Eastern Europe's property market - investors should tread carefully

If the estate agents' blurb is to be believed, Eastern Europe is the golden property investment at the moment. The Western European market is slowing down and returns are slipping to around 5% per year, while Eastern European markets are still steaming ahead.

A closer inspection confirms this, but with some caveats: investors should be aware that socialism left behind some messy ownership situations, property laws and mortgage practices very different from the ones in Western Europe, and bureaucracy which likes dragging its feet.

Once that is taken into account, some very good returns are to be had in the region.

The route which offers the highest rewards and highest risks is property development. Martin Thorpe, a UK-based property developer currently involved in Croatia said he prefers going it alone, rather than through estate agents or funds because "you retain your independence, retain the profit and you don't have to consult with anybody on things like layout and design." Thorpe, who previously developed property in Britain, France and Spain says the downside is that paper work, building permits and other challenges like getting connected to local water and electricity supplies, take twice as long as one would expect, meaning that he had to recalculate his initial forecasts for returns.
 
"The planning system is so slow, a year takes two years. A building permit takes three to four months and then if you want to make any changes you have to resubmit and start all over," he says. In addition, Croatia has been getting more strict with its planning regulation because it wants to avoid having the coast filled with high rises, like in Spain, and it passed a swathe of new laws, such as restricting new building on the coast to three floors, which are only coming into affect now. "This means that you frequently deal with people in the planning department who are not quiet sure about the new rules," adds Thorpe.

But overall the hassle will be worth it in the end and he estimates his investment of €1.5 million will return roughly another €1 million.

However, both Thorpe and Nick Barnes, research analyst at estate agency Knight Frank, note that Croatia's moment as the golden investment opportunity is almost over. A few years ago, before tourists started coming back in large numbers, it was still possible to buy land or property cheaply, but now the market is almost overbought. "Croatia has definitely been discovered," Barnes says, adding that prices for property and land in tourist hot spots such as Dubrovnik are no longer cheap. It is still possible to find bargains off the beaten track, but such places might be much more difficult to sell to foreign buyers or rent to tourists.

For a similar type of property - holiday homes, retirement homes and property aimed mainly at the tourist market - Bulgaria is currently one of the best picks in the region. It has a beautiful beachfront stretch on the Black Sea coast, and it is also developing its ski resorts in its mountainous interior. Property returns this year are expected to be around 15%, according to Barnes. This is higher than in countries which have already joined the European Union like Poland, Czech Republic and Hungary, but also means that the legal system is not yet in line with the rest of the EU. Although Bulgaria is making strides towards improving its legal system in line with the European Union's standards, which it hopes to join soon, a recent report by the Economist Intelligence Unit was less than flattering about the actual functioning of the system. The report noted that in practice the judiciary is weak and there is persistent corruption. The new government has made several high-profile arrests in recent years to show that improving property rights is high on its list of priorities.

Separately from the legal side, it is still not as easy to arrange financing and other paper work as it is in Western Europe, although should be less of a problem for institutional investors with a track record of investing in Eastern Europe. However, for those seeking to add fast growing East European commercial property to supplement Western European investments, expert legal advice is necessary to avoid red tape 'entanglements.' It is not uncommon to find that property, particularly city property, was confiscated by the state during the communist period and that relatives of owners are in disputes over the rights. It is also not uncommon for property to be owned by half a dozen of owners, perhaps children and grandchildren of original owners and that to acquire it requires consent from all of them.

In the former Yugoslav countries Slovenia, Croatia, Serbia, Bosnia and Macedonia, things are further complicated by the fact that during the break-up of federal Yugoslavia, certain laws were brought in which made it difficult for nationals of some of the former Yugoslav republic to own property in the new states. This means that, for instance, Serbs who lived in Croatia up until 1990 and were caught up in the conflict became foreign nationals and perhaps had to leave the country, while their property could have been moved into by somebody who has no legal right to it. Trying to disentangle such a situation has caused many a headache to private property buyers, but could also impact on some commercial real estate transactions.

Bulgaria is involved in a number of restitution cases to do with property that was confiscated either during World War II or during the communist period, as are a number of other countries, with the notable exception of the Baltic states. 

An official at Bank Austria Creditanstalt, who asked not to be named, says that with such messy situations the bank can not afford to provide mortgages. "Our problem is that the land deeds are not sorted and it is not clear who is the owner. In theory, if we give out a mortgage we become the owners of the property and if the situation is not clear we can not afford to get involved."
 
But as countries get ready for EU accession most of them are making sure that their laws and regulations are investor-friendly.

Poland, Hungary and Czech Republic are more regulated and typically attract a different type of buyer - those interested in commercial and city rental property. Flats in central Prague or Warsaw cost three or four times less than similar property in Paris or Berlin and are expected to bring in returns of around 10% this year. Those three countries, which have joined the European Union last year, have probably gone the furthest in terms of the developing the banking system - most banks are now owned by big Western banks - and the simplicity of their legal procedures. Investment returns for EU newcomers compare well with Western Europe, and particularly the two favoured markets - France and Spain - in which growth has stalled.

"What for instance happened in Spain, which was an excellent investment market up until last year, is that it became overplayed. Parts of the country where people bought for the sun and the great climate are now congested and not as attractive. Parts of Costa del Sol are a prime example and we had problems shifting property there in the last 18 months," says one specialist in Spanish real estate. This also goes some way towards explaining the current interest in Eastern Europe.
 
Russia remains one of the more exotic markets in the region, and as one investor told this magazine, "for most people a bridge too far." For one, this is because the country doesn't have a booming tourist industry to attract those who are buying retirement homes abroad and secondly, because several financial crises in the 1990s left investors hugely sceptical about the financial stability of the country. However, some investors argue that there are interesting opportunities, mainly in Moscow on the buy-to-let market and commercial property market, which, with the right research, could provide good yields. Nick Barnes of Knight Frank explains that Moscow could provide good capital growth and rental income. This is perhaps a better investment for larger investors who don't necessarily need high margins over a short period of time to make up for their investment, rather than for smaller investors looking for a quick return.

Other interesting areas include the Baltic states - Latvia, Estonia and Lithuania, which are all forecast to rise in double digit numbers this year, particularly in the city rental market. In the short term, those markets are set to blossom, but some market analysts are sceptical about whether they are a good a long-term investment. Latvia is seen as one of the best up-and-coming regions but those investing in buy-to-let property should be aware that domestic population growth there is stalling and rental demand may slow down over the coming years.

A good starting point for establishing what will be a good investment is to look at the countries' growth forecasts, domestic demand and demographics. Typically economic growth goes hand in hand with rising property prices and for most of Eastern Europe forecasts are for faster growth than in the West. But it also depends if the property is bought with foreign buyers or local buyers in mind, and if the answer is local buyers, than domestic population growth forecasts are crucial.