Andrew MacDowall in Sofia -

Bulgaria's property market went from being one of the best performing in Europe to one of the worst performing. A year of stagnation is now likely.

For several years the country was an investors' darling, drawing in a glut of investment. With the economy averaging 6.1% growth between 2003 and 2008, residential prices and rents in Sofia soared, and previously rare malls and modern office buildings sprang up in and around the capital and some of the bigger provincial cities. Meanwhile, budget-minded Brits snapped up holiday homes in the beach and ski resorts. In what appeared to be a virtuous circle, economic growth stimulated foreign direct investment inflows (FDI), much of it in real estate, fuelling rising values while yields remained generous. This FDI in turn drove continued GDP expansion.

Bulgarian residential property prices grew 34.6% in 2007, the highest rate in Europe, according to Global Property Guide. There was a quiet consensus that prices couldn't carry on rising at the same pace, that the market would "mature" and "stabilise." There might even be a "correction." Few expected the crash that came.

The credit crunch caused a dramatic draining of liquidity from Bulgaria (and other emerging European countries), partly due to international banks drawing back capital from their subsidiaries, cutting the credit lifeline that had helped sustain investment, and, to a degree, consumer spending. The drip-drip of corruption allegations gummed up the flow of EU cash that had been a key growth driver and a source of hope for Bulgarians and investors alike that the country could overhaul its creaking infrastructure and support the upgrading of lagging sectors like agriculture. And the financial crisis and global recession made foreign firms scale back expansion plans in Bulgaria. Overall, the economy shrank by around 5% last year - a pretty drastic decline, given the fact that the recession only started mid-year.

Residential prices dropped by around 20% in 2009, according to real estate firm Colliers, whereas Bulgarian counterpart Address estimates that fall at 28%. Other sources suggest they fell even further, perhaps by a third, while some properties built as buy-to-let in the resorts have halved in value, as investments from the UK and Ireland in particular dried up. In 2008, when these countries were already heading towards recession, some optimistically suggested that the buy-to-let slack would be taken up by new buyers from Eastern Europe, including Lithuania and Russia. In the end, those economies tanked even more severely than the UK in 2009.

Office rents registered a relatively small decline, perhaps due to the continued tightness of Class-A supply, but retail rents fell by as much as 30% in the provinces.

Outlook: grim

While much of the rest of Europe is experiencing restored, if sluggish growth, Bulgaria's immediate outlook remains fairly grim, partly because the recession and real estate crash started somewhat later. While the government has switched its forecast for 2010 from a 2% contraction to 0.3% growth, a great deal of uncertainty remains about the property market, with analysts disagreeing about whether the market has hit rock bottom yet or will start to pick up this year.

The most likely scenario may be the median: neither a further plunge predicted by the pessimists, nor the optimists' forecast of 10% growth by year-end. "In my opinion, in most sectors of the market the prices have bottomed out or are very close to the bottom and there will be no large further corrections in 2010," Todor Breshkov, chairman of Bulgarian Real Estate Fund, an investment trust, says. "However, 2010 will be a year that the market will continue to be stagnating and liquidity will be low - nothing will happen. Activity might be expected in the fourth quarter of the year after the EU markets are further stabilised."

Fiscal tightening by the right-of-centre government, while necessary, may constrain a rebound in demand for most of the year, particularly when coupled with low liquidity from a recovering financial sector.

Foreign investment will probably remain cautious at best, keeping the damper on prices across the board, and particularly high-end office space in Sofia and Varna, and of course those buy-to-lets. Meanwhile, rising unemployment will dim hopes of a retail rebound. On the other hand, few major residential or office developments will be launched this year, keeping a lid on new supply.

A growing fear is that banks will start to offload foreclosed properties on their books in the coming months, flooding an already depressed market. A report by Address suggests that this would induce a collapse in prices. Widely publicised, it has exacerbated the air of doom and gloom around the Bulgarian real estate sector.

However, Breshkov thinks the banks are "very unlikely" to dump foreclosed property - to the market's detriment. "The banks are afraid to do so," he says. "They are not happy to accept and announce the fact that they have problems with pledged properties and they are afraid to show losses. Therefore, we can expect that they will try to make vehicles that will acquire the problematic assets and freeze their prices for better times. This, however, is not good for the market itself, as it will prolong the low liquidity in 2010."

Breshkov and other analysts point out that there are some segments where the outlook is more hopeful, particularly logistics, as Bulgaria's role as a transportation centre grows, and certain residential niches where supply is tight (prices are apparently rising for two-bedroom apartments in Varna). However, 2010, if not an annus horriblis, looks likely to be a year in the doldrums.