Baltic States – CIS, Investments, Latvia, Legislation, Real Estate

Having divided into two sectors in the beginning of this year, Latvian real estate market has continued to develop in a multidirectional way in the third quarter.

Stagnation and even certain decrease in price was noted in the summer in the sector of serial secondary housing which nowadays is exclusively attractive to local buyers, however, elite real estate market, where foreigners are particularly active, has developed very actively.

Although in the first case the level of drop in price was equal to the default level 0.5%, the decrease of buyer’s activity remains noticeable at the moment. However, the average price per one square meter in Riga in late September was 580 EUR/m2, which was also characteristic in June. This sector was also characterised by the market appearance of so called “bank” apartments which somewhat increased the offer, thus preventing the expected price increase.

Moreover, many buyers prefer to wait for now, considering the spate of rumours about the second wave of the crisis.

The situation in the elite real estate sector is quite different, and it is not related to market relations. Over the last quarter the prices in Riga increased by 3% and in Jurmala by 5%. Thus the increase over the year has been 15 to 25% accordingly. In Riga the prices vary from 1.200 to 1.600 EUR/m2 depending on quality and location of the housing. In the Old Riga and in the most popular places of the city the price per one square meter in a new housing project was 2.500 – 3.500 EUR.

In Jurmala the price range is much wider: from 1.200 EUR/m2 to 6.000 EUR/m2 depending on the quality and location. This price range is primarily due to the actual lack of offers in the high-quality housing market. At the moment Jurmala City Council has issued 14 small apartment house construction approvals which will be commissioned not sooner than in one year. Furthermore, the total number of these apartments will not exceed 200, which will not radically solve the issue. This number will be sufficient for about one year of active sales.

However, as we have already mentioned, it is not related to the market. The real estate in Latvia is mostly purchased by those who intend to get residence permit in the European Union. There were 1.667 such people by 1 October 2011 (from 1 July 2010, when the amendments to the Immigration Law came into effect), 1.479 people among them have already got the residence permit, and the others are waiting for the decision. A total of 105.3 million of lats (about 150.5 million EUR) were invested into Latvian economy due to this programme, and the state budget additionally received 1.5 million lats as state taxes.

536 people among them purchased real estate, 127 made investments funds into banks, and 47 made investments into companies. 256 real estate units were purchased in Riga, 199 in Jurmala, and 18 in Babite Parish. Moreover, it is characteristic that the great majority of these investors are citizens of Russia, Ukraine and Kazakhstan.

That is not to say that these investors are not interested in such factors as actual market indicators, prospects of price increase and rental rates, but they did not enter the Latvian market because of its promising situation or because there is a perfect situation for investments in Latvia in respect of tax laws, etc. They came here because Latvian conditions for getting a residence permit are somewhat attractive to them.

This is precisely why the elite real estate market failed to bring alone commercial real estate, although it seemed that businessmen (who constitute the majority among these investors) would think about their future activities when moving to another country. So far, having purchased real estate in Latvia, businessmen prefer to live and work in other countries, besides, not only in Russia: businessmen go to the countries with more congenital investment climate, e.g., to our neighbouring country Estonia.

Latvian authorities currently seem to get irritated by the fact that foreigners are only interested in Latvia as in a “window to Europe”. Indeed, 105 million lats passed by the state treasury, but the budget got money in dribs and drabs. Moreover, some cases of fraud have been revealed when sellers in collusion with buyers several times overpriced real estate units.

Therefore amendments to Immigration Law came in to effect in spring 2011, introducing a new player – appraiser. These amendments stipulate that now it is not enough to buy real estate at 100.000 lats in Riga Development Region. The real estate must conform to another condition – its cadastral value must exceed LVL 30.000. However, cadastral value of most items at the cost of 100.000-120.000 lats in Riga is generally LVL 20.000-25.000.

The Law stipulates that in case of discrepancy between the sales price and cadastral value, clients can refer to licensed appraisal that will pronounce the final verdict about the actual price of the item.

However, events proved the recently adopted amendments unreasoned. The investment deals have fallen apart with increasing frequency, because the appraisal assessed the real estate under the cost at which the seller was willing to sell it to the buyer. It’s not just the dishonesty of the parties to the contract, but the method used by appraisers in Latvia (and in the majority of other countries). This method is based on the comparative analysis of the deals made with similar real estate during the previous period. It works decently in a normal market. In Latvian market it is quite efficient in case of horizontal price trend, in case of falling market, and when it is implied that a certain number of deals in made in the same segment without appraisers.

However, such deals are not made in the segment in question in elite real estate sector. They can only be made by eventual foreign investors, for whom the rising market turns out to be an unsolved problem: they need at least one deal made without the appraiser, and this deal can only be made by someone who doesn’t need a residence permit. Furthermore, the appraiser is not worried by the objective price increase, and he doesn’t want to be the first one to assess an item in question higher that his predecessor. Eventually the item remains unclaimed, and the investor, if his enthusiasm has not slowed down, is forced to buy a more expensive apartment, which causes negative emotions and artificial price increase in elite segment. This is a vicious circle.

The authorities are pondering if Latvia lost by adopting investment amendments to Immigration Law, especially in respect to exchange of investments and real estate to residence permit. The Ministry of Economics expresses particular disapproval and proposed two truly revolutionary solutions: remove investments to real estate from the list of conditions sufficient to get residence permit or, in the worst case scenario, increase fivefold the price threshold for investments. Thus Artis Kampars, Minister of Economics, believes the price tag must increase fivefold. In practice it means that Latvia as a player in residence permit market will completely lose its competitive ability, as the level of proposed investments will be by an order of magnitude greater than similar offers in Western Europe and the USA.

The imperfection of the amendments to the laws allowing to foreigners to get residence permit in exchange for investments into real estate was noticed by our experts during their adoption by the Parliament. It is obvious that Latvia entered the residence permit market without having made its complete analysis. It is also obvious that there are other programmes, primarily, interest-free loan programmes which are successfully implemented to the great benefit of the state in Canada, Bulgaria and other countries.

Therefore, if the question is improvement of the amendments, attention should be drawn to alternatives that give hundreds of millions of dollars to other players’ budgets. However, the investment programme of residence permit without the most popular section – real estate is a proof of poor judgement and politic involvement of the authorities in power.

At present the amendments have already stimulated construction sector and developer’s business. Without these amendments they would be in the same zero condition, like two years ago. The amendments prevented unavoidable bankruptcy of several Latvian businessmen whose construction projects in Riga and Jurmala were delayed.

However, the Ministry of Economics is not embarrassed by this fact. They want to get direct investments into production. At least two conditions are required for production investments: low taxes, including production real estate taxes, and liberal labour market which allows engaging foreign labour force, which is usually cheaper. The government is not ready for either condition, although there have been discussions about engaging guest workers for a long time. Instead the government mentions again the necessity to increase taxes and retirement age. Which production investments did Mr. Kampars talk about? Statistics show that Latvia received only 14% of foreign direct investments in the Baltic States last year.

Today the only real investments are investments into real estate that can revive the construction industry. It is evident that the lack of “investment” housing in Jurmala and Riga is able to attract investment into construction in the nearest future. Moreover, the real estate operations still ensure one fourth of Latvian gross profits. So why are we killing the goose that lays silver, if not golden eggs?

On the contrary, today the government must do its best to simplify the residence permit procedure for the investors to the real estate!

In fact, some measures have been taken over the last 3 months: a new procedure simplifying residence permit formalities for real estate buyers came into effect on 6 August. Formerly the documents required for residence permit had to be submitted to the Embassy of Latvia in the country of residence, now they can be also submitted in Riga to the Office of Citizenship and Migration Affairs; moreover, they can be submitted immediately after the purchase.

Furthermore, investors will not have to spend their time going to public institutions. Now the documents to execute and receive annual mark on residence permit prolongation can be submitted by authorized persons. The investors (and members of their families that are to get residence permit) must be in the country where the documents are executed – whether in Latvia or in the territory of their country of citizenship, if the documents are submitted to the embassy. From now on the residence permit will be executed as a separate document instead of passport inset.

These changes are very positive, but it would be even better to introduce investment visas which would give to eventual investors the right to enter the country upon condition to make necessary investments within a certain period of time (in this case they can be sure their residence permit will not be refused, as it happened to Y.Luzhkov, ex-mayor of Moscow), and this visa must be automatically replaced by residence permit in case required investments are made. It would also be necessary to facilitate the receipt of permanent residence permit to investors, as the current “temporary” status puts off the main buyers – citizens of China and South Asia. Finally, developers have been waiting for law amendments that will allow getting residence permit in exchange for investments into sites being built.

However, the attitude of government officials shows their complete incompetence and lack of understanding in the current and future processes in the real estate market and in economics as a whole due to implementation of the aforesaid amendments to Immigration Law.

Early parliamentary elections held in Latvia a month ago failed to make us feel confident about the future. So far it seems that the government will be made of the parliamentary coalition consisting of national radicals from the party “All for Latvia”. This parliamentary group unsuccessfully tried to cancel formerly adopted amendments in the previous Parliament.

Сentury21 experts estimate that these efforts are unlikely to be successful in this Parliament. There is the risk to increase minimum price threshold. However, it will not refer to the completed transactions and issued residence permits. Moreover, the coalition which has been unable to form government for a month is not stable, as it can only rely on 56 mandates out of 100. The government, if ever formed, is likely to be of short duration, and new elections are round the corner.

We can be sure about one thing: economic insecurity and frequent changes of “game rules” are the two factors that damage investment process in any country. Both factors are present in Latvia at the moment.

Meanwhile there are also objective conditions of development of Latvian real estate market. This year, Latvian GDP has increased by 3.5%, and salaries have increased by 5%, in comparison to the last year. Actual unemployment has decreased by 2%, achieving 16%. Another important factor is the growth of tourism by almost 15% this year.

This all means that despite its cruelty and antinational character, the governmental policy had effect, even with significant sacrifices: mathematically Latvians’ consumption has become less than production. People have money and economic security. The middle class that was almost destroyed during the crisis is reappearing. It is also proved by the number of issued mortgages. Nowadays 15% of all transactions in the market are completed using loaned funds – this amount is significantly higher than two years ago, when the amount of such transactions was lower than 3%.

The consumers’ demands are growing. According to commercial experts’ estimations, consumers’ emotional well-being and economic activity has improved, they tend to buy less mass market products and more high-quality products and services.

The rental market has also grown. It was especially evident last summer in Jurmala, where the prices varied from 300 to 1.500 EUR per day during New Wave Contest (July – August). Formerly it was quite difficult to rent housing in Jurmala during winter, now people tend to rent apartments for the whole year, although they are mostly used only in summer and not on a regular basis.

The demand for housing rental has also grown in Riga which is due to students’ drift to the capital city in the early autumn and activities in the labour market related to people coming from depressive regions.

Does it mean that Latvian real estate market is expected to grow in the next three months? As to the elite real estate market, everything depends on politicians, as they subjectively influence this market. They determine the investment climate and attitude towards investors, 80% of whom are Russian citizens. This year’s 15-20% growth of this market sector and the growth of rental market objectively give good chances for the future.

As to the serial housing market, the situation is not quite bloomy. The growth of the market which has good objective conditions is slowed down by subjective factors. This is referred to entry to the market of the apartments which were withdrawn from turnover due to unprecedented price drop in 2007-2009. Now they are mostly so called “bank” apartments, i.e., they were collected by banks from careless borrowers. These apartments are numerous and they are introduced into turnover gradually in order to prevent market collapse. However, we cannot expect any growth in the nearest months.

This growth can be expected much later, when the majority of real estate sites for sale will be sold out. Let’s hope that investment environment will also be much advantageous by that time.

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