BRICKS & MORTAR: Black Sea boom

By bne IntelliNews November 6, 2006

Rob Whitford in Sofia -

Bulgarian REITs are proving to be the darling of the local stock market.

It's been a boom time for real estate in Bulgaria. And unsurprisingly so: the country is on the verge of EU membership, the last few years have seen GDP growing briskly, people's incomes are rising, successful local firms are expanding and tourist numbers on the up.

It's a boom time, too, for real estate investment trusts (REITs). Enabled by a law little more than three years old, they're now the fastest growing class of companies on Bulgaria's no-longer-quite-fledgling capital market, accounting for most of the IPOs on the Bulgarian Stock Exchange-Sofia (BSE) this year.

As of late October, no less than 24 REITs were listed. By the middle of this year, the registered capital of those trading on BSE was nudging BGN170m and their total assets amounted to BGN319.6m — increases, respectively, of 101% and 147% versus the end of 2005.

End-September figures are eagerly awaited, but they'll almost certainly be a lot higher than those for end-June, since hardly a week went by in the second quarter without at least one IPO or capital increase.

That's unsurprising too. Investors find REITs alluring because they're exempt from profit tax as long as they pay out at least 90% of profits in dividends. They're also a way for pension funds, for instance, to tap into the booming real estate market: those funds can hold just 5% of their assets in the form of real estate, but 20% in the form of REIT shares, which are admirably liquid. And, being listed companies, REITs are subject to what, by regional standards, are pretty strong corporate governance guarantees that was put in place by the yuppies-turned-politicians who returned to Bulgaria in 2001 with experience of Western capital markets.

On the waterfront

REITs are doing nicely on Bulgaria's Black Sea coast, for instance, where foreigners have been drawn to invest in holiday homes by low but rising property prices and the much-touted promise of high returns.

Intercapital Property Development, for example, is well advanced on its first project, Marina Cape, at Aheloy near the main southern resort of Sunny Beach. Built on 30,000 square metres (sqm) of land, this project involves 330 apartments each with a sea view, as well as shops, entertainment facilities and a central pool. In terms of total sales revenue, the project should be worth a cool €31m. The first batch of apartments, around two thirds of the total, is due to be finished next month.

Apartments have been selling very briskly, with advance payments providing Intercapital with that bit more leverage. The Irish were first on the scene, says Nicolay Mayster of the REIT's affiliated brokerage Intercapital Markets (IM). Then came the Brits, whose media have been abuzz with stories about Bulgarian real estate. Most recently, there have been the Danes, who arrived for the rather more specific reason that many had holiday homes in Turkey but, for cartoon-related reasons, came to feel uneasy and sold up. Bulgarians have also been buying.

"They have cash and can get mortgages on good terms," Mayster says. "If you buy something for €100,000, you can get 70% as a mortgage loan and cover payments from rental income. It's a nice way to get exposure to property."

Sensing a good deal of interest in real estate development among its brokerage clients, IM took the initiative in creating Intercapital back in 2003 – though its role remains an advisory one, neither participating in the management of the REIT nor acting as a shareholder.

Intercapital's IPO occurred at the same time as its listing, in December 2005, and saw shares with a face value of BGN1 apiece selling at BGN2.14 on the Bulgarian Stock Exchange. Come the second capital increase, in September this year, which took the number of shares up from 3.25m to 4.82m, they sold at over BGN4.50. And they're trading even higher now, at around BGN5.00.

Quite a rise – one which IM's Mayster puts down to several factors.

First, a very clear investment strategy: Intercapital only does property development – it buys land, builds on it, then sells it. Contrast this with most other REITs, which mix development with the purchase of assets. Furthermore, these assets, bought or developed, aren't necessarily sold, but may be retained for rent or eventual speculative resale.

Second, Intercapital had Marina Cape well planned by the time it kicked off the IPO. Some REITs are none too specific as to what projects they have in mind, holding onto the cash for some time until they use it. Investors too can open bank accounts, jibes Mayster.

Third, the project itself makes sense: there's a nice spread between construction cost and sale price. At Marina Cape, Intercapital's total cost is expected to be about €400 per sqm, while its sale proceeds are €800-900 – the sale price to the client being around €1,200, including 20% VAT, legal fees, etc.

For investors, the big question is whether Black Sea coastal property has been absurdly hyped and the market is now heading for a fall? Experts think not – it's just you've got to be a bit cleverer nowadays.

Two years ago, the market on the coast was very easy. Front-line properties and those in less desirable locations sold, alike, for around €700-800 per sqm. However, the market has now differentiated. Prices away from the sea, and on the wrong side of the Burgas-Varna road, in the Sunny Beach area have actually gone down, while those in the best locations have gone up considerably.

Mayster thinks they will continue to do so. Prime locations are already spoken for, newcomers will be faced with infrastructural constraints that won't be eased for two or three years, and demand will be rising with Bulgarians' incomes. So those who have chosen wisely will be sitting pretty.

Farming for profit

Not that REITs in Bulgaria are all about building. In fact, a good deal of REIT activity has focused on farm land.

Of all the real-estate assets held by REITs at mid-year, BGN61.9m, or 42.8% of the total, was in the form of agricultural land. And this figure will almost certainly rise further, with some projections showing REITs will own as much as 90,000 hectares (ha) within a couple of years, or getting on for 3% of Bulgaria's 3m ha of arable land.

"Farm land is an excellent investment," says Tsvetoslav Tsachev, capital market analyst at Elana Trading, which is part of the leading local financial services group Elana Holding.

Experts reckon the value of farm land could rise as much as five-fold over the next five years or so. That's not just a matter of impending EU membership, though that has sent farmland prices up in earlier accession states, but it's also a matter of ownership patterns.

The lengthy process of post-communist restitution has returned almost all agricultural land to private hands, explains Tsachev. But subdivision between the numerous heirs of pre-communist owners has left it massively fragmented. And, in some cases, idle because these little parcels of land aren't viable farms. That's one reason why land prices are so low nowadays. Buying up the little parcels, consolidating them into farms capable of operating viably in the new EU environment, and finding good farmers to rent them for the next few years as land prices climb – all that is work for specialists like REITs.

Sure enough, another Elana Holding affiliate, the Elana Agricultural Land Fund (EALF), is busy buying and consolidating. Not just in the obvious places, like the wheat lands of Dobrudzha in the northeast, but also in hillier country and for more exotic crops like orchids.

First on the scene among farmland funds, and still the largest, EALF was created in 2005 and by mid-June 2006 had accumulated around 10,000 ha. That should rise to 38,000 ha by February 2007, EALF indicated in the lead-up to a capital increase in July.

Investors were duly impressed: the capital hike raised a record BGN49.8m. Nominal capital now stands at above BGN61m and there are plans for this to top BGN100m eventually. “But I wouldn't be surprised if that figure hit BGN200m or even BGN500m in a few years,” says Tsachev.

Eventually, Elana may sell its land, which has already appreciated considerably. But there's no rush, while the seven-year lifetime of the fund isn't, in practice, much of a constraint. The main thing for now is to buy, consolidate and find good tenants to put on it.

Send comments to Rob Whitford

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