Russian Investors Target Turkey

Matthias Kabel / Wikimedia Commons

The partial collapse of the Cyprus banking sector may have a growing impact on commercial real estate prices, and not only on the island. Experts say returns will be affected by changes to the domicile or tax treatment of holding companies and deals should reflect that.

Cyprus, like Luxembourg and many other tax havens, is used as a location for special purpose vehicles to hold and manage real estate located in eastern Europe, especially Russia and Ukraine, but also Poland and other countries.

Dr George Mountis Partner at Leaf Research, headquartered in Nicosia said it was likely that Cyprus would raise taxes further, affecting locally-owned property and companies holding property overseas.

"Property taxes and additional taxation, like corporate, dividend, etc, are currently under way, or will be. The new bill for property taxation is to be voted by the parliament the next month or so. And maybe more taxation could be in place over the next few years. Cyprus has to repay off its Russian loan and bailout facilities. These will affect both corporates and households."

Confidence in Cyprus would change if the European Union tried to unify tax rules across the community. But I would not say this is really possible.

Cyprus' corporate tax rate recently rose from 10 to 12.5 percent and remains highly competitive. The island also offers the benefits of English common law, which businesses often consider more flexible when drawing up contracts.

Cyprus may have held excessive debt but in terms of the scale of its banking sector relative to GDP it was not unique. In Cyprus the banking sector had grown to eight times GDP, and in Luxembourg the volume of bank deposits is closer to 22 times GDP. The European average is 3.7. This suggests other countries may face fiscal adjustments, writes Damian Harrington, regional director of research for Colliers International, in a research note.

Deals must be priced to account for the impact of the possibility that tax regimes may change, says Harrington. "The chances are that whether a deal is priced at a yield of 6.5 or 8 percent, there could be an increasingly wide variation in returns around that number, as a result of the deal structure or domicile involved."

Investors may limit their use of Cyprus, because tax may be just the first step to be followed later by greater demands for transparency and information, said Mark Rovinskiy, deputy head of tax practice at Egorov Puginsky Afanasiev & Partners. However he doubts a new tax haven will replace Cyprus for Russians. "Definitely Cyprus will have some outflow of investment. It is not invested there anyway; Cyprus is a hub. But I don't think everyone is running and asking to relocate and find some other place."

Many wealthy Russians acted promptly to remove their money from Cyprus. For several months, individuals had been buying expensive real estate in New York, for example. About 3.6 billion euros ($4.67 billion) was removed in two weeks of March by holding companies. Of those 129 companies, 39 were ultimate owned by Russians or Ukrainians, according to Reuters.

Russian bank VTB, which had assets of up to $1.8 billion in Cyprus, claims to be virtually unaffected.

Cyprus banks were shut down for almost two weeks by the Euro zone and the International Monetary Fund on March 15th in order to prevent depositors transfering funds abroad. Banks later reopened with tight restrictions.

Kommersant newspaper estimates that Russian companies still lost from 1.5 billion to 2 billion euro ($1.9 billion to $2.6 billion).

Many smaller Russian business people did not get their money out, and are destined to finance the bailout of Cyprus while trying to manage their properties and enterprises.

Dr Mountis of Leaf Research, said there was foreign ownership of commercial real estate though there are not yet any figures, and the sector had suffered significant reductions in terms of volume sales and prices.

Given the structure of the agreement with the European Union, he said the recession in Cyprus would be deeper and longer than first expected.

He fears a "negative feedback loop" as local banks squeeze borrowers while austerity measures increase the burden on an economy already in recession. He argues that a fiscal consolidation of 5 to 7 percent of GDP is likely to shrink the economy by 16 to 18 percent.

"Unemployment is rising, people cannot afford to pay off their loans, this means additional provisions for the banks and hence additional capital shortfalls," Dr Mountis said. "The priority for Cyprus is to minimise spending and unemployment and obtain corporates and people trust in its banking and financial sector."

Capital controls and the effective suspension of lending may affect the ability of businesses to pay their suppliers, which may force local companies to lay off staff or dispose of assets at distressed prices. This process could, he wrote, turn currently performing loans into non-performers, puttting further pressure on Cypriot banks.

Russians have been the most active buyers of Cypriot real estate. Konstantin Popov, chairman ofproperty developer Inkom's board ofdirectors, said Russian investments inCypriot real estate amounted to$10 billion over thepast 10 years. As many as 45 percent ofRussian real estate deals inCyprus were concluded forinvestment purposes, followed by40 percent forfamily reasons.

Russian investors might lose more than $3 billion onthe island's property market if thecrisis deteriorated, Popov said incomments published onthe RRE.ru property research site.

According to Charalambos Petrides chairman of the Property Valuers Association, which represents about 90 percent of valuers in the country, residential property prices have already fallen by 50 percent in some parts of Cyprus and by 35 percent for some commercial real estate. That's compared to the peak of the market at the start of 2009, Charalambos told Reuters.

While Chinese are beginning to buy property in areas like Limmasol, bargain hunters are hardly likely to support an economy that was driven by real estate. Inkom's Popov said capital outflows fromCyprus would lead to property prices falling 25 to 30 percent insuch popular places as Paphos and Limassol, where Russians prefer tobuy villas for around 300,000 euros ($386,000) or or townhouses priced around 600,000 euros.

At the same time there will be beneficiaries of that capital outflow, such as liquid and diversified markets like London and Paris, even if some people questioned the pricing, said David Hutchings of Cushman & Wakefield's European Research Group.

The top cities for investment by high net worth individuals have been mature, familiar capitals, though according to Real Capital Analytics, Moscow was the second-placed market in 2012.

"Confidence in Cyprus would change," Rovinskiy said, "if the European Union tried to end tax competition and unify tax rules in the EU. People would move quite quickly but I would not say this is really possible. It is hard to imagine because countries within the euro have very different tax rules. For example, Germany is an extremely fiscally-oriented country that tries to tax everything that can be taxed. Then there is Cyprus which provides a very flexible tax regime. It would be hard to imagine how they could unify. However, in Russia 30 years ago some things looked like they would last forever."