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Published by the CIPS Network of the National Association of REALTORS®
First Quarter 2003
Advice to Investors in Eastern Europe
By Norman Flynn, CIPS
With opportunities for domestic investors in the U.S. increasingly difficult to find, and yields lower each year, many clients and practitioners are wondering if it is time to look to Eastern Europe for real estate investment. This is particularly true when considering that four or more of the countries in this region are expected to join the European Union (EU) in the next two to four years. (See item on page 11.) Because of this, there is an expectation that current prices in the emerging markets of Central Europe and the former Soviet Bloc offer an aggressive investor some potential. A shrewd eye and an early entry into these markets could possibly yield windfall profits. Although there are prospects of rational profits in these markets, it is not without risks.
Restrictions on Foreign Transfer
It is safe to say that there is no country in this region that doesn’t have some restrictions on foreign ownership of land and other forms of real property. These can range from a complete prohibition of foreign ownership—as in Ukraine—to a requirement to set up legal entities within the country or to partner with a resident before land transfer is allowed. In addition, in countries where access is somewhat easier—as in Hungary—there are still permits required and permission to be given by national ministries, and in some instances local ministries.
Even where land can be bought with limited restrictions and issues—for example, in the case of restored land in Slovakia and in parts of Poland—there is significant nationalistic feeling supporting unwritten restrictions to ensure control of the land, and hence national destiny remains with the nationals in those countries. This is particularly true in countries like Poland that suffered invasion and occupation during and after World War II.
Ascending into EU Opportunity
Some investors see opportunities in countries now seeking membership in the EU to buy land at a very low price, and, at the same time, to benefit from the agricultural subsidies made available by the EU elsewhere in Europe. The current agricultural subsidy in Austria on a per annum basis, for example, is equal to the cost of the land in Poland. By all accounts, the EU is unlikely to maintain the same subsidy levels in newly admitted countries that it has through Western Europe. Also, some countries now coming into the EU, such as Poland,
have determined that it would be more desirable to lease land rather than to sell it.
Poland has 2 million farms, but 1.2 million of them are smaller than 17 acres, and produce only enough to feed the farmer and his family. Of the remaining 800,000 farms, there are only about 100,000 that produce on a commercially viable scale. After the collapse of Communism in 1989, Poland’s democratic government created a new agency to manage and ultimately privatize 11.3 million acres of statecontrolled agricultural land. The Agricultural Property Agency opened its doors in January 1992. Of those 11.3 million acres, fewer than 80,000 have been sold to foreigners. Only 427,000 acres have been leased to foreigners. The terms of some of these leases are fairly onerous, and some foreign farmers are reported to be abandoning their leases to return to their own countries.
Land for Speculation
There are some opportunities for speculating in land particularly in urban settings in the region. Developers seeking entrance into what they believe to be extremely profitable upside markets are focused on the central cities and major capitals for residential blocks, hypermarkets, supermarkets and other commercial entities. Urban land is easier to acquire than farmland, although with similar levels of restriction.
The difficulty here is to accumulate a sufficient number of acres to make a purchase viable, and to meet necessary government restrictions to rezone the land for high-end commercial use. Typically, additional infrastructure is required which is also very expensive.
One of the risks associated with re-entitling land in these markets is dealing with countless bureaucracies and endless approval processes, many of which have been corrupted by a bureaucracy so underpaid that bribery is a storied way of doing business. Understanding how and when to move the process forward is critical to success.
Title Questions
Clarity of registration and a clear cadastral system is still wanting in most of the region. Some countries have made great progress in this area, such as Hungary, which has a very sophisticated system. Others are still struggling to define registration methodology and bring to the market a transparent recordation of ownership. While some title companies have been working to establish a title insurance industry in the region, none has successfully done so at this writing. Stewart Title from the United States has demonstration projects in Poland, Hungary and Slovakia and is hoping to develop methodology that will be transportable to other countries of the region.
At the moment, title insurance does not exist. Most countries in the region rely on attorneys and a notary public to review documents before recording an interest in the property. While nationals are reasonably comfortable with this looser form of documentation, most Western capital investors are reluctant to make substantial investment with this rather lean assurance of their title or ownership. The court systems are also severely underdeveloped which makes it difficult to impossible to have reliable recourse in the event there is a title dispute.
Top Opportunities
The top opportunities in the region can probably be grided in the following manner:
- The Central European countries that are closest to assession into the EU (Poland, Czech Republic, Slovakia, Hungary, Slovenia and in some instances, Romania) are likely to have the more civilized real estate and legal environments in which to do business.
- Land speculation and building development opportunities exist in these markets and are less overbuilt outside of the major cities of Czech Republic, Poland and Hungary.
- Urban land and “underdeveloped” real estate that could benefit from Western know-how could provide opportunities in almost all markets.
- Look for opportunities where nationals are investing in themselves. For years, there was massive capital flight out of the region and virtually no banks that would lend for real estate purchases. This trend is slowly reversing itself. Look at mortgage rates and terms, as well as local investment trends to identify the “lower risk” markets to enter.
- Agricultural land, while appearing to be attractively priced, is still very difficult if not impossible to acquire (Russia recently put a prohibition on the foreign purchase of agricultural land). These are probably hangovers from the former collective farms and the mentality that all land should belong to the state and be available for the general good of all of that country.
Summary
Central Europe and the former Soviet Bloc are potentially very good places for people to invest their capital. They represent, in the European environment, a market that is seriously under priced when contrasted with improved and unimproved real estate in the Western markets. It is clear that in the future these prices will gain more equilibrium especially as these countries ascend to the EU. There is little currency risk, as most pricing is pegged to the dollar. As the EU’s influence grows in the region and the euro stabilizes against the dollar, the euro could well become the currency fluctuation hedge in these markets.
The risks involved in reaching for these investment opportunities are many and varied. Every investor should exercise extreme due diligence in these marketplaces. The phrase “caveat emptor” or “let the buyer beware” must be an investor’s mantra. They should be aware that the rumors, innuendos, and stories of corruption, not only within the bureaucracy but also in the general population, can be become painful reality. As a consequence, it behooves any investor to find suitable and strong partners that will be identified by the work of a strong team
that should be put together before any acquisition is seriously considered.
How to Approach this Opportunity
If you are interested in investing in Central and Eastern Europe, here are a series of steps you should follow to ensure the lowest risk and the highest yield possible for you:
- Hire first-rate, internationally recognized, legal representation with an office in the country in which you are interested in investing. Rely on their judgment and data on recent legal regulations and restrictions on the market you wish to enter. Get guidelines and directions as to what permits and permissions are required to acquire in those markets.
- Seek out a local real estate professional to assist in property identification and entitlement. Check your CIPS Network directory, “Who’s Who in International Real Estate,” or go to the CIPS Web site at www.realtors.org/international for a fellow CIPS in the region. Each country in Eastern and Central Europe now has a professional association that adheres to a code of ethics, has educational opportunities, and recognizes the competence of their most skillful practitioners. You can find a list of NAR Cooperating Association Partners at the NAR International Web site. These associations will provide you with a list of professionals that would have expertise in the type of property that you are seeking. Interview two or three of the top players in selecting your representative in purchasing of these properties.
- Obtain collateral services. With the help of your attorney and real estate professional, obtain advice on what valuer, notary public, accountant, tax specialist should be retained to help evaluate property acquisition opportunities. In addition, this team should help select a partner where partners are required and/or help create the necessary legal entity to acquire the property.
- Identify professional property management if you intend to be an out of country owner. There are some professional property managers in Poland, Hungary, Czech Republic, Slovakia and Russia that have actually developed sufficient company expertise to provide Western level management. Unfortunately, in other countries, the property management industry has yet to emerge and, as a consequence, the common areas in most properties are substantially below Western standards or those of any Western investor. To be comfortable, therefore, it is important that you assess the qualities and capabilities of the property management industry within the country in which you are seeking to invest.
Norman D. Flynn is Chairman of the Board of the International Real PropertyFoundation (IRPF). He is a past-president of The National Association of REALTORS® (1990). He has actively practiced real estate since 1970 and holds the professional CIPS, CRE, CRB and GRI designations. He has traveled and worked extensively in Eastern Europe for the last 10 years and has presented counseling programs in the region.
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