Retail

THE LATVIAN PROPERTY MARKET REPORT Research, 2005 Contents 4 Chapter 1 Introduction 4 Chapter 2 Executive Summary 5 Chapter 3 Latvia: Geography And Population 6 Chapter 4 Major Latvian Cities 7 Chapter 5 Economic Overview 2004 8 Chapter 6 Office 16 Chapter 7 Retail 19 Chapter 8 Industrial 22 Chapter 9 Hotel 24 Chapter 10 Investment Market 26 Chapter 11 Koba’s Market Expectations 30 Chapter 12 SWOT Analysis 35 Chapter 13 Legal Facts About The Commercial Property Market 36 Chapter 14 Koba Company Profile 39 Chapter 15 Kronbergs & Cukste Company Profile 40 Chapter 1 Introduction The purpose of this report is to provide an overview of the current commercial property market in Latvia. The information is based on external data obtained from official Latvian institutions, leading commercial banks, the opinions of market participants, international institutions (The World Bank, EBRD etc.), Eurostat, internal information and data from KOBA and the law firm, Kronbergs & Cukste Attorneys at Law. The information provided in this report is correct to the best of our knowledge, and the publishers can take no responsibility for any errors found within it. The report is divided into 14 chapters, each of which can be read independently. Chapter 2 Describes the general market situation Chapter 3 Gives a broad overview of the geographical and demographic situation in Latvia Chapter 4 Presents information about Latvia’s biggest cities Chapter 5 Describes Latvia’s economic achievements and trends Chapters 6 – 9 Gives an overview of the office, retail, warehouse/logistics and hotel market developments and patterns, as well as future developments in this segment Chapter 10 Describes recent events in the investment market Chapter 11 Presents the strengths, weaknesses, opportunities and threats to Latvia’s commercial real estate sectors Chapter 12 Gives an overview of KOBA’s expectations of future trends Chapter 13 Gives an overview of the legal facts on the environment for investment in commercial property Chapter 14 Presents an overview of real estate business taxation The Latvian Property Market Report 2005 has been prepared by KOBA, together with the law firm, Kronbergs & Cukste Attorneys at Law, primarily for professional investors, leaseholders and developers taking an interest in the Latvian property markets. The Latvian Property Market Report 2005 describes Latvia’s future property market in an economically promising, rather small country with old democratic traditions. Chapter 2 Executive Summary With independence in August 1991 Latvia transformed itself from a planned economy to a market economy. Many difficult changes have been made, not only to the old laws but also in the way that people think in order to create Latvia’s identity, market economy and well-regulated economic and legal framework. During these difficult changes, the Russian economic crisis of 1998 hit hard. However, the country overcame the crises and is once again back on track towards economic growth and prosperity. In the years 2003 and 2004 GDP grew by 7.5% and 8.5%. A growth of 6.7% is projected for the next two years. In 2004 Latvia also joined NATO and the European Union. With this long desired dream finally achieved, modern Latvians feel more secure about their future, a fact that is best reflected in the steady growth of internal consumption. In the year 2004 the largest increase was seen in the retail and office sectors. As in other Baltic countries, new industrial/warehouse construction is rare. The Latvian capital, Riga, added 62,000m2 of shopping centre and 49,000m2 of office space. However, the total modern office supply in Riga is small. Just a few new office developments exist. Clustering, as has occurred in the other Baltic capitals of Vilnius and Tallinn has not been triggered to date. Therefore, developers have many opportunities in this service segment. Today, most companies have offices in Old Town buildings, which have several disadvantages such as extremely limited parking and bad planning. These problems don’t exist in the offices renovated from industrial space in the city centre suburbs. However, these latter buildings don’t come with the prestige of those in Old Town locations. Despite intense competition in the shopping centre segment, more developments are proposed in Riga. Some have already been planned for a number of years, meaning the possibility of realising these plans is lessening as time goes by. There are currently plans to develop some 167,000m2 of shopping centre space. The industrial/warehouse market segment could be called a “sleeping beauty’, which one day will open its eyes and offer investment opportunities. However, it is difficult to predict when exactly this will happen as the demand will depend more on international rather than local companies. The investment market was not particularly active last year, as no big transactions in terms of square meters and funds have been recorded. However, this doesn’t mean investors aren’t interested in Riga or the Latvian market in general. None of the owners of attractive (from an international investment point of view) properties express any will to sell. However, a few smaller property investment objects (ie. less than 5,000m2) have been sold to international investors. Due to EU accession many Latvian laws have been harmonised according to acquis communautaire. Latvia, together with other new EU member states from Eastern Europe, has successfully harmonised its laws and met all requirements regarding EU membership. Now, Latvia is set to replace its national currency, the lat, with the euro before 2009. This means that the country will have to meet the strict Maastricht Treaty requirements in order to be able to do so. 6 Chapter 3 Latvia: Geography and Population 3.1. Country Location Area Land Boundaries Coastline Climate Terrain Natural Resources Eastern Europe, bordering the Baltic Sea between Estonia and Lithuania 64,589km2, of which water 1,000km2 and land 63,589km2 Total 1,150km. Latvia borders Belarus (141km), Estonia (339km), Lithuania (453km) and Russia (217km) 531km Maritime. Wet, with moderate winters Low plain Peat, limestone, dolomite, amber, hydropower, wood, arable land Land Use Arable land 29.01%, permanent crops 0.48%, other 70.51% Independence 21 August 1991 (from the Soviet Union) 3.2. Population Latvia's population has been multiracial for centuries Ethnic Groups Latvian 57.7%, Russian 29.6%, Belarusian 4.1%, Ukrainian 2.7%, Polish 2.5%, Lithuanian 1.4%, other 2% (2002) Age Structure 0-14 years 15% (male 177,223, female 169,241), 15-64 years 69.2% (male 772,496; female 823,410), 65 years and over 15.8% (male 118,035; female 245,901) (2004 est.) Languages Latvian (official), Russian, Lithuanian, others Major Cities Riga (the capital), Daugavpils, Liepaja, Jelgava, Jurmala, Ventspils Chapter 4 Major Latvian Cities Latvia is not evenly populated as the largest percentage of people live in Riga. Latvia can be characterised as Riga, with six major satellite cities. 4.1. Riga Riga, the oldest city in Latvia, has, since the Middle Ages, developed into an important economic, political and cultural centre. Riga became the capital in 1918, when the formation of an independent Latvian Republic was declared. Riga’s more than 800-year history has left its mark on the face of the city, where ancient dwellings and church towers coexist with Art Nouveau and eclectic architecture. Riga’s Old Town has been included in UNESCO's list of the world's most important cultural and natural sites. Its unique architecture, combined with comparably low prices and cheap air fares has triggered a large growth in tourism. Today more than half of Latvia’s population lives in Riga. The city is home to the country’s largest manufacturing companies, as well as the central government and administration boards. Riga remains an industrial centre. A number of industries are situated in the capital, like machine building, metalworking, woodworking, food processing, chemicals, pharmaceuticals, electronics, textiles and paper. �� 4.2. Daugavpils Daugavpils is the second city in Latvia and dates back to 1275. It is a big industrial centre and railway junction in the southeast of the country. Various industries are operating in the city, such as energy companies, metal-processing plants and food manufacturers. 4.3. Liepaja The ice-free port of Liepaja is a city combining many manufacturing traditions. The city’s economic development was built on traditional industrial infrastructure combined with the advantage of the sea port. The combined urban and rural population of Liepaja is 140,000. The main industries are metal processing, textile, food, paper production and ship building. 4.4 Ventspils Ventspils was founded in 1378 and is one of the oldest cities in Latvia, and has been a sea port from the very beginning. One of Latvia's most important harbours, and with free economic zone status, a great deal of shipping uses the city harbour every year. The port of Ventspils is a world known transit centre for crude oil, oil products, potash, ammonia and other liquid chemicals, metals, ferroalloys and timber. Latvia’s economy has grown significantly since independence in 1991. It was shrinking by an astonishing 35 percent a year in 1992, but, thanks to market reforms, it saw a positive growth just two years later. In 2001, Latvia registered one of the highest growth rates in Europe (7%). Latvia is a key transit point for Russian oil, which helps increase the growth. 8 Chapter 5 Economic Overview 2004 �� 5.1. GDP Recent years have seen rapid economic growth. Increases in GDP were 8% in 2001, 6.4% in 2002 and 7.5% in 2003 respectively. Growth indicators were also very good during the first half of 2004, at 8.2%. Similarly, as in the previous year, stable domestic demand and increasing commodity exports were the main reasons for growth. A favourable financial situation (low interest rates on loans and expanding mortgage lending) encouraged investment. Among the strongest areas are construction and tourism-related segments (hotels, transportation). Manufacturing output in the first half of 2004 exceeded the level over the same period during the previous year by 8.5%. Construction grew even stronger, by 12.5%. A more moderate increase was seen in agricultural production output (3.5%). However, early experience with EU structural funds shows that agriculture and manufacturing might be the first (and largest) winners from this process, therefore helping to sustain growth. �� 5.2 Inflation An increase in the inflation rate was seen in the second half of 2003 and at the beginning of 2004. At the end of 2003 inflation had reached 3.6% (12-month inflation, December over December), the highest level in the past six years. Inflation has risen more than expected, and annual 7.7% CPI in September was the highest inflation rate in the EU25. Including forestry and fishing. Including hotels and restaurants. 3 Public administration including healthcare and education. 1 2 This was caused by several main factors • A rise in prices of imported goods due to an appreciating euro exchange rate • The imposition of VAT on public utilities • Increased tariffs for gas and heating • The rising purchasing power of the population • A global increase in commodity prices In the first half of 2004 a variety of other factors emerged that caused further inflationary pressure. EU accession and globally rising oil prices likewise had a substantial impact on mounting inflation. However, it could be seen that competition in the Latvian market is weak due to the price increases in the country being higher than those in its two Baltic neighbours. Susceptible upward price pressure in Latvia was exerted by factors such as the increase in excise tax on fuel and oil prices, a broadening of the VAT base, the coming into force of selected EU legislative acts that substantially raised entrepreneurs' operating costs, as well as EU accession-related changes in the institutional framework of foreign trade. In addition, the second phase effects of the rise in energy prices continued to determine rising inflation in the second half of the year. However, electricity tariffs will not change next year, but in the long-term prices might increase, as there will be a shortage in electricity supply in the region. Gas prices are still subsidised in Latvia, and gas prices are 20-50% lower than in other European countries. In the longer term the higher inflation and higher debt payments (relevant for some groups), larger parts of the purchasing power may dry up, and producers would then have to solve the dilemma of how to balance higher costs with a competitive consumer market. �� 5.3. Unemployment Economic development in recent years has had a positive impact on the labour market. Although the working age population (15-64 years) is diminishing, the number of economically active people is increasing, and the rate of employment is growing. Most people work in manufacturing, and represent 17.4% of the total workforce. Next comes trade (15.3%), then agriculture, hunting and forestry (13%). Compared with the corresponding period from the previous year, the number of people employed aged between 15 and 64 rose in the second quarter of 2004 by 7,400, due mainly to an increase in the number of people employed in the construction, transport and communications industries. Along with an increasing number of employed people, the number of those actively looking for work in Latvia has dropped. According to the Latvian State Employment Agency, there were 92,500 unemployed persons registered in the country at the end of 10 September 2004 (compared with 89,800 at the end of September 2003). During the year the number of unemployed in Latvia has increased slightly owing to more people officially registering themselves as unemployed. The lowest unemployment rate was in Riga, and the highest in the city of Latgale. This process isn’t equally fast across all sectors of the economy. Labour costs increase much quicker in the service sectors, which are not related to external competition, whereas unit labour costs within manufacturing are shrinking rather than going up. Although, it should be noted that the provisional data for the first three quarters of 2004 indicates faster growth of labour costs than sector productivity also in manufacturing. �� 5.4. Labour Costs In recent years, as wages grow faster than productivity, unit labour costs increase. The growth of labour costs was especially swift in 2003 (table below). �� 5.5. Wages In 2003 wage growth was in excess of 7% (in real terms). However, during the first two quarters of that year the real annual growth of salaries dropped considerably (to 4.9% and 2.3% respectively). The average monthly net wage in the second quarter of 2004 was €212, an increase in €17.11 compared to the same period of the previous year. Wages in the public sector are higher than in the private sector, by almost 25% on average. One of the reasons for the increase in the average wage is the annual raising of the minimum wage by €14.20 to €113.83. Nominal wages continued a moderate rise, though consumers didn’t benefit much from this due to a pick up in inflation. It’s expected that inflation will be one of the automatic stabilisers cooling the consumer boom. One factor partly offsetting this in 2005 will be increased social benefits (child payments and payments to young mothers, regular pension indexing) and the wage increases of some public sector workers, such as teachers. Moreover, the government intends to slightly increase the non-taxable income of private persons. Share of registered unemployed persons in economically active population from 2002 according to the new methodology. 5 I-III quarters of 2004 against I-III quarters of 2003 6 Index of labour cost changes divided by GDP deflator 7 GDP growth divided by index of employment changes 8 Index of labour cost changes divided by index of productivity changes 4 Compared to the previous year, the average size of the monthly pension paid in 2003 to old-age pensioners registered with the social security institutions increased by €3.13, or 3.5%. Minimum pensions were raised from December 1, 2003. The average size of pensions in the third quarter of 2004 was €101. �� 5.6. Investments At the end of 2003, foreign direct investment (FDI) in Latvia amounted to 1,775.3Ls million or 28.1% of GDP, and the volume of FDI inflow in the last three years equalled on average 10% of fixed investment. Construction remains one of the fastest growing areas, and we expect this to maintain its leading position in the future. While in previous years activity was primarily in office and retail space development, lately we have seen many residential space projects (during the first half of 2004 completed housing space was up by 56% per annum). The development of residential housing is set to expand during the next few years, and simultaneously the building of commercial projects will continue. With the adoption of EU structural funds construction might see a bigger demand from industry. The increase in investments came primarily from the private sector investments. The investment process was favourably influenced by better accessibility to financial resources and the gradual reduction of interest rates on long-term loans. International institutions have noted that foreign investors in Latvia see obstacles such as corruption, bureaucracy and uncertainties in legislation. Although foreign interest in Latvian companies has risen, acquisition often involves the use of heavy debt. Thus the actual inflow of new foreign capital into the Latvian economy is moderate at best, and is rarely targeted at the creation of new business. Only a few so-called Greenfield projects, involving the introduction of new and modern technologies by foreign investors, have been implemented in Latvia. �� 12 �� 5.7. Budget Since 1996, with the exception of 19999, the fiscal deficit of the general government consolidated budget in Latvia has been lower than the level allowed by the Maastricht Treaty (3% of GDP). In 2003 the fiscal deficit of the general government consolidated budget was lower than projected and equalled to 102.4Ls million, or 1.6% of GDP. Revenues of this budget in 2003 were 12.5% higher than in 2002, while expenditures grew by 9.4%. �� To begin with, the budget deficit for 2004 will be 2.1% of GDP, but envisaged restrictions should reduce this amount to 1.8% of GDP in 2004, and 133.5Ls million, or 1.67% of GDP. The government has resolved to consistently ensure that the Maastricht fiscal criterion will be met in Latvia, setting a non-deficit budget as the medium-term goal. �� 5.8. Retail Trade Consumers have been one of the key demand sources this year. A high domestic demand promotes development of services, especially those related to the wholesale and retail trade (in 2002 this sector grew by 12.7%, and in 2003 by 11.3%). In 2004, price acceleration for services was higher than it was for goods. The dynamics of domestic demand is stable, and safeguarded by income growth, the stability of the financial system, widening of credit facilities, accession to NATO and the EU, and the crystallisation of positive further expectations. It is expected that the increase in household incomes and the widening of consumption loans will foster further growth of domestic trade (especially non-food consumer goods) and other market services. Nevertheless, growth rates will be slower than up to now due to market saturation. High growth possibilities are lying ahead for the tourism sector, which has developed rapidly over the past few years. 9 Fiscal situation in 1999 mostly reflected consequences of the Russian crisis. �� Loans continue to grow at a rapid pace. Primarily, this growth is due to the expansion of mortgage loans, though other loans are also increasing. The mortgage loan portfolio in eight months grew by 360Ls million - 84% more than a year ago. The high level of bank competition, low interest rates and rising real estate prices are the main factors behind such growth. It’s expected that an increase in global interest rates might slow down mortgage lending. �� 5.9. Foreign Trade Latvia's commodity exports in 2003 rose rather rapidly, by 17.2%. Imports in the same period grew by 19.7%. The rapid rise in the export unit value made a favourable impact on commodity exports in 2003, and can be explained mainly by the more advantageous changes in the exchange rate. Exports to EU countries in 2003 increased by 20% compared to the previous year. Exports to CIS countries in the same period rose by 15.5%, with an increased share of exported wood processing and chemical products. Latvia's commodity exports between January and October 2004 were considerably higher (by 26% in current prices) than in the respective period of the previous year. Imports in this period exceeded the level of the preceding year by a considerable amount (24%). Imports grew particularly fast during March and April 2004, determined by the wish of entrepreneurs to import as many intermediate and consumer goods as possible using the old system in the last months before Latvia’s accession to the EU. 14 �� In the period January-October 2004 exports to CIS countries increased at an especially rapid pace, namely 44%. The biggest contribution to this export growth was made by the machinery exports (30% of total export growth to CIS countries), transport vehicles and chemical products (12% and 11% respectively). �� 5.10. EU Funding The main purpose of EU funding is to help Eastern European economies reach an average EU level in as short a period as possible. History has shown that if such funds are realised efficiently, the effect can be very positive indeed (Ireland 104% EU average BVP), but it isn’t a rule (Greece). 1. EU Structural Funds €625.57m 2. Cohesion Fund €433.65 - €606.78m 3. Community Initiatives: • INTERREG - €13.5m • EQUAL - €7.1m A total of €230.5m has been allocated for Latvia, and should be accumulated until 2006. 10 With countries where foreign trade turnover with Latvia is no less than 5%. �� Moreover, on January 10, 2005 the European Commission confirmed €36 million support for financing Eastern European small and micro size company development. This decision has been made on the premise that about 90% of all European companies are small and face problems obtaining finance from banks. Therefore, these funds should help small companies in Latvia to find financing for their development. 16 Chapter 6 Offices The history of the Riga office market is similar to that of the office market in Vilnius and Tallinn. It began with the remodelling of apartments in Riga’s Old Town and city centre into office space. But this is where the similarity ends. Riga’s combined Old Town and city centre area is comparably larger than Tallinn’s and Vilnius, offering many opportunities for different developments. Quite a few buildings were and are in the hands of private individuals, which naturally, as there was a demand for office space, were converted into office space. Tenants at that time could choose between three options • Locate in the Old Town with its strengths and weaknesses • Locate in the city centre • Locate in offices converted from old factories in the city centre outskirts or suburbs Riga’s Old Town with its inherited natural prestige has few disadvantages • Premises have a lot of unused space (corridors) due to their original purpose as apartments • Air conditioning is rare • Car access is forbidden • Apartment prices are higher than office prices, therefore it is not in the best interest of the owner to have an office The city centre has similar disadvantages, with the exception that it can be accessed by car • Premises have a lot of unused space (corridors) due to their original purpose as apartments • Parking is a severe problem. Some office buildings can only offer one parking space or none per 700m2 of office space • Air conditioning is rare and in most cases is an additional cost • The city centre is relatively big, with many companies located in it, but it cannot offer the same opportunities of doing business as modern office buildings with several companies located in the same building Offices in the suburbs don’t offer prestige, but they do have certain advantages • Lower rent • Almost always unlimited, free parking However, almost all of the premises don’t meet modern office requirements, like rarely offering air conditioning or/and good ventilation. Consequently, given the choice, the majority of successful international and local companies and banks locate their offices and branches in the city, as the suburbs have the effect of lowering the prestige of their businesses. In 2004 the biggest users of office space were banks. However, they have moved to build-to-suit office buildings. For example, Unibanka has moved to a 9,500m2 and Hansabank to a 18,500m2 office building, which they currently own. As the supply of a better quality of office space is limited, it can be assumed that premises should be rented as soon as they come onto the market. However, many premises remain vacant despite attractive rent prices of €10-14/m2. In general, the office vacancy is about 10 % for normal and higher quality office buildings. The Riga Office market is currently very complex in nature and very intransparent with significant rent variations, even for comparable premises. Locally there seems to be a difficulty amongst tenants to differentiate between the quality of premises and the related effects on the rents. Lately however there is a clear understanding of an oversupply in the market, which is being exploited by the tenants to negotiate the rents downward. There is currently quite an oversupply of renovated old city buildings converted from residential to offices. These premises are generally attractive for sales representation offices for 5-10 people but not efficient for large organizations. According to KOBA research there is currently a significant hidden demand in Riga for A-class efficient office space with access to parking. This demand can however not really be qualified, as there is very little supply of this product. Currently only the Valdemara Centrs and the new Hansabank building provide vacant space in this category. Due to the limitations in the A-class market segment, tenants often only compare to lower quality. This may in the short term mean that there can be a continued pressure on the rents in A-class buildings. Moreover, due to the reason that businesses are maturing, bigger companies, which require more space than 500m2 and have expectations of moderate company growth, are looking for premises to buy. The norm is to either buy with a reserve, allowing for some growth in the number of employees, or to build an office building for themselves. Generally the preference is to buy office premises, but the problem is that such offers does most often not exist in the market. Because of this issue, often companies are looking for opportunities to own or rent their offices outside the city centre, where they can enjoy the benefits of convenient parking and good accessibility. Therefore, KOBA expects that the biggest proportion of companies moving out from the city centre will be trading companies, who needs warehouse as well as office space. Generally, such companies require an office space and a warehouse space with a ratio of 1 to 3. These companies are indifferent about renting or building, however building in a favourable location is rather expensive in Riga due to high costs and scarcity of available land. Therefore KOBA expects that rent, rather than construction will dominate the immediate future. When companies rent office space in the centre, B+ quality office building located in the city centre suburbs is preferred. The greatest demand is for out-of-centre sites with comfortable car access and parking facilities. As rent is the most important factor, most demand is for B-class premises. A-class space, or expensive offices, are still not a priority for Latvian companies, and remain non-existent anyway. It should be mentioned that the number of companies - even local ones - searching for open plan offices is increasing. This is because they understand that Old Town apartment-style premises are increasing together with costs. Moreover, knowledge sharing between co-workers is better in open space rather than closed rooms. �� Lack of supply non-withstanding, rents for A-class premises continued to drop, 20% in one year to €15-16/ m2. The rationale for such behaviour is as follows;. As location the Old Town really only has the advantage of prestige, but comes with higher rent and negative losses due to the shortage of the parking and time losses, companies prefer to move out even to B-class offices in the suburbs. Clustering is not yet working in Riga, and the places where developments could take place and thus trigger a cluster effect are owned by powerful companies who sell land at excessively high prices. It will take time before a new real business district will arise in Riga, although projects like Saliena (a mixed “New Town” development scheme of more than 600 ha of land on the way to Jurmala) and several larger areas along the Daugava river holds the potential. �� 18 � �� It was recently announced that Riga airport is going to build a business park on a 90-hectare site near the airport terminal. A few hotels and office buildings are expected to appear on the market before 2010, which will increase airport revenues. �� 6.1. Secondary Cities No A-class offices are available in Latvia’s other cities. Buildings are constructed to suit. B-class reconverted premises from flats, industrial purpose buildings or old offices dominate the market. As secondary cities are rather small, KOBA doesn’t expect that any large or A-class office buildings will be built, with the exception of build-to-suit properties. �� Chapter 7 Retail Latvia’s retail market started in July 1989, at around the same time the country declared its sovereignty and economic independence. It started with the privatisation of supermarkets and premises located on the first and second floors in buildings in Riga’s Old Town. Until the first shopping centre “Mols” opened in Riga in 1998, most retail was located downtown. During that period all the premises offered in downtown, even on secondary streets and those with relatively little traffic were rented out. The situation started to change as consumers began to experience the convenience of shopping under one roof. The “Mols” shopping centre and the department store “Centrs” started to face competition with the introduction of the shopping centres “Alfa” and “Spice” in 2001, which gave consumers a greater choice and broader product selection in different shopping centres in one space. This is the time when the shopping centre era in Latvia really began. New shopping centres also increased the possibilities for retailers to select where to locate their shops. The streets with not much traffic in Riga’s Old Town lost many tenants who moved to shopping centres, this had a direct negative effect on the rent levels in the Old Town. Barona and Terbatas streets remain the top streets, with almost no vacancies, however in streets like Caka, Brivibas, Dzirnavu, Gertrudes, Stabu and Lacplesa, vacancy has increased considerably. �� Recently a trend has been observed wherein fewer retailers remains in the Old Town or “active” city centre. With a focus on middle and lower class customers they often prefer to be located in the shopping centres. The major brands like United Colours of Benneton, Mango, Zara, Max Mara, Tommy Hilfiger, Emporio Armani, Betty Barclay and Hugo Boss are generally located in the City however most often outside Old Town. Most are located on Barona, Brivibas, Elizabetes and Terbates streets. At present the most active retail areas in Riga’s city centre are on Terbatas and Barona streets between Elizabetes and Lacplesa Street, as well as in the Old Town on Valnu and Kalku streets. Retailing in the Old Town has its limitations, and only a few shops can offer spacious premises. This is because most buildings in the centre of Riga were built in the period between 1850 and 1920. Most of these buildings are architectural monuments, and so according to the law the reconstruction of their exteriors or changes internally is in most of the cases not permitted. Retailers require large windows, which, due to the above-given reason, aren’t possible. Likewise, interiors can’t be changed, because in the old days shops were small and separated by solid walls. Therefore, the total space on a first floor building that a retailer could expect to find seldom exceeds 400m2, of which approximately 300-350m2 is usable. Thus it is extremely difficult to find premises in the centre of Riga for such stores as Zara, H&M, Stadium, whose optimal space is not less than 700m2. In most cities in the world, the major retail high streets are most often located in or near the Old Town and many are exclusively pedestrian. In Riga those main streets are named Kalku and Audeju, but due to tradition, these streets are currently not considered the main shopping streets, but rather as a part of the Old Town entertainment area. It is however our expectation, that in the future, these streets will become the retail high streets of Riga, mainly because of the large people flow in Old Town. Parking is also a severe problem in the Old Town and city centre. Moreover, entrance for cars to the Old Town is charged, as well as parking in the central district. 20 7.1. Shopping Centers Competition among shopping centres is high these days. Most retailers located in the shopping centres have been experiencing a reduction in turnover over the last one and a half years. In the period between 2001 and 2005, a total of five new shopping centres have opened their doors. �� On top of that in September 2003 the Finnish company Stockmann opened a four-story, 14,000m2 department store selling such global brands as Armani, Marco Polo, Tommy Hilfiger and Emporio Armani. The supply of shopping space is extensive, and the market is already seeing its first winners and losers. Consequently, retailers in the losing shopping centres are experiencing a significant reduction in the turnovers. It should be mentioned that as it is generally standard in Latvia today, retailers have lease contracts with minimum rent and turnover provisions, meaning that the NOI of shopping centres is reducing as well. As mentioned earlier, most retailers are not strong enough on their own to operate successfully, therefore shopping centre management must ensure that the shoppers keep coming as the competition among shopping centres further increases. Therefore shopping centres are building extensions, filling them with new tenants and are running extensive promotional marketing campaigns. Currently the most successful shopping centres in Riga are “Alfa”, “Mols” and “Centrs” (all operated by Linstow Varner). Domina, Origo, Olympia and Spice shopping centres are in the “second league”. �� As opposed to the restrictions already mentioned in the Old Town, shopping centres all offer large areas of free parking. �� 7.2. International Retailers Only a few international retailers work directly in Latvia. The retail market, especially the clothing and footwear markets, are serviced through franchise agreements for the large brands such as Zara, Mango, Salamander and so on. On the other hand, if by “international retailer” one means somebody who services several markets and has segmented recognition, there would be more as several retailers from Scandinavia and the other Baltic countries are operating in Latvia. It should be noted that most of the franchisees operating in Latvia are Lithuanian or Estonian companies. �� It has recently been noticed that international retailers are becoming increasingly interested in both the Latvian and other Baltic markets. The reasons for this are twofold, namely an overall increase in purchasing power throughout the region plus a maturing of the retail market. �� 7.3. Secondary Cities Hypermarkets and supermarkets dominate in Latvia’s secondary cities, most of which are built by big retail chains for their own use. As one would expect, the owner/retail chain rents or occupies the biggest part of the premises. Small tenants broaden the assortment of the services. �� 22 � Chapter 8 Industrial The industrial/warehouse market is a slowly developing commercial real estate segment in nearly all postSoviet countries. Not even cities like Moscow haven’t experienced much growth. For example, in the first half of 2004 only 100,000m2 were offered in the market, with only 40,000 pre-rent agreements. As a rule, rent is related in opposite to the volume of space rented by the tenant. Compared to other sectors it seems that there is a lot of growth potential within this segment because little new space is offered within this segment. To analyse the reasons behind this, one must analyse the logistical strategies of international and national companies. As growth in nearly all business sectors is stagnating in developed countries, companies have turned their attention to cost reduction. One of the main costs for companies is logistics. The reduction of logistics costs brought about the closure of warehouse and distribution facilities all over Europe. Many companies outsourced logistic services to companies like DHL, DFDS or Golner Spedition. Other International companies significantly reduced the number of country warehouse facilities, and started to use facilities servicing several countries. For example, companies like Sony service the Latvian market from a warehouse in Copenhagen. Therefore, demand from this type of international company should not be expected in the immediate future. Different rationales apply to local companies. These companies are mostly privately owned, where the manager is not concerned with balance sheet ratios, but maximising his wealth. Therefore, buying rather than renting is relatively preferred. However, as already mentioned, not many offers exist in the market for the sale and construction of small premises is inefficient. Therefore the development of warehouse/ distribution facilities has a lot of potential. In general renting is preferred for three reasons: • No time to wait for construction • Flexibility should be maintained due to future business development • Lack of funds for development As financing is rather inexpensive with current FED and CEB policies, larger tenants tend to focus more on strategic decisions when deciding to rent or to buy rather than solving a shortage of funds. Despite a limited supply of modern industrial/warehouse space in the market, but bearing in mind the unpredictable future demand, developers are minimising their risks, and will only start construction after the pre-lease agreements are signed. Most of them develop projects in several stages • Marketing phase (looking for clients) • Beginning of construction (after the developer has found a pre-designated number of potential tenants) �� 8.1. Business Parks There are about 20 business parks, including those that are in the project stage, which can be divided into industrial, technological, logistics and distribution parks. The future perspective of a growing number of business parks can be envisaged, as the demand for the land needed to establish such parks is growing. Presently, in most cases business parks land is offered for lease, but taking the demand of the market into account, those business parks where the entrepreneur could purchase a parcel of land with ready-made infrastructure and utilities and construct the buildings necessary for the business, will be more successful. �� 8.2. Industrial Space Riga is the largest industrial centre in Latvia. However, since 1989 a fall in the volume of production has been experienced. Industrial re-structuring corresponding to the new requirements has been hindered by a shortage in financial resources available to manufacturers. Most of the largest enterprises still need substantial investments from abroad. The industrial structure has also changed dramatically. Today, one can see rapid growth in industries based mostly on local resources, such as wood processing and the food industry. Today more and more large companies, such as Laima, Staburadze, Aldaris and Rigas Miesnieks, are capable of producing goods and high quality services, which meet with the most exacting western standards. And with an inflow of foreign investment, it’s expected that other enterprises would recover and become more competitive too. It has been announced that the US Company JELD-WEN INC is implementing a €40m Greenfield investment project in Latvia. The project involves building a wood treatment facility for the production of fibre door skins that will in turn supply JELD-WEN INC’s European factories. The British giftware concern International Greetings has announced a decision to invest €29m in a production plant in the southwestern city of Liepaja. Moreover, the city of Ventspils is looking into the possibilities of opening an international airport to attract inward investment and develop a logistic hub in the area. The project would serve the steadily increasing tourist and trade flows between the east and the west Baltic Sea coasts. To date, substantial investments have been made, and the project is already underway. The project will require a total investment of €3-5 million. �� 24 � � � � �� Chapter 9 Hotels The development of tourism is often seen as one of the most promising opportunities for future growth in Riga. Its hotel industry, like the city itself, has come a long way since independence. Nowadays visitors have a much wider choice than the one or two “Intourist” hotels offered a decade ago. The selection of high-class hotels is especially good, and the mid- and low-priced options have also improved significantly. The number of foreign visitors to Riga increased so much in 2004 that during the summer months it was hard to find a vacant room. The demand for more rooms in Riga is therefore obvious. �� Tourism is one of the largest sectors of the world economy, yet in 2003 tourism made up just 2% of GDP of Latvia, by no means exploiting the full potential this industry offers the country. Riga has all the prerequisites for tourism because of its favourable geographic position, a historically inherited trade route and a rich cultural heritage. In recent years Riga’s architecture, changing with the passing of time, has accepted the modern architectural curves, whereas the Old Town, with its medieval fortified compactness, has been preserved. According to the Latvian Central Statistical Bureau 2.52 million people visited Latvia in 2003, most of them tourists. Moreover, the number of passengers through Riga’s international airport is growing constantly, but it has yet to reach the flows achieved during the 1980s. It’s expected that the number of passengers will reach 1.2 million by the end of 2005. The main reasons for the steady increase in passenger flow are: • The entrance of cheap carriers (Ryanair, EasyJet) • EU and NATO membership The maximum capacity of Riga Airport has yet to be reached, but already some improvements have been made, and new expansions are planned. Air freight is also increasing, however the present volume is not particularly large (8,752 tonnes in 2004). �� Although fewer tourists visit Riga than Tallinn or Vilnius, all hotel rooms in the capitals are pre-booked. Room rates currently are quite stable, and should remain in the same level for few years. �� 9.1. Secondary Cities Small, new, private and Soviet-era hotels dominate secondary cities. The quality of service varies. New, private hotels offer a good standard, whereas most of the privatised Soviet hotels have a long way to go before they even reach a moderate level. Rates are much lower than in Riga. As tourism grows in Latvia the number of hotels should increase throughout the country. �� 26 � � � � � � �� Chapter 10 Investment Market The investment market was not very active last year, as few larger transactions in terms of square meters and funds have been recorded. However, this does not mean that investors aren’t interested in Riga or the Latvian market. No owners of attractive - from an international investment point of view - properties have expressed a willingness to sell. Only a few smaller investment properties (less than 5,000m2) have been sold to international investors. The stability of shopping centre rent rates and future growth prospects may well tempt the current owners and developers to sell and to move to other countries to conduct similar business. For example, if current rent rates remain stable or even decrease as a result of the increasing competition between shopping centres, an increase in property value can be expected in case the yield reduces further. However, even today the investment market is so competitive that a lower yield for good and big investment objects might be realised. Therefore, businessmen are in the situation of choosing the timing of realising the gains from their developments. As it has just been concluded, during the next few year’s significant increases in property value from the perspective of a Western rationale is not to be expected. Therefore, as some other Eastern Europe countries, like Ukraine, is lacking commercial space, developers could increase their wealth by using the funds and knowledge they have obtained in Latvia or other Baltic countries. If such a pattern is followed, the Latvian investment market should witness more investment. The development of emerging markets in terms of the type of investors engaged in market activities can be separated into five categories • High, opportunity-driven local and foreign investors with around two years of investment range • Mostly locals, who renovate existing buildings and offer high quality projects on the non-supply market • More established developers, who develop larger objects and add value by renting • Property funds and wealthy individuals buying the net income, adding value by managing the asset, and optimising the investment portfolio • Institutional investors who buy cash flows and add value by managing a portfolio together with shares and bonds �� Most CEE countries have already been through these market evolution steps and currently most of them, Latvia included, are somewhere between the fourth and fifth generation. This is because a substantial number of developments are still in the pipeline. Institutional investors, such as investment trusts, have already acquired properties in Latvia. Pension funds are yet to come, but this type of investor is looking for bigger objects, which so far have not been on sale. Therefore, it is hard to elaborate on this issue. The risk that first movers in Latvia saw is no longer an issue due to the country’s NATO and EU membership. Moreover, the market has developed and matured considerably since independence, and consequently investors are accepting lower yields than before. Also, the examples of success of investments in Ireland increased the hopes of small investors to have the same kind of profits in Latvia, which also enlarged the pressure on the yield-curve. �� 10.1. Office Market Because just a few office buildings are on the market, few transactions have been carried out so far. For the same reason it’s difficult to expect that these kinds of transactions will be recorded in 2005. Several new office projects have been initiated, and should be completed in 2005, therefore increasing the supply of potential investment objects on the market. As already mentioned before, the supply of modern office space is scarce even compared to its immediate Baltic neighbours in the north and south. It is highly probable that new developments will be initiated, thus increasing the supply of office investment objects even further. �� 10.2. Retail Market A few, relatively small retail objects have been sold by developers to international investors. The biggest transaction in this market has taken place in Riga. The two-floor, 5,100m2 Juglas Shopping Centre was sold to the international investor Baltic Property Trust in the third quarter of 2004. Because Riga’s shopping centres and hypermarkets belong to just a few developers (Linstow, Pro Capital…) and retail chains (VP-Market, RIMI…), retail investment market transactions depend on the strategic approach of these companies. For example, retail chains own most of the properties today, but due to increased competition and fast expansion these companies might decide to sell part of their properties to investors and use the funds later on. However, it’s highly speculative whether such an event would happen. 28 10.3. Industrial/Warehouse The industrial/warehouse market situation is similar to the office market. As virtually no investment objects exist, no transactions have been recorded and KOBA doesn’t expect this situation to change the near future before new developments will appear in the market. 10.4. Hotel Market As the market looks good for expansion, local hotel owners and international retail chains could decide to sell and lease-back their properties to investors and concentrate on their core business, increasing their wealth by opening new hotels. However, such transactions didn’t take place during 2004. 10.5. The Yield Curve During the last year the market became more sophisticated as more international investors with not only money but also with experience of structuring deals came into the market. Therefore, the acquisition of 100% of a property is no longer an issue. Sellers are including expectations about the positive economic effects on real estate prices and income, therefore, more complicated techniques are being introduced by investors/buyers to make sure their expectations are realised with an increase in income. Moreover, confidence is so high that on smaller transaction deals, the yield decreased further. This is due to several reasons 1. There are more buyers in this segment as both rich Latvians and opportunistic foreign investors are working in it. Moreover, locals are speculating on the future trends in land and small developments 2. Latvians are lacking investment opportunities, and for the time being real estate seems to generate the best returns 3. A lot of private foreign investors came in search of higher yields. The investment amounts are in the range of a few million euros. But they are looking for cash flow, which is difficult to find, as locals are interested in the property itself, not as money generator Latvia is small and a lack of products generates a need to search for them in the country’s smaller cities. As competition among investors is high, the yields start to drop to yields similar to that of the capital. However, in case of an economic slowdown, is the property in the neighbourhood of the secondary city of a similar quality to that in the heart of the capital? As would be expected, most deals are carried out in the lowest value range as more investors can afford to acquire them. Investments in commercial real estate between €1m and €3m are affordable for middle-sized investors. However, this range consists of investors who don’t have enough resources to obtain the best information to base their decision on, and might misjudge a situation. An investment range of between €3 million and €20 million is accepted by big local or international investors. This range of buyers has the experience to judge a situation adequately. Those investing more than €20 million are the big institutional investors who have teams of staff for analysis but use local consultants on acquisition matters. Therefore the yield curve is as following. �� 10.6. Secondary Cities Since just a few deals are carried out and few investment properties exist in Riga, naturally investors are broadening their views and considering secondary cities as well. Unfortunately, most of the larger shopping centres in Latvia’s secondary cities are owned by retail chains, which were built for their own use, and so not much is to be found here either. However, the remaining part slightly enlarges the potential of the investment object list. In the office segment the situation is different. Unprofessional property owners dominate the market. Sometimes, depending on the quality of the tenant, they can offer attractive investment objects. 30 Chapter 11 Koba’s Market Expectations 11.1. General Remarks After fourteen years of independence and a lot of hard work building the economy by restricting the country for investments into leisure and other publicly used objects, Latvia, with a significant economic growth and positive future expectations, decided it was time to begin developments. The following is a list of these developments, ongoing or planned for the near future. Under construction • GoPlanet - the largest entertainment centre in the Baltic States. Investment €15 million • Ice Hockey Arena - a €30 million construction currently going at full speed. The project is expected to be finalised in 2006 • Saliena Town - a new 600ha town on the outskirts of Riga. Development is on-going. So far the ice-skating arena has been completed. Construction of the residential area and an 18-hole golf course is ongoing. Total investments are expected to reach from between €500 million and €1 billion • Southern Bridge - a €200 million project, due for completion in 2007 In the near future • Pentagon Modern - police administrative headquarters with an expected investment of €30 million. Builders were contracted in 2003 but political scandals have so far prevented the start of construction • Airport North Terminal - not quite in Riga, but close enough. Design tenders are at an end, and the project should be completed in 2008 • Concert Hall - ready by November 2008. The government has secured the major part of the €20 million financing already • Zakusala Multifunctional Centre - 8 hectares of land to be covered with the largest exhibition centre in the Baltics, plus sports club, hotel and conference centre. And international tender has been announced • Latvian National Library - an unusual design, 12-floor building with a required investment of around €120 million. The project should commence in 2005 and is expected to go on until 2008. It’s been announced that the municipality has reached an agreement to take over all 26 private properties on the project site • Ship Passenger Terminal - completed by 2007. Investment around €12 million • Spilves City - a project of several thousand hectares called on either side of the river, with the aim of building a new town within the city. The developer is Viesturs Koziols with Arnolds Laksa Longer term • Eastern Magistral - scheduled to begin in 2007, and requiring €80 million in investments. Design and land purchase for the project under way • Skanstes Street Business District - high-rise buildings. Design begins in 2005, when the major works at the Ice Hockey Arena (see above) are completed • Daugava Northern Crossing - due to start in 2007, and will require €200 million investment • High-tech Industrial Park - near the airport on almost 230 hectares of land. A long-term project to cover the area with small and larger high-tech industries as well as residential areas. Construction has already begun, but the project isn’t expected to be completed until 2018 • Riga City Council - following in the footsteps of Vilnius Municipality, a new HQ to be built in Pardaugava • Bus Terminal - a complete reconstruction of the current building and surrounding area. Expected cost, about €30 million Riga Municipality owns a considerable amount of land, and therefore has a big influence on the development of the real estate market. At the start of 2003, the municipality owned the following real estate • Land A total of 1,815 separate land plots, with a combined value of €147.9 million • Other Real Estate Some 10,485 objects with a total value of €371.37 million, which included dwellings, administrative buildings, schools, hospitals and other property In order to control urban developments according to the city’s strategic interests, the municipality prefers a policy of leasing rather than selling land. In Riga, as in the rest of Latvia, real estate market development and the number of market transactions are influenced by the privatisation of state and municipal property. The number of new constructions and renovation of existing buildings is frequently seen as an indicator of both the amount of economic activity and the overall economic environment. Data obtained from Riga’s Development Department shows that the number of approved development projects has been growing constantly since 1993. KOBA expects the number of developments to continue, as some real estate sectors remain highly underdeveloped. �� 32 �� 11.2. Offices Compared to its Baltic neighbours in Estonia and Lithuania, Riga has little in the way of new, modern office space. However, it’s hard to predict if any developer will take the challenge and move the existing business locations that for the moment can mostly be found in the Old Town and in reconverted industrial buildings in the city centre and its suburbs. As mentioned earlier, the Old Town and city centre, despite offering a prestigious location, both have limited supply of parking as well as inconvenient and inefficient premises set-up. The trend is that companies move out of these areas into less prestigious locations but with the same quality of buildings that can offer lower rent and in most cases unlimited parking. It is speculative to argue wherever this move has been for the benefit of developers’ profits or as a result of management wanting to lower the rent payments and increase parking space, but it is certain that the move exists and it should continue. It seems that a clustering effect could be initiated, but the best places for office building developments are high priced, a direct result of the boom in the residential market. We project that even in such a highly uncertain situation regarding potential tenants moving, new high-rise modern office developments should be initiated in the near future. 11.3. Retail The shopping centre segment is very crowded, but new projects (Latlada, Riga Plaza) are still to be initiated in Riga. KOBA expects that even more developments will be carried out. For example, Lithuania’s VP-Market, the owner of the land plot for the development of a 100,000m2 shopping centre and 50,000m2 office building named “Akropole” might also initiate a project as well. On the demand side • Consumer purchasing power has increased and is still increasing • The retail market has grown considerably during 2004 • International and local investors are looking for real estate investment objects On the supply side • Interest shown by international retailers due to an enhanced market potential is increasing. However, to date most of them have franchised rather than entered the market on their own (ZARA, Hugo Boss, Salamander…) • More retail chains have announced entering the Latvian market, including Lithuania’s second largest retail chain, IKI. These companies believe that there still are opportunities in the mediumsize retail and supermarket segments, and that the competition is not as fierce as it is in Lithuania. 11.4. Industrial As already mentioned, it’s difficult to predict if this segment will grow, as for example the retail segment in Riga has grown. It really depends on the demand from international companies as well as for the need for funds for further business development for local companies. As financing is cheap, companies choose renting only for flexibility, which is a rather minor argument in a small country like Latvia. Despite that, there remains a need for new, modern industrial/warehouse facilities at least for businesses for regional distribution. 11.5. Hotel The final piece of news is that all hotels are pre-booked for the summer of 2005, suggesting that a need for new hotels is huge and that the few developments that are currently underway might not satisfy the demand. Several new hotel projects are initiated on Riga market • Developer Linstow is enlarging the current Reval Hotel Latvia by building around it. Construction has started and the cost is estimated to be €20 million • A Dutch investment company is reconstructing a hotel at Dzirnavu Street 33. Work on the 8,000m2 building is expected to finish in autumn 2005 • Developer Linstow is engaged in a hotel development project on Jakaba Street Moreover, Riga Municipality has initiated several programmes aimed at the development of the tourism infrastructure in Riga, such as increasing the number of tourist information centres, the introduction of special tourism trails and the reconstruction and modernisation of Riga’s Passenger Ferry Port. Riga is still behind Stockholm, Helsinki and Tallinn in terms of number of tourists, but there has been a slight increase over the recent years. KOBA expects that the hotel developments scheduled for 2005 will be followed by more, which should absorb the ever-increasing number of tourists. 11.6. Sale Lease-Back The sale-leaseback segment experienced few signs of activity. A few small deals have been recorded in the Baltics but they are just the first signs of a coming boom. The reason for such an inactive segment is cheap financing. The banking sector experiences fierce competition, and rates must be low before the European Central Bank or FED will decide a different policy. Moreover, due to economy growth and other reasons, real estate prices have gone up, leaving less incentives for deals as not all the increase gains will be realised. Despite that, international companies want to clear out their balance sheets from huge inactive real estate wherefore sale-leaseback agreements are under consideration. We believe it’s just a matter of time until the market hears the big news. 34 11.7. Liquidity – an Exit – For Property Investments Despite a significant growth in the market over the last couple of years compared to any other Western or CEE country, the growth is still fairly small. However, as mentioned earlier, interest in Latvian commercial real estate over this period has increased significantly, and therefore a profitable exit on the investment should be a minor problem. Currently, several international investors and a few international institutional investors have invested in the market. Most of them started out with shopping centre development, centres which they currently own and manage. Institutional investors perceive approximately seven years of investment horizon. Furthermore, during the last couple of years Latvian companies and a few individuals have accumulated wealth from business activities. As less growth is expected in their core business markets or some businesses closed down naturally, this money has subsequently been invested in the booming real estate market. They are engaged in the commercial real estate market from different sides, as developers, investors or turnaround specialists, increasing the potential customer base. Moreover, political risks exist but are a minor problem. In 2004 Latvia joined NATO and the EU, making political risks and third party annexing an absolute minimum possibility. What’s more, Latvia already has almost 15 years experience developing democracy and an “arms length” economy. 11.8. Conclusion The Latvian commercial real estate market is developing further, and presenting fruitful opportunities for local and international retailers to gain from increasing consumer purchasing power. Retail space growth is spreading throughout Latvia into its furthest corners. Up until now, significant developments have been made in both the retail and office segments, but as mentioned earlier, other kinds of properties and types of transactions are finding their way into the market. The yield development pattern in Latvia is similar to the CEE markets. However, CEE countries such as Poland, Hungary and the Czech Republic have already been through these same phases and are currently slightly ahead of the Latvian markets. The yields in these countries for prime location investment products decreased to 8%. First movers are already enjoying the gains from the yield decrease, and in the long run should experience an increase in rent levels, as the new EU entrants’ economies develop further. It should also be noted that Latvia is more developed compared to its Eastern neighbours, like Belarus, Ukraine, Romania and others. The Latvian commercial real estate market yield, combined with the liquidity this market can offer, is the kind of attractive product international investors are looking for, and therefore the market should experience more transactions in the near future. Chapter 12 SWOT Analysis A SWOT analysis is the most common tool in analysing the expected performance of equities. It describes in verbal terms the strong and weak sides of an investment together with its opportunities and threats. It does not pretend to give an exact answer to invest or not to invest, but illustrates the expected yields and risks. Strengths • Demand for high quality properties in attractive locations • Favourable investment environment • High yield level • Well-educated and cheap labour force • Fairly developed market • Favourable financing Weaknesses • High expectations about future values • Lack of parking space in the city centre and in office buildings • Shortage of land plots for development • Land prices are quite high in Riga’s logistic/industrial developments due to the boom in the residential market Opportunities • Increase in economic growth and consumer spending • Stable political climate with a democratic spirit • Development of western consumer habits • Fairly low construction costs • Fast commercial project developments Threats • Political instability in neighbouring countries • The so-called ‘shadow economy’ is still considerably active. It is estimated that between 20% and 25% of production is not being reported A SWOT analysis of the Latvian property market describes the potentials and risks of a typical emerging market and can be compared with other Central and Eastern European countries which are currently at a more developed stage (eg. Poland, Hungary and the Czech Republic). However, this gap has started to close during the last couple of years. 36 Chapter 13 Legal Facts About The Commercial Property Market The Latvian real estate market is in general terms supported by a fully developed legal and professional infrastructure for real estate ownership, occupancy and investment. Additional law reform is still required and drafting is already underway with respect to a legal framework for condominium formation and administration. Additionally, while the basic foundations for real estate law are already in place, a certain amount of care must be exercised in the purchase and sale process, particularly with respect to the mechanics of conveyancing and title searching. It is recommended that before entering into a real estate transaction, the support of a professional legal and tax advisor is sought out. 13.1. Real Estate Acquisition In general, there are relatively few material limitations to the acquisition of land or buildings for development by foreigners. Foreign investors have the right to purchase or lease buildings or lease or purchase land. This is, however, not an unqualified right. EU citizens may acquire land in Latvia except a) agricultural land and forests, unless specifically qualifying, and b) land in the area of national borders, land adjacent to the sea, land in national parks and land by lakes and rivers. These restrictions do not automatically apply to land in cities. Latvian and other EU member state companies may acquire land in Latvia provided 1) at least half of their share capital is owned by EU citizens or the Latvian state or municipality either individually or jointly, or 2) at least half of their share capital is owned by companies registered in countries with which Latvia has entered into mutual trade and investment protection treaties with ownership of the shares in the companies by citizens of such countries, 3) their stock is publicly traded on the Latvian Stock Exchange. It is advisable to review the legal description and physical location of the target acquisition with a lawyer to ascertain if the planned purchaser can legally acquire the target acquisition. In the event that the planned purchaser is not eligible to take title to the object, it may be possible to do so indirectly through the utilization of a Latvian registered special purpose vehicle to acquire the property. Prior to contemplating a purchase, it is advisable to review the legal description and physical location of the target acquisition and where further development is contemplated, the applicable planning and density restrictions. 13.2. Registration of Title Current law requires that real estate purchase and sale agreements and official requests to register title or leasehold estates under the registry system, (called the “Land book”) be notarised by a notary. The mere act of notarisation, however, is not sufficient to ensure registration of good title. It is important to note that the relatively rare cases of conveyance disputes or failures can often be attributed to the failure of a party to attend to the Land book with its notarised request to register in hand on a timely basis and register its title to the property. In other words, there has been a slow start in the race to the ‘registry office’. Usually such difficulties can be prevented by utilization of escrow agreements such that the buyer’s money is held by a third party escrow agent, (almost invariably a local bank) and only transferred to the seller once good title is registered in the name of the purchaser. 13.3. Purchase and Sale Agreements There is no such thing as ‘real time closing’ in Latvia, as there is always a delay between the moment of submission of documents to the Land book and the moment of registration of property under the Land book. For this reason, aside from the relatively self explanatory requirement that purchase and sale agreements include precise particulars of the buyers and sellers, legal descriptions (cadastral number and municipal addresses) and purchase price, it is, from a buyer’s perspective, advisable that purchase and sale agreements stipulate an escrow closing. In many other jurisdictions, lawyers commonly act as escrow agents. That is, however, very rarely the case in Latvia, where local banks are almost invariably chosen as escrow agents. Such banks acting, as escrow agents tend to insist on use of their own pro-forma escrow agreements as the agreements to govern the escrow closing arrangements between the purchaser, the seller, and the bank. Investors are well advised to require a legal professional to review the draft bank escrow agreement to ensure that it does not contain wording that defeats the purpose of using an escrow agent. We refer here, for example, to the often encountered attempt of the escrow agent to insert escrow agreement language having the effect of deference to the instructions of the purchaser and seller prior to transfer of the funds held in escrow to the seller, essentially de-escrowizing the escrow agreement. As a result, escrow agreements frequently require amendment and in some cases, perhaps surprisingly to purchasers, negotiation over the content of the escrow agreement may take more time than negotiation over the purchase and sale agreement itself. We therefore encourage parties to factor a sufficient amount of time for escrow agreement negotiation and finalization into their timetable for closing. While escrow agreement drafting may require more time and effort than one might first expect, whatever the complications with escrow agreements, the use of an escrow agreement in the conveyancing process is infinitely preferable to a closing without an escrow agreement under which payment is first transferred to the seller and only then is an attempt made to register title. While the land titles system in Latvia has been found to be in remarkably good condition following the collapse of the Soviet regime in Latvia, it is still true that not every building, apartment or plot of land is yet registered under the Land book. Where the target acquisition is registered under the Land book, searches of the Land book can reveal encumbrances such as easements, rights of common use, mortgages, pledges, arrest orders and certain other clouds on title. Public auctions of property should be approached with caution, particularly where closing is not contemplated through an escrow arrangement. A curious case recently occurred in Bauska in which the winning bidder of an auction on a piece of real estate was surprised to find that despite bidding on a property that was represented by the auctioneer as being unencumbered, after his ‘winning’ the bid, but prior to his registering title to the property in his name, a third party managed to register a substantial mortgage on title to the property. This case only demonstrates just how critical it is to close on an escrow basis only. No assurances from auction organizers should be taken seriously as an alternative to an escrow closing. Deposit agreements are often relied upon as a means of securing a property from alternative purchasers prior to actual negotiation and conclusion of an agreement of purchase and sale. Unfortunately, the customary legal mechanism for return of the deposit on a two fold basis by the vendor or the forfeiture of the deposit by the purchaser in the case of a failure to close for reasons of ‘fault’ of the respective purchaser or seller is fraught with ambiguity and may in fact create more legal confusion than it is intended to rectify in the case of a default. In the event that a deposit agreement is necessary, advice from a legal professional is suggested in the drafting of such agreement. 13.4. Rights of First Refusal by Municipalities and Other Third Parties Section 78 of the law on Municipalities provides that a municipality is entitled to a right of first refusal on a purchase of building on the same terms and conditions as those proposed by the prospective parties to an agreement of purchase and sale. 38 In order to legally circumvent the municipal right of first refusal, it is common practice to separate what is essentially one purchase transaction into two parts as a form of conveyancing. Judicial consideration of such practice has yet to be forthcoming, but the practice is so widespread that a retroactive reversal would likely be in conflict with public policy considerations, and is perhaps therefore unlikely to emerge. 13.5. Leases A lease does not require notarisation in order to be a binding lease. It does, however require registration in the Land book in order for it to be binding upon third parties without notice of the lease. In order to effectuate such registration, it is necessary to attend to a notary’s office and sign and have notarised the request to register the lease. As the law does not specifically mandate the registration of subleases, Land book notaries are sometimes reluctant to register subleases, even where the parties so agree to their registration. If the main tenant is contemplating subleasing part or all of the lease premises to a sublessee, it should first ensure that unequivocal language authorizing it to unilaterally enter into such sublease agreements without the express further permission of the landlord. Further language deeming the landlord to consent to registration or undertaking to fully cooperate in the execution of a Request to register may also be helpful, but it remains the case that success in registering a sublease is not assured under current practice, particularly if the landlord enters into a dispute with the tenant. Additional legal advice should be sought before contemplating a Land book registered subleasing scenario. Most aspects of commercial real estate leases are negotiable, and typically commercial leases have a term of three years or more. Where a landlord or tenant makes a significant capital investment in the leased space, lease terms may typically range from five to ten years. Rent control does not apply to newly erected buildings. In cases where rent control exists, various approaches are available for owners to try to terminate rent controlled tenancies, more often then not requiring the acquisition of alternate accommodation for tenants. Residential lessees in protected tenancy situations are provided considerable protection under the law in practice. Courts will, for example, typically find that even part payment of rent demonstrating intent to honour the lease relationship will shield a tenant from eviction. 13.6. Planning and Development Zoning of territory is governed by the law on Territorial Planning and Regulation Nr. 83 of the Cabinet of Ministers “ on territory planning by municipal government”. Planning takes place at four levels: national planning, regional territorial planning, regional municipality territorial planning and local government territory planning. It is important prior to acquisition of property to determine whether it is planned for the use, which the purchaser requires. Density and minimum plot sizes may also be of concern. The City of Riga is scheduled to introduce its new municipal plan as early as August 2005. Chapter 14 Koba Company Profile Since 1989, KOBA has striven to be a serious, competent and professional real estate consultant company, constantly adjusting to the conditions with an ever-changing market. Today, our organisation is composed of qualified and motivated employees always focused on the needs of our clients. We are organised in various business fields ensuring that each employee has a sound general knowledge of the property market to complement a profound insight into his or her specialist field. This enables us to provide added value to our clients, not only as real estate consultants, but also as professional and trustworthy advisers and partners at the strategic level. Project teams in which each specialist field is represented handle major projects. KOBA was established in Copenhagen in 1989, and opened an office in Vilnius in June 2000. The organisation into business fields enables us to operate in all parts of the Baltics. Investment Acquisition and sales of investment property. Preparation and implementation of buying and selling strategies combined with consulting services. Valuation Maintenance of high professional competence in valuation services related to change of ownership, property financing, accountancy, and expert appraisals. Corporate Services Selling and leasing offices and industrial premises. Locating headquarters for large and small businesses. Retail Real estate services to chains of retail outlets wishing to acquire or sell shops, including strategic consulting services. Letting and sales of retail shops. Property Management Various assignments related to property management, including collection of rent, care-taking and maintenance. Research Preparation of newsletters addressing the market situation, preparation of market reports, market analyses, and continued monitoring and evaluation of market conditions. Preparation of special purpose analyses. KOBA Konstitucijos 7 Vilnius Lithuania Tel. +370-5 248 72 22 Fax +370-5 248 72 23 www.koba.lt koba@koba.lt 40 Chapter 15 Kronbergs & Cukste Company Profile Kronbergs & Čukste is a full service law firm, specializing in corporate commercial law, energy & utilities and real estate and construction, founded by two former ‘big-four’ accounting firm legal practice partners, Valters Kronbergs and Vineta Cukste. Kronbergs & Čukste is a founding member of Baltic Legal Solutions, a pan-Baltic integrated legal network of law firms which includes Teder Glikman & Partnerid in Estonia and Jurevicius, Balciunas & Bartkus in Lithuania. This high quality legal network has the ability to provide a one-stop-shop approach to all of the client’s needs in the Baltics. On a wider scale, Kronbergs & Cukste continues to have a best friends relationship with the former EY Law member firms in Europe and elsewhere, together with Pinsent Masons of the UK, comprising a formidable international legal team capable of providing the quality and scope of services international clients require. Contacts: valters.kronbergs@kclegal.lv vineta.cukste@kclegal.lv Kronbergs & Čukste Kronvalda bulvaris 3-5 Riga, LV-1010 Latvia tel. +371 704-3801 fax +371 704-3804 www.kclegal.lv

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