Real estate developers have had a memorable year. The expected value-added tax (VAT) increase on housing construction (from 5 percent to 19 percent in 2008), coupled with low interest rates on mortgages created record demand for construction. The boom is expected to continue, but the rosy outlook has been threatened by an interest rate hike and talk of keeping the housing VAT at its current level. Roger Dunlop, CEO of Quinlan Private Golub, talks with The Prague Post about what these moves mean for his industry.

Finance Minister Vlastimil Tlustý wants to label all housing as "social housing," which would keep it in the 5 percent VAT bracket. Are you afraid that this initiative could reduce the boom in the housing market in 2007?

Tlustý says developers will cheat by creating small units that can be labeled "social housing," only to convert them into larger apartments later. Do you think that will happen?

It is difficult to predict what might actually happen, but naturally there is a possibility of this type of thing. However, I would anticipate some form of control measures would be brought in to try and prevent this.

So it seems as though there will be cheating either way: by the government labeling everything as "social housing" or developers creating a loophole.

It is necessary to consider the reasons behind the problem. We are facing a substantial increase in the potential cost of residential units which fall outside the "social" definition. This additional tax will have to be paid for by either the developer or by the buyer. If it is the former, then developers will have to change their business models drastically. If it is the latter, then it has the potential to make homes less affordable and slow sales.

Which VAT level would you lobby for?

It is always difficult to come down on a specific level, but as a developer I want certainty in many of the variables that exist in the development process, and VAT is just one of these variables. The discussion and lack of clarity as to what might or might not happen is not positive and has the potential to distort the market.

How much are developers affected by the delay in any decision on the VAT?

The continual uncertainty makes the assessment of acquisitions and development decisions harder. It means that there is a potential financial and structural change coming, but when, how and to what extent is not known. The fact that there is still discussion means that we have to make assumptions, which we hope are right. Potential negatives in the market are varied, but the biggest potential problem, as I see it, is one of possible distortion of levels of activity in the short term, which would overinflate sale prices to unsustainable levels and lead to a dramatic slowdown and possible correction in the market.

Is there a danger that further expected interest rate increases on mortgages could become a bigger obstacle for the housing sector than the possible VAT hike?

The residential market is fundamentally driven by consumer confidence. The levels of interest rates and their likely upswing will make the cost of servicing a mortgage higher. In the short term, I feel that the VAT issue could produce an increased level of activity in the market, either until it is clear what will happen or it is implemented. The levels of the interest rates will have a long-term effect on the market.

Is there any danger of speculative trading on real estate anytime soon? Or is the demand already speculative?

There are local purchasers, some of whom are investors and some who actually are purchasing the property to live in as well as looking toward the long term. There are also foreign investors active in the market. They are all in some manner speculating that the value of property will be going up — a good speculation.

Housing prices in this country are still below the EU average. When do you think prices here will match the average?

I think that there will be some time before we see the Czech average prices reaching the EU average. However, it must be remembered that the EU average itself is distorted by some very expensive markets. As to when this will be, it is dependent on a whole series of factors such as economic growth, inward investment and sentiment.

Why do you think it is that, despite the current lower prices, more foreigners aren't demanding Czech real estate?

In terms of levels of foreign investment, there is interest from a wide range of foreigners. However, there is a split in this market between second-home owners who are looking for a resort type destination and the serious investors looking for capital growth.

The government will open its labor market to Romania and Bulgaria when they join the EU Jan. 1. Many construction companies still employ illegal workers, helping them keep low wages. Isn't there a danger that the opening of the labor market will reduce the amount of illegal workers and increase costs?