Eastern Europe Property

By Kerin Hope and Theodor Troev
Financial Times

Popular television programmes have encouraged thousands of UK investors to buy a holiday apartment on Bulgaria’s Black Sea coast or at a ski resort for half the price of a similar property in Spain.

But the country’s fledgling real estate market is moving beyond the second-home construction boom.

Bulgaria, which is due to join the European Union by 2008 at the latest, has launched eastern Europe’s first US-style real estate investment trust (Reit). These trusts are tax-friendly property funds that have to pay out most of their income to shareholders. The aim is to broaden and deepen the real estate market.

Already well established in France and Turkey, Reits are likely to be introduced as early as next year in the UK and Germany. In both countries, concerns about possible tax losses have delayed the legislative process.

Reits may be listed or non-listed, and are not liable for corporation tax. Tax is only paid on the shareholders’ dividends.

Bulgaria’s finance ministry has opted to give up tax revenues in favour of persuading investors to accept professional management of real estate assets. Its Reits legislation, part of financial market reforms launched by a liberal government, is based on similar frameworks in the US and France.

“As long as the appetite is there for people to buy these things, one of the attractions for government is that you create transparent and free-flowing equity in and out of property markets,” says Mike Prew of Citigroup.

Bulgaria’s fledgling Reits market is still too small to attract attention from big international players. But Reits have become popular with Bulgarian pension and mutual funds, as well as increasing numbers of retail investors, according to local brokers.

The 10 funds listed on the Sofia stock exchange have a combined market capitalisation of around Lev100m, equivalent to about 1 per cent of the bourse total.

“Reits are a bridge between the capital market and the booming real estate market. It’s a narrow one for the time being but this is just the start of the process,” says George Draychev, the bourse executive director. Another six Reits are preparing to list, he says. The sector has gained 44 per cent this year, with daily trading volumes sometimes exceeding Lev2m.

“These funds give good downside protection because of the real assets they hold,” says Vassil Karavainov of BAC-IP, a Sofia-based investment group. The two biggest funds, Prime Property and Bulgaria Reit, both with net asset values of about Lev20m, have already attracted strategic investors from abroad.

Immoeast, a subsidiary of Austria’s Immofinanz which has more than €500m of investment in central and east European real estate markets, acquired 42 per cent of Prime Property earlier this year. Prime Property was set up as a joint venture between Israel’s TBIH, which owns pension funds in Slovakia and the Balkans and Balkan Advisory Company, a Bulgarian investment banking firm.

“Asset prices in Bulgaria are lower than central Europe, so there’s a decent amount of room to grow,” says Alex Bebov, portfolio manager at Prime Property.

Estonia’s Hansa Bank and Danski Bank of Denmark have both taken stakes in Bulgaria Reit, which was set up by First Investment Bank, a Sofia-based private bank.

Todor Breshkov, the chairman, says the fund decided to build a broad-based portfolio, including agricultural land and sites for industrial development “because in a small economy like Bulgaria it’s risky not to spread the investment”.

The local construction industry’s focus on resort developments means that, in contrast with Reits elsewhere, Bulgarian vehicles allocate funds for residential as well as commercial and retail investment.

“Property development in Bulgaria will continue to be based mostly on coastal and ski resorts. But there’s growing demand for modern commercial and office space in Sofia and other cities,” says Robert Jenkin of Bulgarian Dreams, a UK-based property company with resort projects on the Black Sea coast and office developments in Sofia.

Some people have trebled their money in Central Europe and Russia. Can it continue?

By Jenne Mannion
Published: 30 October 2005

If you’ve got a taste for adventure, then head for “emerging Europe”. Those investors who took the plunge in 2002, and opted for funds pushing money in this area, will by now have trebled their stake – and this strong performance looks set to continue.

There have been two key drivers: the accession of eight central European countries into the EU just over a year ago – Poland, Hungary, the Czech Republic, Lithuania, Slovenia, Estonia, Latvia and Slovakia – and a strong economic recovery in Russia.

There are two main funds that specialise in this region available to private investors: the £340m Jupiter Emerging European Opportunities, which celebrated its third anniversary last month; and the £28m Credit Suisse European Frontiers.

A £1,000 investment in the Jupiter fund three years ago (to 17 October) would now be worth £3,154, after charges and basic-rate tax, according to figures from ratings agency Standard & Poor’s. And the Credit Suisse fund would have turned a £1,000 investment into £3,041. The value of both is up by around 50 per cent in the past year alone.

Ingrid Kukuljan, co-manager of the Jupiter fund with Elena Shaftan, says the EU accession is important as it means that Central Europe is far less risky than in the past. Legislation and regulations have been harmonised with those of the EU, leading to better corporate governance.

Mike Lenhoff, chief strategist and head of research at stockbroker Brewin Dolphin, which has recently added the Jupiter fund to its buy list, says these countries aspire to the living standards of the West, which is driving consumption. Meanwhile, their cheap and skilled workforces are helping to attract the overseas investment that will set them on the long-term path to prosperity. Additionally, low taxes and higher spending are resulting in more stable economies.

Gavin Haynes, a portfolio manager at Whitechurch Securities, says economic growth in converging Europe is far outpacing that of the eurozone.

The flipside, though, is that investments are not as cheap as they used to be. “We have already seen a very strong re-rating in the valuations of shares,” he says. “For example, the Hungarian and Czech stock markets currently trade at price- earnings ratios [a measure of company valuations] of over 20 times, compared to 10 times three years ago.”

Russia, of course, remains outside the EU orbit, and political concerns have dominated this market over the past few years.

But Ms Shaftan says the economic backdrop has improved. After reaping the benefits of a high oil price and responsible government policies, the country has current account and budget surpluses.

Russia dominates most emerging Europe funds, says Stephen Marriott at independent financial adviser (IFA) Bestinvest. It currently accounts for 47 per cent of the Jupiter fund, for example. But he says investors need to remember that oil is the backbone of the Russian economy – so price movements in the black stuff will have a big influence on these funds.

“When investing in emerging Europe funds,” he adds, “be aware of the weightings towards specific countries and sectors.”

But Mark Dampier at IFA Hargreaves Lansdown says the opportunities in Russia are not restricted to oil.

“Mortgage lending has not even started in the country, so the growth potential is enormous,” he says. “Mobile penetration in Russia is also a low 70 per cent, and in other republics of the former Soviet Union it is still below 50 per cent. This compares to above 100 per cent penetration in most of Western Europe, so there is plenty of room for catch-up.”

A marked improvement in Russia’s relationship with the West has also furthered the outlook for its exporting companies.

But Mr Haynes at White-church warns that despite these positive factors, Russia carries risks. “Areas such as banking still require reform, while scandals like the one at [oil giant] Yukos highlight the need for better corporate governance.”

The consensus among investment specialists is that funds backing these areas can continue to deliver strong growth – though Mr Haynes feels the “easy money” has probably already been made. It is unrealistic, he explains, to expect such strong returns to be repeated in the short term.

That said, he believes there is still good reason to include the funds within a diversified portfolio. “These markets are suitable for investors seeking long-term growth opportunities [of five to 10 years or more].”

Philippa Gee at IFA Torquil Clark points out that if you already have a managed fund, it is likely you will have an allocation in this area. “For someone with a well-diversified portfolio, 5 per cent is a sensible weighting.”

Mr Dampier at Hargreaves Lansdown agrees, but says investors should be prepared for a bumpy ride, because these markets can be extremely volatile.

If you’ve got a taste for adventure, then head for “emerging Europe”. Those investors who took the plunge in 2002, and opted for funds pushing money in this area, will by now have trebled their stake – and this strong performance looks set to continue.

There have been two key drivers: the accession of eight central European countries into the EU just over a year ago – Poland, Hungary, the Czech Republic, Lithuania, Slovenia, Estonia, Latvia and Slovakia – and a strong economic recovery in Russia.

There are two main funds that specialise in this region available to private investors: the £340m Jupiter Emerging European Opportunities, which celebrated its third anniversary last month; and the £28m Credit Suisse European Frontiers.

A £1,000 investment in the Jupiter fund three years ago (to 17 October) would now be worth £3,154, after charges and basic-rate tax, according to figures from ratings agency Standard & Poor’s. And the Credit Suisse fund would have turned a £1,000 investment into £3,041. The value of both is up by around 50 per cent in the past year alone.

Ingrid Kukuljan, co-manager of the Jupiter fund with Elena Shaftan, says the EU accession is important as it means that Central Europe is far less risky than in the past. Legislation and regulations have been harmonised with those of the EU, leading to better corporate governance.

Mike Lenhoff, chief strategist and head of research at stockbroker Brewin Dolphin, which has recently added the Jupiter fund to its buy list, says these countries aspire to the living standards of the West, which is driving consumption. Meanwhile, their cheap and skilled workforces are helping to attract the overseas investment that will set them on the long-term path to prosperity. Additionally, low taxes and higher spending are resulting in more stable economies.

Gavin Haynes, a portfolio manager at Whitechurch Securities, says economic growth in converging Europe is far outpacing that of the eurozone.

The flipside, though, is that investments are not as cheap as they used to be. “We have already seen a very strong re-rating in the valuations of shares,” he says. “For example, the Hungarian and Czech stock markets currently trade at price- earnings ratios [a measure of company valuations] of over 20 times, compared to 10 times three years ago.”

Russia, of course, remains outside the EU orbit, and political concerns have dominated this market over the past few years.
But Ms Shaftan says the economic backdrop has improved. After reaping the benefits of a high oil price and responsible government policies, the country has current account and budget surpluses.

Russia dominates most emerging Europe funds, says Stephen Marriott at independent financial adviser (IFA) Bestinvest. It currently accounts for 47 per cent of the Jupiter fund, for example. But he says investors need to remember that oil is the backbone of the Russian economy – so price movements in the black stuff will have a big influence on these funds.

“When investing in emerging Europe funds,” he adds, “be aware of the weightings towards specific countries and sectors.”

But Mark Dampier at IFA Hargreaves Lansdown says the opportunities in Russia are not restricted to oil.

“Mortgage lending has not even started in the country, so the growth potential is enormous,” he says. “Mobile penetration in Russia is also a low 70 per cent, and in other republics of the former Soviet Union it is still below 50 per cent. This compares to above 100 per cent penetration in most of Western Europe, so there is plenty of room for catch-up.”

A marked improvement in Russia’s relationship with the West has also furthered the outlook for its exporting companies.

But Mr Haynes at White-church warns that despite these positive factors, Russia carries risks. “Areas such as banking still require reform, while scandals like the one at [oil giant] Yukos highlight the need for better corporate governance.”

The consensus among investment specialists is that funds backing these areas can continue to deliver strong growth – though Mr Haynes feels the “easy money” has probably already been made. It is unrealistic, he explains, to expect such strong returns to be repeated in the short term.

That said, he believes there is still good reason to include the funds within a diversified portfolio. “These markets are suitable for investors seeking long-term growth opportunities [of five to 10 years or more].”

Philippa Gee at IFA Torquil Clark points out that if you already have a managed fund, it is likely you will have an allocation in this area. “For someone with a well-diversified portfolio, 5 per cent is a sensible weighting.”

Mr Dampier at Hargreaves Lansdown agrees, but says investors should be prepared for a bumpy ride, because these markets can be extremely volatile.