Nadia Damon in Sofia -

In a country that is reaping the rewards of a property market still in the ascent, it's hardly surprising that many investors in Bulgaria have opted to place their capital in real estate investment trusts (REITs) while they ride out the global credit storm. But Bulgaria's progress in reducing the rampant corruption that the European Commission recently highighted has become a key factor in the future success of these investment vehicles.

In July, the Commission took the unprecedented step of freezing several Bulgarian infrastructure streams as a response to the misuse of these funds by government agencies and the continuing high levels of corruption within the country. While the tone of this damning report was hard for Bulgarians to hear, it was the announcement that sanctions were being imposed on the EU-funded infrastructure programmes - the same schemes that many Bulgarian REITs had built their strategies around - which caught everyone's attention.

"Professional investors carry out their own thorough investigations of a market and I'm sure that this report contained nothing new for them. In fact, this process actually attracts a lot of investors," states Manu Moravenov, CEO of Fairplay Properties REIT, one of the leading real estate investment companies in Bulgaria. "But in REIT terms, it's not good, because many of these projects were chosen [with many already in progress] because of infrastructure projects that we knew would be taking place. If this doesn't come to fruition by a certain time, then these REITs could lose a lot of money."

Fortunately, the gravity of the situation appears to have finally hit home in Sofia, with the government claiming it is moving swiftly to end the crisis. And many industry players insist they too are confident the sanctions will only remain in place for the short term.

REIT renaissance

Such an outcome would be music to the ears of those investors who have turned to the Bulgarian real estate sector during the credit crunch. The EU bombshell aside, after the halcyon days of three or four years ago, the country's REIT funds are actually enjoying something of a renaissance.

IPOs may have been the darling of the Sofia bourse over the last couple of years, but at present they are yesterday's news - the reduced levels of liquidity that have resulted from the global downturn bringing this gravy train to a screeching halt at the beginning of 2008. "When it was very easy to acquire a 50-100% income with just a few months' investment, the popularity of REITs began to diminish," explains Moravenov, a former employee of the country's Financial Services Commission (FSC) and the former director of trading and surveillance at the Bulgarian Stock Exchange. "However, in today's climate, lots of investors are opting for REITs as a method of saving their money.

Indeed, a report published by Focal Point Investments (FPI) on July 28 highlighted the stark difference in performance of real estate equities and other companies listed on the BSE by comparing the performance of two of the BSE's indices since the start of the year: the BG-REIT index and the overall Sofix index, which includes the 19 most liquid stocks on the BSE. The report noted that total market capitalisation of BG-REIT companies declined by 4%, while the companies included in the Sofix lost 30% and the BSE's total capitalisation decreased by 19%. Despite the 23% decrease in the BSE's turnover, many REITs remained actively traded. Some companies even had a triple-digit increase of trading volumes for the quarter.

In general, the Bulgarian funds that invest in real estate are much more stable - enjoying securitised assets, but also lower returns. In terms of capitalisation, these REITs (there are currently 59 of them) are worth around €800m, almost double the value of mutual funds at present. According to data from Focal Point Investments, in the 2005-2007 period the total assets managed by REIT companies investing in real estate properties and agricultural land reported a nine-fold increase (from €67.3m to €656m).

Credit crunch aside, the unusual features of Bulgarian REITs have always made them worthy of a second glance. Unlike their Western counterparts, these special purpose vehicles are free from corporate or capital gains tax, as long as they distribute at 90% of their profit as dividends. The tax on these dividends is also set at an enticing 5%. Unlike their Western counterparts, Bulgarian REITs are allowed to invest in a mixture of land, residential, office and retail assets. Classical REITs - which increase the liquidity of properties by converting them into smaller shares - remain popular with large institutional investors who prefer a lower risk/lower profit fund structure, with riskier funds often more popular with smaller investors.

With an 80/20 split between residential and commercial projects, Fairplay is one of the largest funds on the BG REIT index, with total assets of €57.4m as of the first quarter. According to Maravenov, the commercial ratio is set to increase, however, with the company planning to convert its portfolio from mainly luxury apartments to commercial properties - not just for sales, but as income-producing properties.

Far from being the fall-back measure that they may currently resemble, Moravenov contends that once the global crisis is over, REITs will see healthy growth, generating significant returns for those investors who are able to accurately judge the bottom of the market. There is also talk of Bulgarian REITs being permitted to venture further afield - something that Moravenov reveals is already being negotiated with the financial watchdog. He predicts this will happen in the next year or so.

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