(AG Real estate) Weak Points of Real Estate Business in the countries in transition

Petar Petrović, dipl. ing. arh

General Manager

EFG Propertyes Services d.o.o.

[email protected]

One of the most important factors for developing economies is inward investment which is dependant on a stable banking and financial system. Requirement for a stable banking and financial system is security for lending. The lack of securities, a reality of countries in transition, results in unfavorable lending terms. This results to unreal value of final products, which leads the market to unreal state of affair. While raising a credit, property is used as a mortgage, from where we can conclude that a functioning real estate market is a prerequisite for progress.

The importance of a real estate market in developing countries is often overseen by their governments. Although they do not drive its development, they are required to make provisions for its advancement. By analyzing these provisions we can evaluate a country’s real estate market and hence answer the question of a country’s risk. The main provisions for the functioning of a real estate market are:

• Legal base for ownership;
• Fair tax system;
• Sound contractual law and dispute resolution;
• Planning and building regulations;

Developments of major cities of the countries in transition are initial driving force for real-estate markets. Withal, one of the major factors which prevent such developments is a problem of land ownership. Many companies lose interest when they discovered the legal framework and procedures surrounding ownership, transfer of rights and the development process in general. In Srebia, primary land has already been ‘leased’ to the local development giants. Those companies have already been encountering problems even before privatization regarding financial liquidity and intellectual know-how. The privatization process is a most secure procedure for potential investor and good source of income for a government to a generally empty budget. Hence, most governments are quick to create a framework for its execution.

All these difficulties add to risks that most foreign developers are not willing to take. The foreign developers that are present in the developing markets are high risk orientated and use to such market conditions. Similar profiles are local investors who are looking to place their money in real estate, without much consideration for return or profitability. The results of such a real estate market are, yet again, uncompetitive prices of executed buildings.

Another factor that greatly influences developments and add to the above issues are taxes. The level of taxes are often set high in changing markets, as they create much needed revenues to governments. However, this leads to distortion of the economic value of the end product. For example: the norm for property sale tax is 1%. In Serbia it is 5%, unless it is a new construction in which case the tax is 8 or 18% depending on the property type. Further, in Serbia, supplement for infrastructure development paid for new construction often offsets the development costs, as it can reach over 30% of the project value.

Legal technical aspects

Contractual law and mechanism to resolve disputes is in the heart of every real-estate market. Most countries in the region had a weak legal system of set codes which was ‘developed’ under non competitive real estate market circumstances. The process of adapting the legal framework, is a long and ever evolving process that is continually happening in all the real estate markets.

Until the complexity of legal issues that surrounds land ownership, transferral of rights, legal framework, the bureaucratic procedures that developers face, high taxes and substitute are resolved, the real estate investments will be considered a risk.

The restitution process is far more complex and governments are reluctant to deal with it at the early stages of the transition period. A series of problems arise: identification of ‘original owners’; property used by someone else for many years; new ownerships acquired lawfully; type of compensation, establishing the value of compensation and resources for compensation. A number of countries introduced statutory schemes dealing with rights of former owners. In Serbia, this is a subject that has been talked about for some years now and only recently we have seen first effects. The government is at an infant stage of dealing with this issue, which is best seen from continual privatisation of properties for which former owners claim ownership rights too.

Secondary issues, although very important for the future of the country as they control development and prevent undesirable social or environmental consequences, are planning and building regulations. These policies are most often undermined by the government bodies and rarely develop under their lead, although there is a legal framework for the same. The role of private sector, once Professional Societies mature, will be to develop a legal, valuation, property management and property brokering skills well equipped to influence government policies. The result is a climate of regulation, professionalism and consistency in a real estate market.

Know-how references

In the west, systems have evolved and developed over a long period of time, adapting to changing circumstances and changes in law and practice, whereas in the new democracies, solutions have had to be found almost overnight. It is a fact that the bureaucratic habits of the past systems are slowed down considerably the progress of the real estete market. The system is often proved to be slow, inflexible and cumbersome. The inflow of western companies and investments are already having some effect in speeding up the development process and this will increase as the market develops and the profession grows.

To conclude, the real estate market exists in all countries in transition, but the reality that surrounds them is somewhat different than in the west and the companies that are willing to operate in these markets have to understand these realities and only then will they manage to operate successfully.