Issue 3, 2014. June-July

   

INVESTMENTS IN REAL ESTATE: THE ANTICIPATED IMPACT OF THE EU ASSOCIATION AGREEMENT

Georgia is slated to sign its EU Association Agreement on June 27. Martijn Kanters looks at what the possible impact of the agreement - and closer relations with the EU - could have on the Georgian real estate sector, based on the experience of other Eastern European countries.

Martijn Kanters

The signing of the Georgia-EU Association Agreement this month is expected to have a significant positive impact on the Georgian economy. Past experiece in Central and Eastern Europe (CEE) has shown that the integration processs with the European Union indeed leads to increased foreign direct investment (FDI) and accelerated economic growth. This will also have an effect on FDI in real estate.This article will examine the anticipated impact of the EU integration process on real estate investment in Georgia.

At this moment, a modern, liquid real estate investment market does not exist in Georgia. Commercial real estate assets are not yet actively traded and the absence of (institutional) investment funds is a big barrier to further development. The fact that commercial real estate developers are not certain about a possible exit prevents a lot of international developers from entering the market. Hence the large share of residential developments, which do offer an exit through direct apartment sales.


This current situation in the Georgian real estate market is very similar to that in most CEE countries in the mid-to-late 90's. If one looks at Georgia's European "cousin" on the other side of the Black Sea - Bulgaria - one can discover striking similarities in the pattern of the development of FDI and real estate investment in the context of the EU integration process. In the period 1995-2002, Bulgaria entered the first phase of FDI attraction, with levels similar to Georgia now, between 0.5-1 billion euros annually. The signing of Bulgaria's EU Association Agreement in 1995, coupled with the new Investment Promotion Act in 1997, caused a strong increase in FDI inflow, which in the scope of a few years increased to levels around 1 billion euros annually. The first FDI in Bulgarian real estate was recorded in 1998 and the real estate sector's percentage of total FDI in Bulgaria started to increase substantially after 2001.

The prospects of NATO and EU membership started to have a visible impact from 2003, when annual FDI in Bulgaria reached almost 2 billion euros. A five-year FDI boom-period commenced, topping out in 2007 (the year of EU membership), when Bulgaria recorded more than 9 billion euro in FDI. By this time, FDI in real estate had increased from average levels of between 5-10% of total FDI to 30%.

The Bulgarian experience is representative of CEE and can - in many ways - be used as an example for Georgia. What can be seen throughout CEE is that the following factors play a key role in the attraction of FDI and stimulation of real estate investments:

1. An EU Association Agreement marks, in almost all cases, the start of a boom in investments, albeit often at an initially slow pace;

2. The adoption of an effective investment incentives law following an EU Association Agreement is a second important factor. In the Czech Republic, for instance, the Law on Investment Incentives (1998) has had a clear effect on the start of a boom in FDI;

3. Clarity on the prospects of NATO and EU membership has invariably been the major driver of a boom in FDI.

In Georgia today, clear progress is being made in most of the above areas and it can therefore be expected that its path of development will be very similar to what most CEE countries experienced before. The year 2014 could prove to be historic in this respect, and only Russia or another natural disaster might spoil the party.The EU Association Agreement will most likely mark the start of a substantial increase in FDI, particularly from Europe.


The trickling-down effect on the real estate market will be positive, but might still take a while longer to materialize. At this moment, the availability of suitable (institutional) commercial real estate investment product in Georgia is limited to a handful of properties; investors don't have that much to choose from and many properties are not "disposable." Much can be done however, by appropriate stimulation locally. The leading banks, investors and developers can work together (supported by the Investment Agency and the Ministry of Economy) to prepare the best properties for disposal and to create an environment that would attract international funds.

In a global context, the time is also right. According recent research by Jones Lang LaSalle, global capital flows in real estate have returned to levels last seen in 2007. Total global direct investment in Georgia reached $130 billion in Q1 2014, up 23% from the same period last year.

The combination of favorable political-economic developments in Georgia and the expansion of real estate capital markets globally provides all the ingredients for the start of a modern real estate investment market in Georgia. But given the fact that Georgia is still an unknown quantity in the global real estate market, active promotion and marketing will be needed - from the bottom up. The main local stakeholders will need to work together to prepare an appealing package that will attract international real estate investors. The key steps in this process are as follows:

1. Identification of suitable assets. The amount of commercial real estate assets in Georgia that could (in principle) be attractive to institutional investors is limited to handful of properties. In a concerted effort with the owners of those properties, leading local banks and local equity providers (such as the Co-Investment Fund) a disposal strategy should be developed;

2. Formulation of disposal strategies. This will involve technical and legal due diligence, with particular attention to possible liabilities related to the property, an asset management strategy and determination of a realistic sales price (valuation). Also, financing options should be formulated, which include commercial lending and possible equity joint-ventures with local partners;

3. Investor promotion. In cooperation with an international real estate brokerage firm, the property should be marketed to a select group of international funds with the appropriate risk appetite. Current high investment yields (capitalization rates) with good prospects for compression, coupled with ample scope to increase rental income by applying modern asset management approaches, should raise sufficient interest.

With proactive local stimulation, the EU integration process will certainly have a strong positive impact on FDI in Georgia and contribute to economic growth and job creation. Now is the time to start preparing appealing investment packages that will attract a growing number of international investors to this small, but beautiful, "niche" country.

Martijn Kantersis a real estate strategy consultant and an Associate at TBSC Consulting, Tbilisi. For the past 15 years, he has been working in the real estate industry across Central and Eastern Europe.

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