management
and consulting as well as in short-term investment in residential real estate.
The Service division offers to the group additional value by generating
analytical data on market demand and supply, also behaviour of potential
clients. Analytical data allows to make better decisions on purchase of land
plots, planning and designing, also on timing the start of construction. 

The Development division develops complete living environments and commercial
real estate. Fully developed housing solutions are sold to the end-consumer. In
some cases the group is developing also commercial properties until they start
generating cash flow for two possible purposes: for the support of the groups’
cash flows or for resale. The group is currently holding completed commercial
properties that generate rental income. 

The Construction division provided general construction and environmental
engineering services, operating as a general contractor and construction
manager as well as a subcontractor. In 2013, the provision of construction
services was finished and in February 2014, the group sold its construction
company Arco Ehitus OÜ. Arco Vara is still responsible for completing possible
warranty works, together with Arco Ehitus. 

As at 31 March 2014, the group comprised 21 companies (31 December 2013: 23).
At 31 March 2014, the group had interests in one joint venture (31 December
2013: 1) and one associate (31 December 2013: 1). 

The group regards Estonia, Latvia and Bulgaria as its home markets.



Group Chief Executive’s review



Introduction



By 2014, the entire Arco Vara group is entirely focused on business activities
concerned with production. We do not spend our important resources on resolving
past problems or exiting unprofitable projects. The central question is the
manufacture and sale of new apartments. 

The sales results and profit of the quarter generally meet our expectations.
Due to the sale of shareholding in Arco Ehitus, we wrote the final set of
assets and obligations with doubtful size off the balance sheet of the group.
The real net value of this set depends on how court actions related to Arco
Ehitus are resolved. 

In the future, we will indicate the group’s results based on the principle of
sustainability only for the units of the service and development division. The
service division is profitable. The development division finished the quarter
at zero. Zero is temporarily a good result, considering that the development
division is currently in the process of building two apartment buildings in
Riga and Sofia, with a total of 17,000 square metres under construction, and
there are no sales. We will completely beat the past gap in the production and
sales chain from the fourth quarter onwards, i.e. this is when the development
division should show stable sales revenue and stable sales revenue is in turn
based on the development division constantly working on obtaining immovables
which suit residential real estate development, obtaining construction rights,
designing and contracting construction. 

The Service Division

The service division is a profitable division with positive cash flows, which
consists of three companies in Estonia, Latvia and Bulgaria, which are
primarily involved in real estate mediation and valuation (Arco Real Estate AS,
Arco Real Estate SIA, Arco Imoti EOOD), two companies in Estonia and Bulgaria
which are involved in real estate management (Arco Vara Haldus OÜ and Arco
Facility Management EOOD). The operational volumes of the service division are
increasing. 

We believe that the increase of transaction activity on the target markets of
Arco Vara is related to the increase of demand for new residential premises,
albeit very moderately. Growth is affected by various factors, including: 

      I.        Increase of the population’s consumer security compared to the
crisis of 2007-2010 in all three countries, which directly influences the
making of long-term investment decisions; 

     II.        The population is concentrating in Sofia, Riga and Tallinn,
which is observed even when the population is decreasing in other parts of the
countries; 

    III.        Relative stabilization of the banking sector, which is
restoring the banks’ need to return to its main field of activity, i.e. create
and increase functional portfolios of mortgage loans, and 

    IV.        the physical amortization of the Soviet residential buildings
and high maintenance costs opposing the consumers’ expectations on modern
residential space and low maintenance costs. 

Growth may stop if the financing conditions worsen significantly or the
consumers’ expectations of the future decrease suddenly. At present, there is
no indication of such tendencies. 



In regards to current processes in Ukraine, it must be noted that they have a
negligible effect on the domestic markets of Arco Vara, if the processes remain
only in Ukraine. The only influence evident so far is the decrease of
residential real estate consumption (visits, wishes to purchase and rent) by
Russian residents in Latvia. The influence of this consumer group on the group
as a whole is marginal, but their decreased consumption may influence the
demand for real estate of the higher price class in Jurmala and Riga city
centre. The events in Ukraine will influence the business operations of Arco
Vara if it escalates to a level of influencing the economy of important member
states of the European Union and thereby on those Estonian, Latvian and
Bulgarian companies which provide the income to the sectors of population which
are the group’s potential clients. In regards to development products, our
target group is consumers whose income is above the state average, which is
approx. 20% of the population. At the same time, the target group of the
service division is over a half of the population. 

The number of employees involved in the service division grew by 6 in the first
quarter. 

The Development Division

The cycle of the group’s development product from obtaining an immovable with
no right of construction, planning, designing, constructing to the sale of the
final product (apartment, house plot etc.) to the consumer can be measured in
years. The production process of the group has gotten gaps in recent years,
which today manifests in the fact that the products in stock are sold out and
the next final products will be ready to sell from the third quarter onwards. 

The first new apartments will be completed by the third quarter of 2014 in
Bisumuisa, Riga (GSA 960 m2 i.e. 960 square metres of apartments on sale) and
by the fourth quarter in Sofia, Manastirski stage II (GSA 12,500 m2). Based on
data of the preliminary sales, we predict both projects to be sold out by the
end of 2015 at the latest. The preliminary sales of Manastirski stage II
(contracts under the law of obligations secured with client deposits) exceed
40% of the sales volume of the entire stage II as of the day of the quarterly
report. Preliminary sales began on 15.11.2013 together with the start of
construction. 

The group continues simultaneously with other half-finished developments. In
the first quarter, the group obtained plots of land with rights of construction
in Harku rural municipality at Instituudi tee 7 and 9 (30 apartments, initial
GSA 2,100 m2) and the detailed plan of a terraced house at Lehiku tee 23 in
Tallinn was initiated (initial GSA 1,100 m2). Works also continue with the
detailed plan of Paldiski mnt 70c, Tallinn, the detailed plan of Liimi 1b and
obtaining other construction rights or designing conditions. The group will
start the construction of Manastirski stage III (existing valid construction
rights of apartments on sale with GSA of apartment space on sale as 6,700 m2)
after the 80% sale of apartments in Manastirski stage II. All above numbers do
not include underground construction rights or underground construction
volumes. 

We will also review the incoming suggestions for new development projects in
Tallinn, Riga and Sofia. The goal of the activities of all companies in the
development division is to achieve the rate of return on share capital of at
least 20% per year. We do not spend resources and do not take risks with
projects with a lower expected rate of return. 

The Loan Burden

The loan burden has increased compared to the end of 2013, but the increase is
caused by funding designing or construction works, i.e. all loans are taken for
the purpose of production and loans are not taken to cover general expenses,
make interest payments or for refinancing. 

The group’s relationship with credit institutions is good. The construction of
Manastirski stage II is completely funded by UniCredit Bulbank. Less than 30%
of the loan limit is being used, because it has also been possible to fund the
construction with preliminary sales deposits received by clients. The
completion of Bisumuisa-1 apartments was funded by the group’s own funds until
the end of first quarter and it is planned to conclude a loan contract with a
Latvian credit institution for the final works in the second quarter. 

Over 75% of all loans of the group are formed by a loan from Piraeus Bank,
granted for the construction of the building at Madrid Blvd in Sofia.
Negotiations are currently in progress for refinancing the loan contract and
concluding it as an investment loan with one principal repayment. The
intermediate results of the negotiations are formalized in writing both by the
bank and by the borrower Arco Invest EOOD, the further progress of the project
mainly depends on the activities of Arco Invest EOOD and the group. Earlier, we
stated that the borrower and the building’s owner Arco Invest EOOD is currently
in violation of the loan contract. The entire principal amount of the loan,
12.1 million euros, must be returned by the middle of 2015 pursuant to the
valid contract, and monthly repayments to the sum of 150 thousand euros had to
begin in January 2014. Piraeus Bank has expressed its willingness to extend the
loan contract by four years if the group decreases the principal amount of loan
by the sum of up to 1.5 million euros. From the group’s point of view,
decreasing the principal amount of loan is reasonable, considering the cash
flow from rent produced in the building at Madrid Blvd since 2013, to the sum
of nearly 1 million euros per year, and the conservative selling value of
apartments in the building which are unsold so far (34 units, GSA 3,800 m2) or
the additional rent revenue received upon the completion of apartments and
renting them out. The group’s parent company does not provide the surety to the
loan obligation of Arco Invest EOOD to Piraeus Bank, nor does any important
development company, and the loan has no other sureties. The group’s possible
loss in the worst case scenario, which is the sale of the Madrid building in
executive proceedings, should not exceed 500 thousand euros. At present, we are
focusing on obtaining a profitable result and depending on the willingness of
the shareholders, this seems realistic. 

Involving Capital

The biggest challenge of 2014 continues to be involving capital, the
preparations for which began in March. 

At present, the group has found the means to finance obtaining the immovable at
Paldiski mnt 70c, Tallinn, and its planning procedure, construction of
Manastirski stage II in Sofia (also called Manastirski AB) and the completion
of apartments at Bisumuisa-1 in Riga. The sales revenue for development
products in Latvia and Bulgaria will start coming in the third quarter at the
earliest. Therefore, the group must “run on fumes” to fund its other
development activities until the first quarter of 2015. 

So far, the group has managed it, but it has also reached the critical limit of
capabilities. Most development projects in the portfolio of Arco Vara or some
development projects waiting to enter Arco Vara deserve a capital investment or
will simply stay in stock until cash is released from other Bulgarian or
Latvian projects. 



The involvement of capital in 2014 has three important reasons.

Firstly, the management assesses that in order to start the construction and
sales on the immovable at Paldiski mnt 70c in 2015, the bank loan of 1.4
million euros which was taken to fund the obtaining of this immovable must be
paid back. Also, enough owners’ equity must be invested for the immovable’s
utility connections, constructing access roads and designing, so as to
construct the apartment buildings with the bank’s finances. The local
government approved the detailed plan on 9 April 2014 and if the product is to
be released on the market in 2015, works need to continue immediately. An
alternative for the development of Paldiski mnt 70c is to freeze it and wait
until finances are released from Manastirski stage II in Bulgaria, which will
happen in the second quarter of 2015 at the earliest. This, in turn, means that
the group will lose one year with the designing and start of construction. The
group’s profitability will also worsen again, because stationary assets spend
rather than produce. 

Secondly, the management finds it reasonable to involve capital to retain
control over the building at Madrid Blvd as an object which produces rent
revenue and as additional revenue, realize the unsold apartments in the
building. The group will only invest to decrease the principal part of the loan
on the building pursuant to negotiations with the bank if there is the
necessary owners’ equity for this (there is none today). The rate of return of
owners’ equity additionally placed in the Madrid building must be at least 20%
per year. Considering that the rent revenue of the building is nearly 1 million
euros per year and the interest expenses calculated on the principal part of
loan are below 700 thousand euros per year, capital investment with this rate
of return is possible, because the building’s owner, Arco Invest EOOD, should
be capable of paying the parent company the difference between received rent
revenue and interest expense paid to the bank. Calculations do not include the
possible sales or rent revenue from apartments currently unsold in the building
at Madrid blvd, which would make the project even more profitable. An
alternative is to sell the building at Madrid Blvd quickly or as part of
executive proceedings, but this way of selling property is generally not the
most profitable for the seller. 

Thirdly, the group has negotiated with various people for obtaining various
development projects in Tallinn and Riga, the designing and construction of
which can begin immediately (construction rights exist) and the predicted rate
of return of owners’ equity of those projects meets the group’s expectations. 

If capital involvement is not successful, the group needs to fund all its
developments other than Manastirski and Bisumuisa either with foreign capital
or freeze other developments until cash is released from the developments of
Manastirski stage II and Bisumuisa-1. The possibilities of involving foreign
capital are complicated, because the owners’ equity, which minimizes the risks
of foreign capital, is already largely tied up and development should not be
owerpowered. Actually, Arco Vara is currently in a circle of slow development,
and the right way of breaking out of it is increasing owners’ equity by
involving capital. 

To stabilize the development process, sales revenue and profits, a situation
must be achieved where active work is taking place simultaneously in different
development projects at different stages of completion. At that, the developed
immovable, construction rights, utility connections and the construction
project should always be obtained or created with the funds of the group’s
owners’ equity, not with a loan. The group violated this general rule by
obtaining the immovable at Paldiski mnt 70c in 2013, for which it used a bank
loan, but that decision was extraordinary in many ways. The main thing was to
restart developments of volume and a prospective land bank had to be created
for that purpose, but there was not enough owners’ equity for this. 

Summary

The year has begun according to plans. The first quarter has been profitable
thanks to the sale of Arco Ehitus, but the second quarter will generate a loss
of approx. 0.3 million euros. The volumes of the service division are
increasing and profitable, but insufficient to cover the lack of sales revenue
of development products in the first and second quarter. Sales revenue from
development will begin to generate only in the third quarter and will again
exceed the level necessary for the group to profit in the fourth quarter. The
management does not change the turnover prediction of 9 million euros and
profit prediction of 0.5 million euros, predicted for 2014. The development
projects being constructed today enable to earn sales revenue of up to 10
million euros in the years 2014-2015. Development projects with construction
rights are added to it. For the sales revenue of the company to exceed 10
million euros and the profit to exceed 1 million euros in 2016 and beyond, the
owners’ equity of Arco Vara must be increased in 2014 already, and the involved
money must be placed in development. The involved sum should be between 3-5
million euros. 





SERVICE DIVISION

In Q1 2014, revenue of Service division was 845 thousand euros, that included
intra-group revenue of 127 thousand euros (Q1 2013: 597 thousand and 62
thousand euros, respectively). Revenue of Service division is increased by as
much as 42%. Sales growth came primarily from Latvia and Bulgaria, there first
quarter revenue from main activities of real estate agencies, brokerage and
valuation of real estate, increased by 44% and 132%, respectively. The sales
growth of 17% for Estonian real estate agency was more moderate. 

Revenue of real estate agencies from brokerage activities

                       Q1 2014  Q1 2013  Change, %
--------------------------------------------------
In thousands of euros                             
--------------------------------------------------
Estonia                    334      285        17%
----------------------         -------------------
                      ---------                   
Latvia                     293      203        44%
----------------------         -------------------
Bulgaria                   146       63       132%
--------------------------------------------------
Total                      773      551        40%
--------------------------------------------------

The revenue growth of Latvian and Bulgarian agencies was caused both by general
increased activity on the market and strongly seizing the market by increasing
the number of employees. There was also significant increase in the number of
brokerage deals and valuation reports, compared to first quarter of previous
year. 

All three real estate agencies ended up Q1 2014 with a small net profit:
Estonian agency’s net profit was 9 thousand euros (Q1 2013: 24 thousand euros),
Latvian agency’s net profit was 17 thousand euros (Q1 2013: 7 thousand euros)
and Bulgarian agency’s net profit was 41 thousand euros (Q1 2013: 7 thousand
euros). 

In addition to brokerage and valuation services, the service division also
provides real estate management service in Estonia and Bulgaria, as well as
accommodation service in Bulgaria. Separate real estate management company Arco
Vara Haldus OÜ started its activities in Estonia from the beginning of year
2014. The revenue from real estate management was 45 thousand euros in Q1 2014,
but only 13 thousand of which was external revenue (Q1 2013: 35 thousand and 8
thousand, repectively). Revenue from accommodation services amounted to 15
thousand euros in Q1 2014. 

The number of staff in Service division has been increased to 167 employees as
at 31 March 2014, growing by 6 people during first quarter. 



DEVELOPMENT DIVISION

In Q1 2014, revenue of Development division totalled 397 thousand euros (Q1
2013: 1 205 thousand euros). The decrease of Development division revenue was
due to the sale of properties developed in-group. In Q1 2014, was sold only 2
apartments in Bišumuiža-1 project with corresponding revenue of 128 thousand
euros. Comparable results of Q1 2013 were 14 sold apartments and 1 plot with
corresponding revenue of 882 thousand euros. Operating profit of Development
division was 44 thousand euros (Q1 2013: 379 thousnad euros). The decrease of
operating profit is caused by significantly dropped revenue. 

Most of the other revenue of Development division consisted of rental income
from commercial and office space of Madrid Blvd building in Sofia, amounted to
246 thousand euros in Q1 2014. In Q1 2013, the rental income was 281 thousand
euros, but there was included also revenue of Pärnu Turg OÜ in amount of 46
thousand euros for the first 2 month of year 2013. Pärnu Turg OÜ was sold on 1
March 2013. 

In Q1 2014, was continued construction on II stage of Manastriksi Livadi
project. At the same time with the start of construction, in Novemebr 2013, was
started presale of apartments. And it is turned out to be successful, because
more than 40% of apartments are already covered with pre-agreements. 

In January 2014, were started works for finalizing construction of the last
14-apartment building (GSA of 960 m2) in Bišumuiža-1 project in Latvia, with
estimated term at the beginning of Q3 2014. Two last apartments of previous
stage in the same project are unsold yet, with selleable area of 210 m2. 



As at the end Q1 2014, 2 apartments and 33 parking spaces have not been sold in
the apartment building of Manastirski Livadi C-block (also named as Manastirski
I stage) in Bulgaria. Madrid complex contains 34 unsold apartments and 120
parking spaces. 11 apartments and all parking spaces, out of all unsold Madrid
properties, are rented out. 

In February 2014, the group acquired as an additon to the land bank, two land
plots with building right for 2 apartment buildings (30 apartments with
estimated GSA of 2,100 m2) near Tallinn, at Instituudi tee 7 and 9 in Harku. 

In Bulgaria, the group has a land bank in the form of Manastirski Livadi
D-block (also named as Manastirski III stage), which enables to build an
apartment building with approximately 70 apartments (GSA of 6,600 m2). The
group’s long-term goal is to create a land bank for all three countries which
enables the development of at least 1,000 apartments. At present, the group has
a land bank suitable for constructing about 500 apartments. 

As at 31 March 2014, 4 people were employed in the development division.

Find out more about the projects at: www.arcorealestate.com/arendus.


         Marko Err
         Chief Financial Officer
         [email protected]