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Home Article categories Business strategy and finance Editor’s Focus: Eye on Latvian Real Estate (part 1 of 2)

Editor’s Focus: Eye on Latvian Real Estate (part 1 of 2)

By Oleg K. Temple, September 2009.

It's no secret that of late, Latvia has become singled out as the "sick man of Europe" — a country crippled, maimed and burned by an overheated economy gone berserk, which has now coughed its last and ground to a halt. Doomsayers foretell a long cold winter ahead, before a slight seasonal revival in 2010.

Specialist's View | Positive Initiatives | LEAN

So why did Latvia's fledgling economy freeze up like a rabbit caught in the headlights of the skidding "18-wheeler" that was the Global Recession? What motivated the government to go on a staff-culling rampage and raise taxes in the people's time of need, filling its depleting coffers at the expense of obliterating the consumers' buying power? GDP crashed by 19.6% in Q2 of 2009, but what do you expect after the leaps and bounds of gratuitous growth at approximately 10% per year between Latvia's EU ascension in 2004 and 2007? I will go into details about all that in another article, for now let's talk real estate.

One of the main culprits singled out for the contemporary ailments of the Latvian economy is the real estate market. It supported a large portion of the economy before it sagged and deflated, dragging countless businesses under. Sure, rampant credits, ravenous taxation, corruption and misdemeanour in the governmental ranks also took their toll, but these were the symptoms, not the actual pathogen. The motivation was simple: human greed — people in power taking advantage of loopholes in the system they themselves designed and still control. More often than not, a good gauge for the avariciousness of the local "officials in business" is the lavish collection of real estate they have horded for themselves and their families.

However, enough negative press has been spewed on the subject over the past nine odd months; it now hangs like a blanket of caustic smog, concealing many of the good things about Latvia. Yes, the figures look grim, yes, the recession happened and yes, it was mostly due to human error, myopic planning and greed. Experts who are on the ground, in Latvia, know better than to scuff at an opportunity to have their say in the media, for it is they who shoulder the onerous task of putting the economy back together again and true experts understand that the media is one of their nearest and dearest tools for setting the mood of the market.

 

A Credible Specialist:

I caught up with Ms. Diāna Štāle, the Head of Valuation Department at Latio Real Estate and had an hour-long discussion about the current affairs in the realm of Latvian real estate. Ms. Štāle has delved in the property field for many years and by now has seen it all. According to her, although the prices for rent are still in freefall, the purchase price for standardized apartments seems to have stabilized over the summer, finally settling around 490 Euro/m2, after having plummeted from the pinnacle in 2007 (when they were about 1620 Euro/m2) by some 70% (house prices have fallen slower, by about 40% to 50% since 2007).

Number of sales has also shrunk remarkably, by about 70%; however, following a six-month lull in activity, the market is currently being revitalized. This new demand is primarily created by locals who have began to dip into their personal savings as the tendency of the prices to keep dropping has dissipated and the market is beginning to harden once more. Some foreign investors (notably from Russia and Scandinavia) are also trickling in to join this "Buyers' Ball" and take advantage of the malleable prices.

The initial consensus was that the banks would flood the market with repossessed properties in a rush to liquidate them and that as a result the supply would continue to dwarf the demand, thereby keeping the prices cascading down a virtually bottomless pit. Fortunately, the banks have proven to be far-sighted enough to invest the repossessed properties into funds and keep them off the market, as a result the supply of cheap real estate is actually dwindling as demand is quickly overtaking the supply of apartments on offer for give-away prices.

Another area of the market that weathered the crisis quite well, is the construction of shopping centres commissioned by various supermarket chains such as IKI, Rimi and Maxima. Despite the low population of Latvia, these grocery giants have a lot of room to manoeuvre as these days people are always on the lookout for discounts and cheaper stores and the grocery store sector is still far from its saturation point.

The government is cooking up yet another increase in tax to levy on the people - for real estate, both domestic and commercial. As the 2008 issue of the Baltic Property Market Report* explains, the Real Estate Tax or RET already exists, it is levied at a rate of 1% applied to the cadastral value of land and buildings, with structures being exempt. The cadastral value is determined by the Land Service considering the type, location and use of a particular property, transaction prices over the previous two years and other factors. Although cadastral value should be approximated to market price, cadastral value usually lags well behind the current market prices. A debate rages to decide what would be the fairest solution: to increase the tax marginally based upon area occupied above a minimum, increase the tax based upon all of area occupied/owned or decrease the overall tax, but strip certain institutions from their tax-exempt status (mostly municipal, diplomatic, religious and cultural buildings) and thus make up for the deficit? Indeed, the Latvian law about real estate tax (clause 3, point 1, last updated June 12, 2009) states that "the rate for real estate tax is: until December 31, 2010 the tax is set at 1% of real estate cadastral value. From January 01, 2011 the tax is to be 0.4% of real estate cadastral value (base rate)." It seems this is not to be...

I asked Ms. Štāle to weigh in on how prudent and effective topping the current tax with another 0.5%would prove in the current state of affairs. She said that this legislation may have paid dividends had it been introduced in 2005-2007, during the boom, but it could result in a backlash of detrimental consequences if introduced to the current fragile system. Timely introduction of this tax could have offset the crisis, though it is doubtful that it would have prevented it entirely. It would have made little difference to the population in the hay days — if people did not mind shelling out 18 LVL per month for cable TV, why then, should they be at all averse to paying as much per year for their abode? However, locking the barn doors after the horses have bolted will solve nothing and only serve to prolong the problem of consumer inadequacy. Another tax is the last thing the people need right now — though miniscule on its own, coupled with all the other levies, it could be the straw that breaks the donkey's back. Fortunately, there is a bylaw that protects the population from over-taxation and prohibits increases of over 25% of current payments. A far more significant problem that requires attention, Ms. Štāle said, is the disparity and imbalance between the cadastral and market values of properties. If aligned properly, they would help stabilize the market and be conducive to a fairer trade environment.

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Positive Initiatives On The Road To Recovery:

A British friend of mine left Latvia for good this summer, saying that things are bound to continue deteriorating and the economy will right itself no sooner than 5 years from now... Before we lean one way or the other, I suppose we must first of all determine what exactly is the state of economy that we would find acceptable? Do we really wish back the "good old days" of 2006-2007? Everyone spiked on a gold craze rushing about like Duracell bunnies, hoping that the market will take a little more stress until their individual business has taken off, with no idea when the bottom will drop out?

We all knew it could not last, that we were playing "musical chairs" with destiny and yet while the going was good we all rushed like lemmings, pushing and shoving each other, toward Cliff Recession. It seems that every generation needs a good jolt of recession to sober and educate it, as experience is the best teacher we know. Hence, it follows that it is unlikely that the economy will be strung out like it was during the mayhem of '06-'07 for the next 15-20 years until the raw memory of the past year and a half as well as that of the next year fades. I expect the economy to cool down, get well back in the black to about 60-70% of the boom growth in approximately 3 years from now, by the end of 2012, but this time it will be built to last. How do I know this? By projecting the incubation and pullulation time needed for the seeds of change planted today to affect the economy.

Ultimately, the real estate market will rebound when the banking sector has healed and that will happen when investor confidence in Latvia has been properly restored. Ergo, if Latvia just sits on the curb with an outstretched hand awaiting alms from the West, then my friend's prediction will hold true. The Western nations have just backed away from the brink of the meltdown abyss, a few years will surely pass before Germany and the others get back to their generous ways. However, Latvia's business community and government have all now tasted their share of the bitter wine from the chalice of failure and depression. It is clear that the economy unravelled because of inane bureaucracy and atrophied industry, there is no way they will just sit back and watch the clear blue sky waiting for a shower of Euros. Correctional reforms are inevitable, especially since the end of last year when Latvia came under the strict, watchful eye of the IMF, EBRD and the World Bank and other international donors that are holding the purse strings to the much-needed credit rations.

As for now, the worst is behind us. The markets in the West appear to have found their feet and Latvia will also follow suit. Sure, ripples of uncertainty will no doubt make the coming winter seem worse than now, but this will be the healing pain. The element of surprise has faded and the panic is over, business leaders now pull together with a common goal to get the economy back on track. We now know the nature of the crisis and its causes have been strung up and dissected by world-class experts in every country.

In the past year, domestic expenditure has come under the knife, the general consensus is that this alternative was the better than its ugly brother devaluation of the lat. As a result, prices for qualified labour and construction materials have also dwindled to a more realistic proportion in relation to what consumers earn. Reasons for long-term investment in Latvia are far more palpable and sensible now than they were 2 years ago; this fact is clearly illustrated by stories such as the legume cultivation initiative from Heinz to Latvian farmers recently reported by Dienas Bizness, one of the most popular business newspapers in Latvia. NOW is the time to build factories and hotels that will be ready to zing into life when the economy picks up in a couple of years.

Gary King of Heinz visits Aizkraukles region, August 2009

Several companies such as Connect Latvia and Latvian Investment and Development Agency, LIAA  have also been making a positive impact on starting companies in Latvia. One of their recent projects is a "Production of glued laminated timber from exotic and other hard wood species" in Ventspils Dendrolight. The Free Port of Ventspils Authority is due to invest 7 million LVL to build a production facility of 7000 m2 and a stack yard with engineering network of approx. 15000 m2. SIA "Dendrolight Latvija" will lease these buildings and install therein a technological line worth approx. 10 million LVL. Production estimated to commence in 2010.

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We LEAN Business!

SWOP, Swedwood's Way of Production is a live manifestation of the LEAN Spirit!

Economists are in agreement: the life-force required to haul Latvia's economy back out of the jaws of recession is production for international trade. Tourism and real estate markets will inevitably spring back into shape when the economy is strengthened by industrial advancements. Prime Recruitment, a fore-runner in the Latvian HR sector and a stout advocate of the Thomas System (an advanced personality assessment method), is among those pioneering the LEAN programme in Latvia. With a strong Kaizen (改善) spirit of ceaseless improvement, inspired by Toyota's Production System, companies incorporating the LEAN Manufacture method aspire to view their business through the eyes of the consumer. In LEAN, all expenditure of resources must result in direct value for the end user (i.e. contribute to a good or service the consumer would be willing to pay for), any other expense is considered wasteful and ripe for elimination.

In our world there are, of course, a myriad of "sure-fire" systems designed to improve production, reduce spending and whet the consumer's appetite. The reason I cite this particular system as a significant step on the road to recovery is because it illustrates the evolution of the business acumen in Latvia — prior to the crisis, many companies just wanted to sell, sell, sell, regardless of how much they splurged on the overhead costs. When costs got too high, they simply increased the price of what they were selling and as long as everyone in the country was making enough money, the buyers did not mind. Now that the "Crazy Money" days are gone, the tables have turned, the buyers have the power to regulate the market (not just in the world of real estate, but in other spheres of business as well) and the manufacturers are forced to streamline their operations and curb their prices. Going LEAN may be a way to save their skin and ultimately keep their business from becoming extinct.

Furthermore, Latvia is a nation of fertile land, sprawling forests, vibrant culture, brilliant and (despite certain governmental policies) multi-lingual people. The country also enjoys a strategic geographic location with the ice-free ports of Liepāja and Ventspils providing gateways to vital logistical arteries between the East and the West. The Latvian education system is also quite advanced in the fields of economics and business management, spear-headed by fine institutions such as the Stockholm School of Economics, Riga Graduate School of Law and the Riga Business School.

Liepāja Port

Fine young talents are joining the fray every year, if we close ranks with them, working for the common good, we will surely turn the tide. The government, instead of flaying the people with taxes within an inch of their lives, needs to introduce policies conducive to start up companies and business incubation so that young people see the sense in building a career in Latvia rather than evaporating abroad. Much-needed positive incentives to increase domestic production and care for the basic needs of the people should be brought to bear, such as the subsidies planned by the Russian government for Russian-made cars and subsidies on prescription-drugs, as reported by Russia Today. Of course, Latvia can be compared with Russia neither in terms of subsidising nor production capabilities, but the population of Latvia is much smaller and hence its needs. Two important parallels that do stand up to reason are: firstly, people need an incentive to stay and anything the government can do to improve the quality of life would in turn increase morale and secondly, subsidising young businesses will pay high dividends in the future, new businesses will develop faster if nurtured and supported rather than if they are spurned and taxed to death.

My advice is: get LEAN and mean for the next high season, but remember that the winter is setting in and business will inevitably subside, so forage well and store some fat to hold you over the cold months — don't overdose on LEAN and starve. Give your business some breathing room rather than stick in a straightjacket and stifle it with rigid concessions. The economy is not some bogeyman that should send your company scuttling off in terror to hide under the bed. Retain your corporate identity and remain visible. Don't eradicate advertising; instead choose sustained, high-value, long-term campaigns. Don't vacate your premises and head for the hills; instead downsize your office to what your company actually needs to keep customers happy and when it comes to staff, remember - they are the life force of your company, be gentle and wise as you separate the wheat from the chaff. Give it your Business Best and good things will soon follow!

Be sure to check back next week: in the second part of this article I will introduce you to experts from other movers and shakers of the real estate sector, amongst whom are State Real Estate and the Mortgage Bank of Latvia (Hipotēku Banka).

 

*prepared by Re&Solution in cooperation with Lawin and PriceWaterhouseCoopers

 

© Oleg K. Temple, CornerstonesWorld.com, 2009.

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