global realestate now
TRANSCRIPT
Global Real Estate NowNovember 2005 Volume 10 Number 3
Insights, observations and research from PricewaterhouseCoopers internationalreal estate accounting, tax and business advisory services professionals.*
Contents
FEATURE ARTICLES
2 The rise of CMBS in Europeby Taco BrinkWill CMBS prove as popular in Europe as it has in the US?
9 Property derivatives in the United Kingdomby Matthew BarlingWhat are the basic property derivative instruments currently being used in the UKand what special tax regime has been introduced to accommodate this new market?
EYE ON ASIA
15 India - the door is now open to real estate investorsby Vivek Mehra and Akash GuptIn India’s fast-growing economy, real estate has emerged as one of the mostappealing investment areas for domestic as well as foreign investors.
23 China - strong and sustained economic growth is attractingforeign investment to the China real estate marketby KK So, Gary Chan and Rex ChanSecondary cities as well as the gateways of Shanghai and Beijing are attractingreal estate investment.
EYE ON THE AMERICAS
31 Mexico - excellent opportunities for real estate investorsby Roberto del Toro, Jose Luis Olvera, David Cuellar and Martin van der ZwanWithin Latin America, Mexico presents an excellent and stable platform forreal estate investment.
EYE ON EUROPE
39 European overview - economy and real estateby Andrew BurrellExpectations for economic growth in 2005 have been sharply downgraded butproperty returns for Spain and Ireland remain promising.
51 Russia - Moving from looking to investingby Steven SnaithInvestors are showing a greater acceptance of the risks in Russia and anunderstanding of how these risks can be managed.
TECH CORNER
57 Budgeting, forecasting and planning: process and technologytrends in the real estate industryby David Yakowitz and Kurtis BabczenkoWhat are the technology options currently available?
I also would like to extend a warm
welcome to PricewaterhouseCoopers
new Global Real Assurance Leader and
U.S. Real Estate Sector Leader –
William E. Croteau. Bill is a veteran
PricewaterhouseCoopers real estate
partner based in San Francisco who has
had many years of experience working
closely with some of America’s most
recognised real estate investment trusts
and development companies.
The past few months have seen some
auspicious developments for our firm’s
global real estate practice.
In early October, Euromoney
magazine handed out its Real Estate
Awards for Excellence, with
PricewaterhouseCoopers winning first
place in three categories: the Global
Real Estate Tax Team, the Asian
Real Estate Tax Team, and the
Central/Eastern Europe Tax Team.
In addition, our Nordic and Baltic Real
Estate Tax Team earned a respectable
second place. What makes these
honours most significant is that they
were the result of votes taken by our
peers in the real estate industry around
the world: developers, management
specialists, commercial banks,
investment banks, etc. So thanks to
those among you who voted for us and
congratulations to my colleagues here at
PricewaterhouseCoopers who earned
that recognition.
In the coming weeks, representatives
from our regional teams will be hosting
real estate client conferences, with the
European meeting scheduled for
November 4 in Barcelona, and the Asia
Pacific meeting scheduled for December
2 in Tokyo. In addition, our Latin
American network continues to grow,
with PricewaterhouseCoopers real estate
professionals well-represented in key
investment targets such as Argentina,
Brazil, Mexico and Uruguay, as well as
major investor sources, including the
U.S., U.K., Germany, Netherlands,
Portugal and Spain.
Needless to say, it is an exciting time to
be at the helm. As we move forward in
the coming months, our purpose will be
to extend the breadth and depth of the
services we provide to our clients, based
on the needs and opportunities that
continue to evolve in the industry. As the
influence of global real estate funds,
including REITs, continues to grow, we
will be incorporating new and innovative
tools and financial products to help our
clients achieve success, including new
methods for real estate calculation
modelling and enhanced merger and
acquisition services.
I am looking forward to the challenge of
leading such a highly-respected team of
professionals and to finding new ways
to assist our clients in meeting their own
challenges and opportunities.
Should you have any questions or
comments on the articles in this issue
of Global Real Estate Now, or any
suggestions for future topics,
please feel free to e-mail me at
Kind regards,
Frank van Zelst
Global Real Estate Tax Leader &
Global Real Estate Now Editorial
Board Chairman
Dear Reader:Welcome to the November edition of PricewaterhouseCoopersGlobal Real Estate Now.
As many of you may know, earlier this summer, in addition to being Global RealEstate Tax Leader, I assumed the role of editorial board chairman for Global RealEstate Now, a position that was previously – and very ably – filled by NickCammarano, Jr., our former Global Real Estate Leader, who has been asked to takeon a broader leadership role within the firm’s Financial Services Industry Group.I want to take this opportunity now to thank Nick for the years of service andleadership that he provided.
The rise of CMBSin Europe
By Taco Brink, Senior Manager, PricewaterhouseCoopers, London
PricewaterhouseCoopers Global Real Estate Now November 2005 FEATURE 3
Securitisation is a form of financing where illiquid,financial assets with predictable cash flows aresold by an originator to a special purpose vehicle(SPV) which has borrowed money to finance thepurchase. The SPV raises funds through the issuanceof either asset-backed commercial paper (ABCP) orbonds (ABS).
Since the sales of pooled mortgage
loans by the US Government National
Mortgage Association (Ginnie Mae) in
the early 1970s, the total outstanding
issuances of Collateralised Mortgage
Obligations (CMOs), Mortgage Backed
Securities (MBS) and Asset Backed
Securities (ABS) has reached levels well
in excess of US $2 trillion.
History
The growth of commercial mortgage
backed securities (CMBS) gained
momentum during the 1990s, primarily
within the US market. With the exception
of 1999 and 2000, the US has
experienced increased levels of CMBS
issuance for many years. Annual growth
during the past few years has continued
to surprise some market participants.
Through the first nine months of 2005
the US market has already surpassed
2004 totals with $110 billion of issuance.
So what does this mean for the
European CMBS market, if anything?
Historically there has been very little
correlation between the US and
European markets with respect to CMBS
issuance. In 2001 the European market
witnessed a significant change in the
levels of CMBS issuance and annual
issuance has been around the €20 billion
mark since. However, 2005 is set to be
a record year. The non-US total issuance
of $33.7 billion includes around 86%
European issuance (Chart 1).
Within the European real estate
community, CMBS was not seen as
a primary source of financing for several
reasons. “Relationship banking” is a
strong and important factor within
European financing and was a major
hurdle to overcome from a lender
perspective. Recently, many European
and, in particular, UK banks have used
this relationship banking network as
a feeder for their conduit programs.
More important for the growth in
European CMBS was the increased
demand from investors. As the US
market matured, investors began looking
elsewhere for product. It didn’t take long
for the arrangers to work on increasing
the supply of CMBS in Europe. Initially
this was achieved mainly through
single-borrower, large loan transactions,
but it has progressed to a more mixed
market of conduit, single-borrower
(single and multi-property), and credit
tenant lease transactions.
The continued growth in investor
demand helped influence a tightening of
spreads. At Mid-year 2004 the AAA
The continued growth ininvestor demand helpedinfluence a tighteningof spreads.
spreads were pricing near 40 basis
points, with some transactions during
the first half of 2005 closing between
14 and 17 basis points for AAA classes.
More recent transactions are closing at
around 20 basis points. The European
CMBS market has been largely
dominated by AAA rating issuance.
As seen in Chart 2, AAA ratings have
made up approximately 60% of the total
issuance to date.
While the tightening spreads reduce the
compensation for bond investors in
comparison to similarly risked assets,
they also reduce the overall cost of
funds for the loan originators and, most
importantly, borrowers. The reduced
cost of funds has helped borrowers to
see CMBS as a more attractive source
of financing to other more traditional
funding alternatives. The result has been
significant growth in European CMBS
issuance from 2000 through 2005, which
is on pace for a record year of issuance.
What’s Next?
Can the European CMBS marketcontinue to grow and sustain a level ofissuance to keep investors, lenders, andborrowers interested in this source offinancing? Given the emergence of anumber of existing and announcedEuropean CMBS conduit programmes,it appears the investment banks certainlybelieve the European CMBS market willcontinue to grow. Currently there areclose to 20 announced conduitprogrammes working the Europeanmarket. There is some debate as to howmany conduit programmes can competeand survive in the European marketplace. Based on the number of conduitscompeting in the US market it seemslikely that 20 or maybe more conduitprogrammes could eventually competein the European market. The US marketgenerally assumes conduit issuances toinclude multi-borrower multi-propertytransactions. However, as seen inChart 3, European issuance to date hasseen 50% of the transactions beingsingle borrower deals with many ofthese deals being originated by theconduit programmes.
Currently thereare close to 20announced conduitprogrammes workingthe European market.
Chart 1: CMBS volume trends US vs Non-US
1998
Non-US $ US $ Source: Commercial Mortgage Alert
1999 2000 2001 2002 2003 2004 H1 2005
100
90
80
70
60
50
40
30
20
10
0
$ b
illio
ns
PricewaterhouseCoopers Global Real Estate Now November 2005 FEATURE 5
While there has not been a dominanttransaction type, the single-borrowersingle-property transactions haveaccounted for 28% of transactions todate, according to Barclays Capital.While this type of transaction isexpected to remain strong, it isanticipated that the true conduittransactions, which includemulti-borrowers, will increase insize and frequency.
To date the majority of Europeantransactions have been UK dominatedwith respect to collateral location.According to Barclays Capital, 74% ofEuropean issuance has occurred in theUK, with the next closest being Franceat 8%. As seen in Chart 4A most othercountries have been fairly evenlyrepresented with respect to collateralpercentage. While these trends are likelyto continue going forward, there is scopefor countries such as Germany andFrance to increase their percentage ofthe market as CMBS becomes morewidely accepted in those jurisdictions.Also, as seen in Chart 4B, the 1st halfof 2005 saw a smaller percentageof issuance attributable to UKtransactions. This is a result of increased
activity in other European locations,rather than a decreasing trend for theUK. It should be noted that Italy’s 1sthalf 2005 share includes a large ItalianGovernment deal SCIP-2 for over €4.2billion. The 2004 issuance had severalcountries with between 3% and 9%of total issuance while the UK was63% of the market.
Recent Activity/Pipeline
One of the largest transactions duringthe first half of 2005 (excluding SCIP-2)was the refinancing of the BroadgateEstate in the City of London, for £2.08billion. Three other large issuances wereCSFB’s £1.06 billion issuance by TheMall Funding PLC and two Eurohypoissuances by the Opera Finance plcplatform. The Opera Finance programwas responsible for three securitisationsof large retail properties owned byCapital Shopping Centres (CSC), amongothers. In August of 2004 the first of thethree deals was Lakeside ShoppingCentre on a loan of £650 million. Then,in early 2005 the MetroCentre loan of£600 million was securitised, followed bythe £710 million issuance coveringCSC’s Braehead and Watford assets.
Chart 2: European CMBSissuance by rating category
AAA AA A BBB
Sub BBB NR
Source: Barclays Capital
5%1%
8%
9%
17%
60%
Chart 3: European CMBSissuance by transaction type
Single borrower/multi property
Single borrower/single property
Multi borrower/multi property
Credit tenant lease
Synthetic
Source: Barclays Capital
22%
28%22%
14%
14%
PricewaterhouseCoopers Global Real Estate Now November 2005 FEATURE6
Chart 4a: European CMBSissuance by geography to date
UK France Netherlands Italy
Spain Germany Sweden Other
Source: Barclays Capital
3%3%3%3%
4%
8%
74%
2%
Chart 4b: European CMBSissuance by geography1st half 2005
UK France Netherlands Italy
Pan-EU Germany Sweden Other
Source: Commercial Mortgage Alert
1%1%
56%
5%2%
4% 0%
31%
Other repeat conduit programmes activeduring the first half of 2005 includedLehman Brothers Windermere program,Royal Bank of Scotland’s EPIC programand Societe Generale’s White Towerprogram. According to Moody’sInvestors Service, new additions tothe European market during the yearwere Barclay’s Eclipse program, MerrillLynch’s Taurus program and ABNAMRO’s Talisman program. Additionally,conduit programmes which are expectedto issue transactions during the secondhalf of 2005 include CSFB’s TitanEurope, Commercial First Mortgage’sBusiness Mortgage Finance program,Deutsche Bank’s DECO program andBear Stearns’ new conduit program.
For the second half of 2005 the issuancelevels continue to improve, which willmake 2005 a record year for Europeanand US issuance. Many are predicting€35-40 billion in total European issuance
before the end of the year. This is asignificant increase over prior yearsand could be the first of many years ofhigher levels of issuance in the EuropeanCMBS market.
Given the increased demand for CMBSissuance on the part of both investorsand borrowers and the increasingnumber of conduit platforms in Europe,it would appear the market willexperience more years of increasedissuance. With the growth in the overallmarket we anticipate more diverseproducts, such as those which haveevolved in the US market place. As theEuropean CMBS market increases andexpands into more complex structures,investor research will need to beimproved with investors also askingmore from the analytic systems andthe issuance platforms.
PricewaterhouseCoopers has extensive global experience in property finance due
diligence which includes all aspects of the securitisation process.
Taco Brink can be reached via email at: [email protected]
Property derivativesin the United Kingdom
By Matthew Barling, PricewaterhouseCoopers, London
PricewaterhouseCoopers Global Real Estate Now November 2005 FEATURE 9
The derivatives markets have seen enormous growthover the past twenty years with derivatives being writtenover an increasingly diverse array of underlying subjectmatter ranging from the “vanilla”, such as interest ratesand foreign currency, through to the “exotic”, such asweather conditions. It is perhaps somewhat surprisinggiven the dynamic and innovative nature of thederivative markets that it has taken so long forderivatives to emerge in the real estate sector given thatreal estate is one of the core investment assets.
For players in the UK real estate sector,
this wait is now over since the past year
has seen the emergence of a property
derivatives market in the UK. Whilst the
market is still at an early stage of
development and trading volumes have
been relatively low compared with
established derivative markets such
as those relating to interest rate and
currency derivatives (being in the
hundreds of millions of dollars as
opposed to trillions), there are strong
signs of interest in the market amongst
a wide range of potential users and there
is a steady stream of new entrants.
The expectation is that the market will
continue to grow as potential users
become more familiar with the basic
property derivative instruments and
begin to see more clearly the extensive
advantages and opportunities which
they offer.
This article provides an overview of the
basic property derivative instruments
currently being used in the market
together with a summary of the special
tax regime which has been introduced in
the UK in order to accommodate this
new market.
The basic instruments
The property derivatives market in the
UK has to date been dominated by two
basic types of instrument:
• Property total return swaps
• Property structured notes (or “property
index certificates”)
Property total return swap
A property total return swap (or “TRS”)
is a derivative contract which enables
a counterparty (referred to below as
the “investor”) to gain exposure to
fluctuations in the value of real estate
without investing in the underlying
physical real estate assets.
The investor would enter into the
TRS contract with a counterparty
(typically a bank or other financial
trader). The TRS would have a specified
term (e.g., 2 years) and would have a
specified notional principal amount.
Under the terms of the TRS, the investor
would make LIBOR-based payments
computed by reference to the specified
notional principal amount and in return
would receive payments computed by
applying the percentage change in a
specified index of real estate values
The expectation is thatthe market will continueto grow as potential usersbecome more familiarwith the basic propertyderivative instruments andbegin to see more clearlythe extensive advantagesand opportunities whichthey offer.
(such as one of the indices run by the
Investment Property Databank or “IPD”)
over the term of the contract to the
notional principal amount.
In substance, the economic effect of the
TRS is equivalent to the investor
borrowing funds equal to the notional
principal amount at the relevant LIBOR
based interest rate and investing those
funds into the real estate assets
underlying the relevant IPD index.
The transaction is illustrated in
diagrammatic form in Figure 1 above.
Through entering into the TRS, the
investor has therefore in effect replicated
the economic return it would have
achieved had it invested in the
underlying real estate assets directly.
However, entering into the TRS offers a
number of significant commercial
advantages compared with borrowing
and acquiring the real estate assets
directly including:
• Implementation costs: The costs
associated with negotiating and
entering into the TRS are likely to be
only a fraction of those which would
be associated with borrowing and
acquiring the physical real estate
assets (which would include surveyor’s
fees, legal fees, agency fees, etc.).
• Execution time: In principle, a TRS
could be negotiated and executed
within a matter of days (although in
practice this may take slightly longer)
compared with the long lead times of
many months associated with a
physical property transaction.
• SDLT costs: Since the investor is not
acquiring any interest in land, the
transaction is not subject to UK Stamp
Duty Land Tax.
At present, TRS contracts are being
written over indices of property values
as opposed to individual property
assets. However, as the market develops
and becomes more liquid it is certainly
conceivable that TRS transactions could
be written over bespoke underlying
property assets.
Through entering intothe TRS, the investorhas therefore ineffect replicated theeconomic return itwould have achievedhad it invested in theunderlying real estateassets directly.
Figure 1: Property total return swap
% change in IPD over TRS term
LIBOR + spread
Total return swap
InvestorCounterparty
e.g. Bank
PricewaterhouseCoopers Global Real Estate Now November 2005 FEATURE 11
Property structured notes
A property structured note is a debt
security with an interest coupon and/or
principal redemption amount linked to
the performance of a specified index of
real estate values (such as the IPD
index). Unlike a TRS, a property
structured note is a “funded” instrument
in that an investor will subscribe an
initial cash investment amount in return
for the issue of the structured note.
The economic effect of investing in
a property structured note is broadly
equivalent to investing cash equivalent
to the subscription amount in the
relevant real estate assets underlying
the reference property value index.
The property structured note will
typically be issued by a financial
institution such as a bank or other
financial trader who may choose to
hedge its position by entering into
one or more TRS contracts with other
market counterparties. The structure is
illustrated in diagrammatic form in
Figure 2 below.
Similar to a TRS, a property structured
note allows an investor to obtain
exposure to changes in the value of real
estate assets without investing in the
underlying physical property assets.
The instruments therefore offer the same
advantages offered by TRS in terms of
reduced transaction costs, no SDLT
charges, etc. Furthermore, since
property structured notes are often listed
instruments which can be traded in the
secondary market they are more liquid
than TRS contracts which cannot be
traded in the market. They may also
be more attractive to institutions
which may be precluded (e.g. due to
regulatory restrictions) from entering into
derivative contracts.
The UK tax regime for propertyderivatives
In the past the development of a
property derivatives market in the UK
was hampered by the uncertainty
associated with the taxation treatment
of such instruments in the hands of
investors. Specifically, there was some
Similar to a TRS, aproperty structured noteallows an investor toobtain exposure tochanges in the value ofreal estate assets withoutinvesting in the underlyingphysical property assets.
Figure 2: Property structured note
Property structured note(Coupon/redemption linked to IPD % change)
Cash
Investor Issuer (e.g. Bank)
concern that profits arising from such
instruments could be taxable but losses
may not be deductible for tax purposes.
This uncertainty was largely resolved
by the introduction by Finance Act 2004
of a specific regime dealing with
the taxation of property derivative
instruments. This new regime came
into effect on 17 September 2004
and applies to property derivative
transactions entered into on or after
1 August 2004.
Broadly, the changes introduced by
FA 2004 bring property derivatives
within the scope of the UK tax rules
(the “Derivative Contracts” rules)
governing the taxation treatment of
derivative contracts in the hands of
companies. Previously such contracts
were excluded from this regime.
The new rules contain specific provisions
governing the taxation of property TRS
transactions in the hands of non-traders.
Under these rules, the property value
linked leg of the TRS is taxable as a
capital item whilst the LIBOR linked leg
is taxable as income. In essence, this
is intended to deliver broadly the same
tax result as would have been the
case had the investor borrowed funds
(on which any related funding costs
would be deductible) and used those
funds to acquire a physical property
investment (on which any future
gain/loss would be capital). The rules
therefore attempt to ensure that the tax
result is consistent with the underlying
economic substance of the transactions.
However, under the Derivative Contracts
rules, the investor in a TRS is taxed in
respect of the movement in the property
value leg of the TRS on an annual basis.
This is clearly less advantageous than
the tax treatment which would have
applied to a physical property purchase
where the investor would have been
taxed on realisation.
The taxation treatment of property
structured notes is more complex as
it will largely follow the accounting
treatment applied to such instruments.
Under International Accounting
Standards and modified UK generally
Under the DerivativeContracts rules, theinvestor in a TRS istaxed in respect of themovement in the propertyvalue leg of the TRS onan annual basis.
PricewaterhouseCoopers Global Real Estate Now November 2005 FEATURE12
accepted accounting practice it is
likely that a property structured note
would be “bifurcated” into two
separate instruments for accounting
purposes: a “host contract” which
would typically be a discounted
debt security; and an “embedded
derivative” in respect of the property
linked element of the instrument.
The embedded derivative may then be
accounted for at fair value through the
profit and loss (or income statement)
of the investing company. Where a
property structured note is bifurcated
in this way, the UK tax rules would
operate in order to tax the “host
contract” under the UK tax rules for
loans (the Loan Relationships rules
contained Finance Act 1996) whilst
the embedded derivative would be
taxed under the Derivative Contracts
rules for property derivatives. Once
again, this should lead to capital gains
treatment for the property value
related element of the transaction.
However, as can be appreciated from
this brief description of the new
regime, both the accounting and tax
rules are complex and would require
careful consideration in assessing the
impact on any particular transaction.
Unlike capital losses generally, the
new rules allow for losses in respect
of property derivatives to be carried
back for two years.
Payments under property TRS
contracts are not subject to deduction
of UK withholding tax since there is
a specific exemption from withholding
tax contained within the Derivative
Contracts rules.
In the case of both a TRS contract
and a property structured note, the
investor obtains no interest in physical
land. Consequently, neither instrument
is subject to UK SDLT.
In the case of botha TRS contract anda property structurednote, the investorobtains no interest inphysical land.Consequently, neitherinstrument is subjectto UK SDLT.
Matthew Barling can be reached via email at [email protected]
Eye on Asia
PricewaterhouseCoopers Global Real Estate Now November 2005 EYE ON ASIA 15
The real estate market in India is on a high growthcurve. A booming economy and favourabledemographics have provided the necessary impetusfor sustained growth. Further, recent policy measureshave opened up foreign investment in the real estatesector, which for a long time lacked institutionalfunding support.
With the liberalisation of the economy
and the consequent increase in business
opportunities, India’s real estate sector
has assumed growing importance.
Indian real estate has huge potential
demand in almost every sector, but
especially commercial, residential, retail,
industrial, hospitality, healthcare etc.
The demand for commercial and housing
space, in particular rental housing, has
grown tremendously since 2002.
Property development has surged in
India since 2002, helped by an annual
doubling in demand for office space as
foreign firms invested into the country’s
information technology (IT) sector and
call-centres in Mumbai, the National
Capital Region (Delhi and satellite
towns), Bangalore and Hyderabad.
Land prices have increased rapidly in
these markets – the extent of the rise,
however, varies from city to city and
even within cities. Gurgaon, a satellite
city of Delhi for instance, has registered
a 40 to 50% increase in property prices
over the past 18 months. According
to estimates, demand from the IT/ITES
(IT enabled services) sector alone is
expected to be 14 million sq m. (150
million sq ft.) of space across the major
cities by 2010.
According to the 2001 Census, 27.8%
of India’s over one billion population
lives in cities. According to the Vision
2020 document released by India’s
planning commission, the country’s
urban population is expected to rise
from 28% to 40% of the total population
by 2020. Future growth is likely to be
concentrated in and around 60 to 70
large cities with a population of one
million or more.
The Indian cities of Mumbai, Bangalore
and New Delhi have emerged as the top
three investors’ choices for real estate
investment in 2005, according to Jones
Lang LaSalle’s annual Investor Sentiment
Survey - Asia. The survey also noted
that investment interest in the region will
By Vivek Mehra, Executive Director andAkash Gupt, Senior Manager,PricewaterhouseCoopers, New Delhi
India – the door is now open toreal estate investors
continue to be robust this year with more
confidence towards the retail and office
property markets across the region.
This can be attributed to India’s strong
economic performance and its
established position as an offshoring
destination for many multinational
corporations, which has translated
into a more robust real estate
market environment.
Regulatory Environment
Until February 2005, the real estate
sector in India was tightly regulated.
Foreign Direct Investment (FDI)
was allowed in only four sectors:
development of integrated townships,
technology parks, industrial parks and
special economic zones. FDI in these
permitted real estate sectors also
had high threshold requirements.
For example, to develop integrated
townships, investors had to develop
a minimum of 100 contiguous acres
with a minimum of 2,000 dwelling units.
This deterred foreign investment
in real estate development and
foreign investment in the sector
remained minimal.
Traditionally, Non Resident Indians
(NRIs) have been allowed to invest in
the following real estate activities:
• Development of serviced plots and
construction of residential premises
• Construction of commercial premises
including business centres and offices
• Development of townships
• City and regional level urban
infrastructure facilities, including both
roads and bridges
In March 2005, the Indian government
announced liberalised guidelines
allowing FDI up to 100% in townships,
housing, built-up infrastructure and
construction-development projects
(including but not restricted to – housing,
commercial premises, hotels, resorts,
hospitals, educational institutions,
recreational facilities, city and regional
level infrastructure).
As per the guidelines, for the automatic
route to apply, the following conditions
would have to be complied with:
1.Minimum area
a. in case of development of serviced
housing plots, 10 hectares (25 acres)
Indian real estate hashuge potential demand inalmost every sector
PricewaterhouseCoopers Global Real Estate Now November 2005 EYE ON ASIA 17
b.in case of construction-development
projects, built-up area of 50,000 sq m.
c. in case of a combination project, any
of the above two conditions
2. Investment
a.minimum capitalisation of :
• US$ 10 million for wholly
owned subsidiaries
• US$ 5 million for JV with Indian
partners – brought in within 6 months
of commencement of business
b.original investment cannot be
repatriated before a period
of three years from completion
of capitalisation.
The investor may exit earlier with prior
approval from Foreign Investment
Promotion Board (FIPB).
3.Others
• At least 50% of the project to be
developed within five years
from the date of obtaining all
statutory clearances.
• Investor not permitted to sell
undeveloped plots (where roads,
water supply, street lighting,
drainage, sewerage and other
conveniences are not available).
The intention of the government by
way of this liberalisation was to clear
the path for foreign investment into
development of the commercial and
housing sectors so as to meet the
demand. NRI investments continue to
enjoy special dispensation from the
above prescribed conditions.
Although the government has not
undertaken capital market level
deregulation measures, such as allowing
REITs (whether domestic or foreign
owned) to operate in India, in 2004
it did allow international and domestic
companies to operate real estate
funds/pooled vehicles through the
private equity fund route. This, combined
with the boom in the real estate market
in India has opened the doors for
a host of realty funds. While most funds
were initially floated by financial
institutions/banks such as HDFC, ICICI
Bank and Kotak Mahindra Bank, real
estate developers like DLF Universal and
Future growth is likely tobe concentrated in andaround 60 to 70 largecities with a population ofone million or more.
even retailers like Pantaloon have now
entered the arena for creating more retail
facilities. Most of the funds floated in
the recent past have received a strong
response from investors. Reports
suggest that over the past six months,
about US$ 500 million has already
flowed into the real estate sector.
Over the next 18-30 months, the flow
may rise to a massive US$ 7-8 billion.
These real estate funds have been
established as venture capital funds
(VCFs) with specific approval from the
Securities Exchange Board of India
(SEBI). VCFs are allowed to invest in
domestic companies whose shares
are not listed on a recognised stock
exchange in India and are engaged in
businesses as permitted under
SEBI guidelines (real estate activity
is permitted).
SEBI guidelines require minimum
investment of INR 500,000 (approx.
US$ 110,000) per investor subject to a
commitment of INR 50 million (approx.
US$ 1.11 million) from all investors
before the start of operations by the
VCF. The VCF cannot invest more than
25% of its corpus in one undertaking,
at least two thirds of investible funds of
the VCF have to be invested in unlisted
equity shares/equity linked instruments
and not more than one third of the
investible funds can be invested in debt.
Opportunities within the realestate sector
All real estate sectors, residential,
commercial and retail are currently
witnessing huge growth in demand.
New customer segments are emerging.
The residential market is not only
witnessing huge growth, thanks to easy
availability of finance, but also the
average age for ownership of new
homes is declining drastically. Younger
customers and nuclear families are
creating fundamentally different
customer segments.
Similarly, in the retail segment, as the
market grows exponentially, newer and
larger formats along with the likely entry
of global retail giants in the Indian
market (subject to impending
New customersegments are emerging.The residential market isnot only witnessing hugegrowth, thanks to easyavailability of finance, butalso the average age forownership of new homesis declining drastically.
PricewaterhouseCoopers Global Real Estate Now November 2005 EYE ON ASIA18
government policy revisions with respect
to FDI in retailing) will necessitate greater
variety and maturity in the retail real
estate market. Mall developers are
already adapting to local cultures and
traditional preferences. Some new
genres of malls are Automobile Mall,
Gold Souk and Wedding Mall, which
are one-stop shopping destinations for
what their name describes.
Recently, the government of India has
legislated the Special Economic Zones
(SEZ) Act to give a long term and stable
policy framework with minimal regulation
for development of hassle-free enclaves
in India. The SEZ Act provides the
umbrella legal framework covering all
important legal and regulatory aspects
of SEZ development as well as for units
operating in SEZs. SEZs are specifically
delineated, duty free enclaves, deemed
to be outside the customs territory of
India. Units operating in SEZs enjoy a
corporate tax holiday on export
earnings, indirect tax exemptions and
liberal exchange controls. The SEZ Act
provides for substantive fiscal benefits
to developers as well.
A minimum area size of 1,000 hectares
has been prescribed for a multi product
SEZ, whereas sector specific (such as IT,
pharmaceuticals, textiles etc.) SEZs can
be set up with a much smaller minimum
area. Hence, SEZs have generated a lot
of interest among real estate developers,
IT players and manufacturer-exporters in
the country.
Tax Incentives for real estatedevelopment
An Indian company is subject to 33.66%
corporate tax on its business profits.
Dividends distributed are tax free in the
hands of the shareholders, however,
the dividend distributing company is
required to pay dividend distribution tax
at 14.06%. Where the company has
booked profits but tax losses, minimum
alternate tax of 8.415% is payable.
A tax holiday is available to companies
engaged in developing approved
housing projects subject to such
projects being approved prior to 31
March 2007 and the project being
completed within four years from the
year of approval.
Recently, the governmentof India has legislated theSpecial Economic Zones(SEZ) Act.
A tax holiday of 10 consecutive years
(out of the first 15 years) is available for
industrial & IT parks provided certain
conditions attached are fulfilled, one of
which is that the industrial park/IT
park needs to be notified prior to
31 March 2006.
A SEZ developer is entitled to a 10 year
corporate tax holiday. In addition to the
corporate tax holiday, the SEZ developer
is also eligible for exemption from
payment of dividend distribution tax,
minimum alternate tax and long term
capital gains tax on the transfer of
shareholding in SEZ company.
Challenges for thereal estate sector
The Indian government’s tax policy is
not in tandem with the government’s
liberalisation initiatives being undertaken
in the real estate sector. There are no
substantial tax incentives for real estate
development except in the limited
circumstances mentioned above.
Even in these situations, the tax
incentive windows have a short life left.
The prevailing tenancy laws in India
are not in favour of owners of the land.
Under the Rent Control Act, tenants
continue to pay the same rent fixed
in 1947. This has deterred fresh
investments in housing for rental
purposes. Poor collection from the
obsolete rental values make repairs
and maintenance unviable for the
landlords, thereby resulting in the
decrepit condition of many buildings.
The Urban Land Ceiling Act and Rent
Control Acts have distorted property
markets in cities, leading to
exceptionally high property prices.
A high percentage of land holdings do
not have clear titles. Land is generally
non-corporatised and is typically held
by individual/families. This restricts
organised dealing and hinders transfer
of titles. Legal processes for property
disputes are time consuming.
Stamp duties continue to be high and
in some states as much as 10-13%.
The industry has repeatedly called for
rationalisation and lowering of stamp
duties to global levels of 2-3%.
The Indian government’stax policy is not in tandemwith the government’sliberalisation initiativesbeing undertaken in thereal estate sector.
PricewaterhouseCoopers Global Real Estate Now November 2005 EYE ON ASIA 21
City urban planning projected smaller
commercial plots and this, along with
rigid building and zoning laws, makes it
difficult to procure larger contiguous land
areas (for example, for retail space).
Land use conversion is both time
consuming and complex.
Occupancy costs may marginally
increase for retail outlets at malls and
for office space etc. with the imposition
of service tax on certain services
connected with management of
commercial real estate (as proposed
in the Union Budget 2005-06).
A period of transition inretail sector
Scarcity of quality real estate at
affordable rentals has traditionally been
a key challenge to growth for organised
retailers in India. However, the retail
boom that is being witnessed in India
today is likely to have a significant
impact on the commercial real estate
sector. Presently, most of the major
Indian cities have significant commercial
projects under construction for retail
purposes and, due to demand and
supply interplays, there has been some
rationalisation in property prices across
the country.
However, the majority of new shopping
malls being developed remain
fragmented and sub-optimally planned
in terms of positioning infrastructure.
In the near future, there is a likelihood of
a shake out within the shopping malls
business with the emergence of a few
large dominant national/regional players
that are relatively more professionally
managed and a host of speciality/niche
local players. With the expected opening
up of the country’s retail sector to
foreign investment, shopping malls of
international scale and quality should
also emerge soon. Since India’s current
foreign investment regime does not
permit FDI in retail trading, the
international brands available in India as
of today are on the “Franchisee” model.
A long standing demand of the
international players has been to open
up the retail sector to FDI, which would
pave the way for India to house all
international retail brands.
A high percentage ofland holdings do not haveclear titles.
An increased alliance/partnership
between large regional real estate
developers and national retail companies
on joint development/management
of retail real estate catering to the
pan-Indian or regional growth plans,
and other synergies between specific
retailer(s) and mall developer(s) can also
be expected.
The key implication for retailers is that
advance planning with respect to market
expansion is necessary since, not only
is identification of optimal property
challenging, the cycle time between
identification and possession of
ready-to-move-in retail property
is rather long, typically between
18 and 24 months.
Conclusion
In India’s fast-growing economy, real
estate has emerged as one of the most
appealing investment areas for domestic
as well as foreign investors.
The real estate sector will continue to
derive its growth from the booming IT
sector, since an estimated seventy
percent of the new construction is for
the IT sector. As the IT sector expands
to second and third tier cities across
India, the real estate boom will follow.
In the last few months, IT companies
such as IBM, Dell, Cognizant, Mphasis
and Satyam have revealed plans for
cities like Coimbatore, Mangalore,
Chandigarh and Vizag and Jaipur.
Demand from the IT sector aside,
the basic need for modern real estate
will provide lucrative opportunities
for investment.
Low interest rates, modern attitudes to
home ownership (the average age of a
new homeowner is now 32 years
compared with 45 years a decade ago),
economic prosperity along with a
change of attitude amongst the young
working population from that of “save
and buy” to “buy and repay” and
liberalised FDI regime have all
contributed to this boom. Once the
government puts into place land reforms
and addresses the challenges facing the
real estate sector (as set out above), this
sector has the potential to contribute
immensely to the country’s GDP.
In India’s fast-growingeconomy, real estatehas emerged as oneof the most appealinginvestment areas fordomestic as well asforeign investors.
PricewaterhouseCoopers Global Real Estate Now November 2005 EYE ON ASIA22
Vivek Mehra can be reached via email at [email protected]
Akash Gupt can be reached via email at [email protected]
PricewaterhouseCoopers Global Real Estate Now November 2005 EYE ON ASIA 23
General trends
The China property market has undergone significantgrowth in recent years. Since 1997, property priceshave grown on a year on year basis and at anincreasing speed. The rapid growth has attractedforeign investors from around the globe, initially fromHong Kong, Singapore and Taiwan, and more recentlyfrom the US, Europe and Australia. Among theseforeign investors, the number of institutional investorshas been increasing.
Strong and sustained economic growth,
as illustrated by the double digit GDP
growth in major cities, has no doubt
been the major driving force behind the
growth of the China property market.
China’s accession to the WTO followed
by the gradual liberalisation of various
business sectors, Bejing Olympics 2008,
Shanghai World Expo 2010, and the
potential appreciation in value of the
Renminbi are among the other factors
which add fuel to the recent growth.
In terms of asset classes, the China
property market presents a full variety
of choices to foreign investors, including
residential developments, office and
retail, industrial developments, logistics
facilities, serviced apartments, hotels,
non-performing loan portfolios etc.
In terms of geographic locations, primary
cities such as Beijing and Shanghai
naturally become the gateways for
foreign investors to enter the China
property market.
Beijing and Shanghai
In Bejing and Shanghai, the luxury
residential market continues to grow
steadily. Years of economic growth
has created domestic demand for better
quality of living. On the other hand,
the continuous expansion of foreign
investment in China has brought to
these capital cities more and more
senior executives, thereby ensuring
the steady demand for the luxury
residential market.
By KK So, Asia Pacific Real Estate Tax Leader,PricewaterhouseCoopers, Hong Kong,Gary Chan, Tax Partner,PricewaterhouseCoopers, Shanghai andRex Chan, Tax Partner,PricewaterhouseCoopers, Beijing
Strong and sustained economicgrowth is attracting foreigninvestment to the China realestate market
In a bid to stabilise the residential
market and discourage speculation,
the government introduced a series of
measures in the first half of 2005,
including raising the interest rate on
housing mortgages, imposing business
tax on the sale of residential property
by individuals, tightening bank lending
and restricting the transfer of
uncompleted projects. It would appear
that the impact of these measures is
transient. As confirmed by Mr Yang Yu,
Chief Representative of Grosvenor
Asia Standard Limited – Shanghai
Representative Office, the demand from
domestic and expatriate dwellers is still
going strong.
Likewise, the retail market in Beijing and
Shanghai has recorded satisfactory
growth. Rising disposable income of the
residents has boosted the consumption
in the retail sector. The prospects of
Beijing Olympics 2008 and Shanghai
Expo 2010 only add to the growth story
of the retail sector. In response to these
developments, supermarket chains,
convenience stores, trendy shops and
other retailers continue to expand to
secure market share. On the other hand,
the liberalisation of the retail market
under the WTO agreement has brought
in more and more foreign retailers,
thereby creating substantial demand for
retail spaces, says Mr Jim Yip, Associate
Director of DTZ Debenham Tie Leung
in Shanghai.
In terms of the office market, due to
new supply in Beijing, the vacancy
rate rose in the first half of 2005.
However, demand for office space in
the central business district is expected
to remain firm.
In Shanghai, the supply of prime office
spaces remains tight, resulting in a surge
in office rents. In response to the rising
office rents, some smaller companies
are seen to be moving out of the
central business district to more
secondary areas.
Apart from the more conventional
sectors, foreign investors are also
considering property projects within
logistics parks and industrial parks.
In this regard, Mr Jim Yip observes that
foreign investors are evaluating the
viability of entering into sale and lease
back arrangements.
The prospects of BeijingOlympics 2008 andShanghai Expo 2010 onlyadd to the growth story ofthe retail sector.
PricewaterhouseCoopers Global Real Estate Now November 2005 EYE ON ASIA 25
Other cities
In addition to the primary cities such as
Beijing and Shanghai, it is worth noting
that foreign investors have been moving
onto the secondary cities to seek for
more exciting opportunities. As observed
by Mr KK Chiu, Executive Director of
DTZ Debenham Tie Leung Ltd in Hong
Kong, the move to the secondary cities
is made possible with the experience
gained by these foreign investors from
their earlier entry into the primary cities.
On the other hand, the very keen
competition, coupled with the limited
supply of trophy properties in the
primary cities, are among the forces
driving foreign investors to consider the
secondary cities to achieve higher yields
and better capital growth potential.
These secondary cities include
Changsha, Chengdu, Chongqing,
Dalian, Fuzhou, Guangzhou, Harbin,
Jinan, Nanjing, Ningbo, Shenyang,
Tianjin, Wuhan, Wuxi, Xian and others.
Shopping malls, residential
developments, industry parks and
logistic parks are among the asset
classes foreign investors are targeting in
these cities.
Structural and Tax Issues forDirect Investment
Foreign direct investment in the China
property market may take different legal
structures, and different taxation
consequences follow.
A typical structure for a foreign investor
to hold property in China is via an
offshore company, commonly referred to
as a foreign enterprise (“FEs”). For a FE
which does not maintain any permanent
establishment in China, its rental income
from its China property is typically
subject to withholding income tax at
the rate of 10%. The rental income also
attracts other taxes; the major ones
include business tax and urban real
estate tax. As a very general indication,
the withholding income tax and other
taxes could add up to something around
27% of the rental income. (Please note
that the actual tax liabilities may vary
depending on the exact location of
the property).
In addition to the primarycities such as Beijingand Shanghai, it isworth noting that foreigninvestors have beenmoving onto thesecondary cities toseek for more excitingopportunities.
Alternatively, foreign investors may
consider buying into an existing onshore
company which owns property in China,
or teaming up with local partners to form
an onshore joint venture company to
undertake property development in
China. The investee company in this
case is commonly referred to as a
foreign investment enterprise (“FIE”).
Unlike FE’s which are generally subject
to income tax by way of withholding,
FIE’s are subject to income tax
generally at 33% based on their net
profits (a lower rate may apply to certain
special economic zones in China).
In arriving at the net profits, interest
expenses and depreciation may be
deducted. FIEs are also subject to the
other taxes such as business tax and
urban real estate tax.
Set out below is a table summarising the
major China taxes which are applicable
to rental income derived from properties
in China under the above two structures:
Disposal of China property is also
subject to various China taxes. In terms
of the tax rates, land appreciation tax
stands out from the others ranging from
30% to 60%. Other major taxes include
income tax, business tax and deed tax.
Again, FEs are generally subject to
income tax by way of withholding at
10% of the gain, whereas FIEs are
subject to income tax at 33% based on
their net profits.
The use of special purpose vehicles
(SPVs) to hold property in China is
not uncommon. In practice, it is noted
that some of these SPVs are set up in
jurisdictions which have concluded
double taxation treaties with China.
The use of such SPVs may help to
mitigate the risk of being deemed to
have a permanent establishment in
China for tax purposes and allow
a more tax efficient exit from the
property investment.
The use of specialpurpose vehicles (SPVs)to hold property in Chinais not uncommon.
PricewaterhouseCoopers Global Real Estate Now November 2005 EYE ON ASIA26
Major Taxes FEs FIEs
Business Tax 5% of gross rental revenue 5% of gross rental revenue
Income Tax 10% x (gross monthly rental 33% x net profit for the year, but a
income earned – Business lower tax rate may apply if the
Tax paid) properties are located in certain
special economic zones.
Urban Real Estate Tax 1.2% of discounted purchase 1.2% of discounted purchase cost, or
cost, or 12% x gross rental 12% x gross rental revenue. (Note
revenue. (Note that the method that the method of calculation and the
of calculation and the tax rate tax rate vary depending on the
vary depending on the location location of the property).
of the property).
Indirect Investment via REITs
For the more cautious foreign investors,
they may add a China element to
their portfolios by way of an indirect
investment. In this regard, the
development of the real estate
investment trust (REIT) regimes in
the region offer an alternative.
The REIT vehicle structure is not
new in the region. Indeed, Singapore
has built up a respectable REIT regime
over the last few years, which is
capable of accommodating cross-border
REIT listing.
On the other hand, the timely removal of
the geographical restrictions for Hong
Kong REITs to invest in real estate
outside Hong Kong has placed Hong
Kong in competition with Singapore to
be the regional centre of REITs. With its
proximity to China, coupled with its
prominent position as an international
financial centre, Hong Kong is well
placed to act as the intermediary via
which foreign investors may indirectly
invest in the China property market.
As a matter of fact, in light of the recent
developments, there are good reasons
to believe that the China REITs market
will grow. In this regard, Mr Edmund Ho,
Director of Citigroup Global Markets Asia
Ltd in Hong Kong, observes that the
Chinese government has introduced
various measures in a bid to ensure the
orderly development of the China
property market, such as the tightening
of bank lending and the restrictions on
sale of uncompleted properties. Such
measures have created cash flow
problems for local developers and
investors, and prompted them to look
out for alternative funding sources.
The lack of an active secondary market
for large or en-bloc properties also
makes it difficult for property owners to
divest their property holding. On the
other hand, while there is no lack of
funds from foreign investors who are
getting ever more interested in the
property market in China, given the
unique business environment in China,
many of them may have concern that
they may not have the necessary
experience and connections to make
successful direct investment in China.
This gives rise to a unique opportunity
for the seasoned financial intermediaries,
such as investment bankers in Hong
Kong who have accumulated a wealth of
The REIT vehicle structureis not new in the region.
China experience, to play the role as a
middleman to bridge the supply
and demand.
Indeed, it is noted that various
investment bankers are at the moment
busy at forming their China property
portfolios in preparation for a REIT listing
in Hong Kong towards the end of 2005
or early 2006. These portfolios comprise
office buildings, shopping malls, and
logistics facilities. It is anticipated that
the successful launches of these REITs
will accelerate the growth of REITs of
China property in Hong Kong.
Conclusion
With its rapid growth over the years, the
China property market has presented a
lot of opportunities to foreign investors.
However, opportunities seldom go
without risks. For example, the
possibility of over-supply is a common
concern shared by many investors.
In this regard, Mr CK Lau, Regional
Director of Valuation Advisory Services
and Capital Markets of Jones Lang
LaSalle in Hong Kong, remarks that,
while there is no lack of supply in the
medium term, investors should look out
for quality properties both in terms of
hardware and software as the demand
for such properties should remain strong
as the economy in China continues to
grow. Tax and other regulatory issues
could also catch the unprepared.
Investors, particularly foreign investors,
should obtain proper advice to avoid
falling into the minefields created by
these issues.
In the long run, it would appear that the
prospects of the China property market
remain promising. Foreign investment
will certainly improve the liquidity and
facilitate the growth of the real estate
market in China.
In light of the recentdevelopments, there aregood reasons to believethat the China REITsmarket will grow.
PricewaterhouseCoopers Global Real Estate Now November 2005 EYE ON ASIA28
KK So can be reached via email at [email protected]
Gary Chan can be reached via email at [email protected]
Rex Chan can be reached via email at [email protected]
Eye on Americas
PricewaterhouseCoopers Global Real Estate Now November 2005 EYE ON AMERICAS 31
The Mexican Real Estate Market
The real estate market in Mexico, which is tightlyrelated to the economy, has grown slowly but steadilyin recent past years. The stable economy, with lowinflation rates, a tax disciplined government,revaluated peso against the dollar, and reducedinterest rates provides an excellent and solid basis forinvestors seeking real estate investments in Mexico.
The size of the real estate market
has shown a steady growth of
approximately 2.3% per annum since
2001. This growth is fuelled by the
increase in the construction of low
income residential homes; commercial
space; tourism, oil, hydraulic, electric
and industrial infrastructure.
The main area of growth has been in
residential development, not only the
low income segment, but also the
middle and high-value residential
segment. This is due to the fact that
the Mexican government identified
and earmarked the development of
residential property and infrastructure
as one of the main drivers in its strategy
for economic development.
It is expected that the growth in
residential development will continue at
its current pace given the stability of
mortgage interest rates and the increase
in the range of mortgages offered by
banks and other institutions.
In further support of this, the current
Mexican residential market conditions
are such that the expected need for
additional residences in the coming
years could be equal to the total
number of homes built in Mexico
throughout its history.
Currently, Mexican and non-Mexican
private investors account for 58.5% of
the total investment in the real estate
market, while the government accounts
for the other 41.5%.
Most of the real estate market activity
is concentrated in Mexico City, Nuevo
Leon, Tabasco, Jalisco, Baja California,
Chihuahua, Tamaulipas, Campeche,
Sonora and Estado de Mexico. In these
states the income and the industrial
activity is higher than in the others.
The Mexican Tax System
The Mexican tax system is very mature
and its impact depends on the location
By Roberto del Toro, Partner,Jose Luis Olvera, Senior Associate,PricewaterhouseCoopers Mexico,David Cuellar, Manager,PricewaterhouseCoopers, London andMartin van der Zwan, Senior Manager,PricewaterhouseCoopers, Amsterdam
Mexico – excellent opportunitiesfor real estate investors
of the investor and whether the
investor invests as an individual, trust
or corporation.
Foreign corporate investors owning
Mexican real estate are taxed on any
capital gains arising from the real estate
at 25% on the gross proceeds of the
sale, without any deduction.
Alternatively, by appointing a legal
representative in Mexico and complying
with other requirements, the foreign
seller could be eligible to be taxed on a
net gain basis at the rate of 30% on the
net gain (29% in 2006 and 28% for 2007
and the subsequent years). The gain is
computed as the proceeds received on
the sale less the tax basis of the assets.
In this respect, the tax basis for real
estate is equal to the purchase price less
depreciation of the construction, and
the balance is adjusted for inflation. It is
important to point out that land does not
depreciate, but appreciates as of the
moment of a sale. Rental income is
subject to a 25% rate in accordance
with Mexican law.
Mexico has entered into treaties for the
avoidance of double taxation with its
major trading partners, for examples,
the US, Canada and most of the leading
European and Asian economies. Such
tax treaties generally allocate the right to
tax income and gains realised on real
estate to the jurisdiction in which the real
estate is located. Mexican real estate
should thus be taxed in Mexico. Sellers
that reside in a country that has a tax
treaty in force with Mexico may apply
either the provisions of the tax treaty
(provided certain conditions are met) or
the Mexican Income Tax Law (“MITL”),
whichever are more favourable.
Transfer Tax
Acquisition of Mexican real estate is
subject to immovable property transfer
tax. The rate varies per state and ranges
from approximately 1% to 4.5% on the
fair market value of the real estate.
The tax is imposed on the acquirer and
is non-recoverable. In addition, other
local fees may apply on the sale of
immovable property such as registration
and notary fees.
Mexico has entered intotreaties for the avoidanceof double taxation with itsmajor trading partners.
PricewaterhouseCoopers Global Real Estate Now November 2005 EYE ON AMERICAS 33
Value Added Tax
Mexican Value Added Tax (“VAT”) is
levied at 15% (10% in the border zone).
The sale or lease of real estate is
generally subject to VAT, but the sale of
land and the sale and rent of residential
property are exempt.
Tax Incentives for HomeOwnership
In 2003, the Mexican government
introduced certain tax incentives to
promote home ownership. As a result,
individuals may claim a deduction on the
interest effectively paid (“interes real”) on
mortgages for the acquisition of a home.
For these purposes, the amount of the
mortgage must not exceed 1.5 Million
UDIS (approximately $500,000 U.S.
Dollars). “Interes real” is in general terms
the interest rate less the inflation rate
(e.g., 10% interest rate less 4% inflation
rate equals a 6% interest deduction).
As a further incentive measure, income
arising from the sale of a house by an
individual is exempt from Mexican
income tax to the extent certain
formalities are met.
Tax Incentives for Investors
To attract and facilitate investments in
Mexican real estate, the MITL provides
special rules for trusts that have the
sole purpose of constructing or
acquiring properties intended for
alienation or lease, as well as the
acquisition of the right to obtain
revenues from those activities.
General Aspects:
The Mexican Real Estate Investment
Trust (MREIT) is itself not subject to
corporate taxes. Rather the beneficiaries
are the parties subject to taxes based on
their status and are responsible for
fulfilling the tax obligations related to
the MREIT.
Requirements for MREIT status:
1.Constituted under Mexican laws.
2.Business purpose is the construction
or acquisition of properties intended
for their alienation or lease, as well as
The Mexican Real EstateInvestment Trust (MREIT)is itself not subject tocorporate taxes.
the acquisition of the right to obtain
revenues from such leases.
3.70% or more of the funds are invested
in the activities mentioned in the
previous point and the remaining
funds in federal government bonds.
4.Compliance with certain information
requirements.
Income Tax:
• The beneficiaries may opt to appoint
the financial institution managing the
MREIT as the responsible party to
determine the profit or loss arising
from the trust’s transactions. The
financial institution must disclose the
corresponding amount of taxable gain
or loss to each beneficiary, based on
their participation in the MREIT in the
immediate prior year. The beneficiaries
must include or deduct such amount
in their annual income tax calculation.
• The MREIT issues trust certificates
(participation certificates) that
represent the ownership in a specific
property or in a pool of properties.
When such certificates are sold, the
beneficiaries must pay the
corresponding tax on the profit
obtained from the sale of such
certificates. The profit will be the
difference between the income
obtained from the alienation of the
certificate and its average tax cost.
Value Added Tax:
• The financial institution shall determine
the VAT due and file the VAT returns.
Asset Tax:
• The financial institution shall determine
the asset tax base considering the
assets and liabilities related to the
MREIT. The beneficiaries will increase
their own asset tax base by including
the asset tax portion that corresponds
to their participation in the MREIT.
Other Advantages:
• Neither the financial institution nor the
beneficiaries are required to make any
advance payments for income tax and
asset tax purposes.
• If certain requirements are met, the
contribution of properties by the
The beneficiaries willincrease their own assettax base by including theasset tax portion thatcorresponds to theirparticipation in the MREIT.
PricewaterhouseCoopers Global Real Estate Now November 2005 EYE ON AMERICAS34
trustees to the trust is not considered
as alienation for tax purposes, thus
providing for roll over treatment.
• Foreign registered pension and
retirement funds that are exempt from
income tax in their country should be
eligible for the exemption granted by
the MITL for the benefits obtained
from the trust, provided certain
conditions are met.
Mexican Real EstateDevelopment Companies
In recent years, Mexican and
non-Mexican residents began to
establish Mexican real estate
development companies for the purpose
of developing real estate in Mexico.
The common practice of establishing a
development company is carried out
during the first stages of real estate
development. After a certain period of
time, and before the development
project is finished, the shares of the
company are sold. This method allows
the acquirer to not pay the real estate
transfer tax, since it is acquiring the
shares of the company, rather than
acquiring the real estate directly.
Regulatory Environment
Real estate developers have been
confronted with an increase in the
regulatory environment. Several tax,
accounting, and environmental
regulations have been enacted.
Furthermore, each municipality or state
applies different rules and regulations
that need to be complied with, including,
among others, the local financial code,
transfer taxes and construction licenses.
For accounting purposes, real estate
developers as well as commercial
businesses are required to apply the
Mexican General Accepted Accounting
Principles. Depending on the information
requirements from parent companies
and/or regulatory agencies there may
be a need to also apply International
Accounting Norms, as required for other
industries and activities.
Several tax, accounting,and environmentalregulations have beenenacted. Furthermore,each municipality or stateapplies different rules andregulations that need tobe complied with.
Future Outlook for the MexicanReal Estate Market
Based on the current situation, real
estate market experts anticipate that the
growth in the real estate market during
the next few years will be concentrated,
in the following areas:
1.Development of low income housing;
2.Ground transportation infrastructure,
including highways;
3.Residential, office buildings and
commercial real estate;
4.Electric, hydraulic and urban
infrastructure.
Conclusion
The Mexican tax system is very
mature with a good tax treaty network.
Specific tax incentives to promote home
ownership and regulations such as those
for the Mexican real estate investment
trust and the use of Mexican real estate
development companies, provide a
sound base for future investments.
The regulatory environment has
increased and investors need to be
aware of differences in local regulations.
In summary, within Latin America,
the Mexican market provides an
excellent and stable platform for real
estate investments by domestic and
foreign investors.
Within Latin America,the Mexican marketprovides an excellentand stable platform forreal estate investmentsby domestic andforeign investors.
PricewaterhouseCoopers Global Real Estate Now November 2005 EYE ON AMERICAS36
Roberto del Toro can be reached via email at [email protected]
David Cuellar is available via email at [email protected] (Mexico) or
[email protected] (U.K.)
Jose Luis Olvera is available via email at [email protected]
Martin N. van der Zwan is available via email at [email protected]
Eye on Europe
PricewaterhouseCoopers Global Real Estate Now November 2005 EYE ON EUROPE 39
Eurozone weakness persists
The Eurozone’s growth rate continues to lag wellbehind that seen in most other advanced economies.External developments, such as higher oil prices andthe strong euro, have hit prospects, but the mainproblems remain internally generated.
Tight policies, high employment and low
confidence continue to undermine
domestic activity, particularly in the
region’s core economies. Expectations
for growth in 2005 have been sharply
downgraded and risks remain firmly on
the downside.
Modest activity in the single currency
area contrasts starkly with other
European countries, such as the UK,
Sweden and Norway, and lags US
activity by an even wider margin. Even
Japan, which has endured exceptional
weakness in the last decade, is now
experiencing a much stronger expansion
than the Eurozone. The sluggishness is
further highlighted by the fortunes of the
region’s largest economies. In Germany,
poor export growth has depressed
activity, while in France consumer
demand has hit a weak patch. Italy
recently experienced a rebound, but this
followed a recession in the previous two
quarters, and the upturn is likely to
prove short-lived.
Moreover, with worries about the impact
on inflation, there is unlikely to be any
immediate boost from monetary policy.
The European Central Bank (ECB) has
emphasised its concerns about strong
money supply growth and over-heating
housing markets in many countries.
Interest rates are likely to stay at
the level that has prevailed since
mid-2003 (2%) over the coming months.
A stimulus from fiscal policy can also
be ruled out given that many budget
deficits are above the 3% limit
allowed by the EU Stability and Growth
Pact guidelines.
Looking ahead, demand conditions in
the Eurozone are expected to improve
gradually, as exports respond to the
recent euro depreciation and sentiment
continues to revive. Labour markets are
also expected to be more supportive,
as unemployment edges lower. These
factors should underpin a modest upturn
in domestic spending in the most
sluggish economies, notably Germany
By Andrew Burrell, Associate Director,Macroeconomics, Experian, London
European overview – economyand real estate
and Italy, over the next year, helping
overall Eurozone growth approach
2% again.
Output growth averages 2% over the
period 2005-9, well below the rates
expected in either the US or the rest of
Western Europe. This continues the
pattern of the past decade. In addition
to tight monetary and fiscal conditions,
the lack of dynamism reflects structural
problems in the Eurozone: high
unemployment, inflexible labour markets,
large government sectors and ageing
populations. But these difficulties
are not universal. There are wide
divergences in performance among
European economies, with Ireland
displaying considerable dynamism
and Spain achieving faster growth than
many non-Eurozone economies.
Germany
A fundamental factor in the lacklustre
performance of the Eurozone is the
weakness of Germany. The Continent’s
largest economy exerts a major impact
on its smaller neighbours, such as the
Netherlands and Austria, and has also
constrained growth in the larger
countries at Europe’s heart, notably
France and Italy.
Over the past decade, German GDP
growth has averaged less than 1.5%
a year – only Japan has done
less well of the major economies.
The under-performance in both cases
relates to weak consumer demand,
reflecting ageing and slow-growing
populations, and an over reliance on
the public sector. Germany has also had
to cope with the integration of the
former-communist eastern zone, where
high unemployment has added to the
burden on public finances. The fiscal
deficit has been over 3% of GDP in each
of the past four years, while fiscal debt
is creeping towards 70%.
German labour market rigidities and high
taxes have driven up labour costs and
eroded competitiveness. In recent years,
the government has attempted to
address these issues with reforms.
There is evidence that these are having
a beneficial impact on relative unit labour
costs, particularly when compared with
progress in Italy and France. Moreover,
Looking ahead, demandconditions in theEurozone are expectedto improve gradually.
PricewaterhouseCoopers Global Real Estate Now November 2005 EYE ON EUROPE 41
Table 1: Summary of Economic Forecasts
GDP % pa Consumer Spending Employment % pa Bond yields % pa Inflation % pa
% pa
Forecast of annual averages 2005-09
Germany 1.6 1.1 0.3 5.0 1.4
France 2.1 2.1 0.5 5.0 1.8
UK 2.5 2.5 0.5 4.9 2.4
Italy 1.5 1.3 0.4 5.0 1.9
Spain 2.8 3.0 1.5 5.0 2.2
Netherlands 1.7 0.6 0.3 5.0 1.8
Belgium 2.1 2.0 0.6 5.0 1.8
Portugal 1.7 2.1 0.4 5.0 2.2
Ireland 4.4 3.2 1.3 5.0 2.3
Sweden 2.5 2.2 0.4 5.0 2.3
Source: Experian
Table 2: Summary of Main European Economies Property Markets
Offices Retail Industrial
Average 2005-09 Rental Capital Return Rental Capital Return Rental Capital Return
Germany 0.5 0.6 5.2 0.5 0.5 5.9 0.5 0.5 4.9
France 2.3 3.0 9.5 2.9 3.4 10.9 1.4 2.3 11.2
UK 3.3 3.4 10.6 2.9 3.1 9.0 2.0 3.3 10.7
Italy 1.0 1.9 7.8 1.7 2.1 8.6 1.3 1.3 8.9
Spain 4.1 4.6 10.4 3.5 4.3 11.3 3.2 4.3 12.5
Netherlands 1.2 0.9 8.1 1.3 1.2 8.5 0.2 0.1 8.4
Belgium 1.7 2.0 8.9 2.2 2.2 9.2 1.5 2.4 9.9
Portugal 2.1 1.9 7.6 2.3 2.7 10.6 1.7 3.1 9.4
Ireland 3.4 4.4 10.9 4.4 6.3 11.0 3.2 4.9 11.9
Sweden 2.2 2.1 8.0 2.7 3.1 9.1 1.8 2.3 10.2
Source: Experian
Offices Retail Industrial
the largest German corporates have
been forced into action to restore
profits and cut costs by harsh global
competitive pressures. More remains to
be done, but the inconclusive outcome
of September’s election is likely to stall
any radical action by the government.
In any case, the effects of liberalisation
are likely to be offset by negative factors
in the near term. High unemployment
and rising energy prices continue to
constrain domestic demand and GDP
growth is expected to be less than 1%
this year. But there are signs of
improvement. Manufacturing orders are
on a rising trend, boosted by the weaker
euro, while business confidence is
building. This should underpin growth
into next year.
Medium-term prospects are for further
slow improvement in economic activity.
Annual growth is forecast to average
1.6% in the period 2005-09, a moderate
improvement on the rate achieved over
recent years, and GDP increases are
expected to reach a more respectable
2% by the end of the decade. But
Germany is set to remain the most
sluggish Eurozone member, with
consumer demand continuing to be
undermined by stubbornly high
unemployment and slow job creation.
Economic underachievement has hit
German property markets. There have
been steady declines in rents in both
retail and office markets over the last
four years and recently the industrial
sector appears to have joined the slump.
Total property returns have been under
4% in the recent past, bottom of the
Eurozone rankings.
The slow economic recovery is expected
to boost occupier demand over the
forecast horizon. Rents continue to
edge lower this year and next, but
thereafter sustained revival is in
prospect, with offices rebounding
strongest. But German investment
performance over the five year forecast
period remains the least impressive in
the Eurozone by a wide margin, with
total returns of 5-6%.
A fundamental factorin the lacklustreperformance of theEurozone is the weaknessof Germany.
PricewaterhouseCoopers Global Real Estate Now November 2005 EYE ON EUROPE42
France
The French economy has been among
the best performers in the Eurozone over
the past decade. Annual output growth
has averaged 2.3%, with employment
creation an impressive 1% a year.
In stark contrast to the sluggishness in
Germany, activity has been supported by
buoyant domestic demand, most notably
consumer spending, which has been
driven by strong income growth.
Activity in France has slowed since
mid-2004, though GDP growth was
a solid 2.3% for last year as a whole.
Hopes that the revival would resume
were boosted by a consumer upturn in
the early months of this year, but the
improvement was short-lived.
Unemployment has fallen in recent
months, but employment growth has
remained subdued. The jobless total
remains a burden on the public finances,
with the fiscal deficit now unlikely to fall
below 3% of GDP before 2006.
French consumer spending is still
expected to increase by around 2% in
2005, but with net trade acting as
a drag, GDP growth is forecast to slow
to 1.5%. Continued anaemic expansion
in major export markets, especially
Germany and Italy, will do little to revive
exports next year, but solid consumer
demand supports a modest upturn.
Output growth is forecast at 2.0% in
2006, still below trend, with only modest
employment growth and reductions in
unemployment in prospect.
Growth is expected to accelerate toward
the long-term trend rate of 2.3% after
2007. This is healthy when compared
with most of the Eurozone, but trails the
forecast for other EU economies such
as the UK, Spain and Sweden, where
structural problems such as rigid labour
markets and over-sized government
sectors are less evident than in France.
French property markets have seen
mixed rental performance. Conditions
in office and industrial sectors have
improved, but remain muted, while retail
is growing rapidly. More balanced rental
growth is expected over the next few
years as occupier demand revives,
though industrial markets continue to
trail. Total returns have held up well
Continued anaemicexpansion in major exportmarkets, especiallyGermany and Italy, will dolittle to revive exports nextyear, but solid consumerdemand supports amodest upturn.
against a relatively weak economic
background and are forecast to remain
close to 10% in all but the office sector,
with industrial the top performer. France,
therefore, remains one of Europe’s
strongest investment markets.
UK
Consumer spending, boosted by strong
borrowing and booming housing
markets, has underpinned the UK’s
economic performance in recent years.
It has enabled the economy to grow at
an above-trend pace for a long period
and has sustained momentum when the
international background has been
unfavourable. Fiscal conditions have also
been significantly looser than on the
Continent, as the Labour government’s
unprecedented spending spree targeted
key public services. In the first five years
of the century, GDP growth averaged
2.7%, one of the fastest in Europe.
Over the past year, however, there have
been clear signs that the long period of
UK consumer exuberance is ending.
More subdued job creation, higher taxes
and interest rates, a weaker housing
market and more cautious borrowing
have combined to curb expenditure in
the first half of this year. Retail sales
confirm that high street demand
remained in the doldrums during
the summer and the outlook is
highly uncertain.
Inevitably, GDP has suffered. In the year
to 2005q2, annual growth was at its the
weakest since 1993. But a number of
factors suggest that the pace of UK
activity will revive over the next few
quarters. The MPC’s cut in interest rates
during August should support consumer
demand, while exports will benefit
from the healthier global background,
supported by the gradual acceleration in
the Eurozone. In contrast to the recent
past, little boost can be expected from
government spending as fiscal
constraints bite.
The labour market has seen a shift over
recent months, as unemployment has
started to rise gradually. The claimant
count measure rose in August for the
seventh month in succession, while the
broader ILO measure also saw an
increase in the summer. But employment
France, therefore, remainsone of Europe’s strongestinvestment markets.
PricewaterhouseCoopers Global Real Estate Now November 2005 EYE ON EUROPE 45
growth has continued and job growth
of 0.5% a year is forecast, as the
economy regains momentum in the
next few years.
Despite a better second half, the
economy is expected to grow by just
2% in the current year. Consumer
spending growth is projected to languish
at a decade-low of 1.8%, with only
modest improvement in prospect next
year. But a stronger external contribution
and buoyant business investment allow
a recovery in GDP growth to around
2.5% next year. Looking further ahead,
we forecast output growth is set to
accelerate to 2.7%, as consumer
spending gradually recovers.
UK commercial property recovered
last year. Positive rental growth was
recorded after two successive years
of contraction, with the marked
improvement in London offices was an
important influence. Meanwhile, total
returns on property soared to 18%, the
highest since 1993, with retail outturns
exceeding 20%.
The gulf between UK investment and
occupier markets is, however, expected
to narrow over the coming years.
Rental growth steadily improves in both
office and industrial sectors, offsetting
a modest retail slowdown. Over the
medium term, five-year rental growth
rates of 3% a year on average are
respectable relative to general inflation
rates of around 2%. Returns are
projected to decline sharply over the
next two years, but average almost
10% per annum over the forecast
horizon – one of the EU’s better
outturns. Industrial property continues to
perform strongest in line with historical
experience, though this is matched by
offices towards the end of the decade.
Italy
Italy’s economy has struggled over
recent years in the face of fiscal
pressures, structural problems and
unfavourable demographics. GDP
growth has averaged less than 1% a
year since 2001. Despite this, for much
of the period, employment creation has
UK Returns are projectedto decline sharply overthe next two years, butaverage almost 10 percent per annum over theforecast horizon
been healthy, thanks largely to
labour reforms. As a result, Italy’s
unemployment rate remains well below
those of France and Germany.
In 2004, activity hit a three-year high
supported by exports, business
investment and residential construction.
But GDP growth remained an
unimpressive 1.2%, year-on-year, with
consumer spending rising at an even
more sluggish rate. Moreover, the
economy slipped back into technical
recession around the turn of the year
and the subsequent recovery largely
reflects influences that are unlikely to
be sustained. Recent indicators confirm
this view, with declining retail sales and
industrial production, and unemployment
edging higher.
Against this weak external and domestic
background, GDP is set to stagnate in
2005, though an improvement is in
prospect during next year, pushing
activity to a four-year high of 1.5%.
Labour markets have held up relatively
well in the slowdown by contrast.
Employment growth of 0.6% is in
prospect during the current year, while
job creation keeps pace with EU-15
average thereafter.
The outlook for the Italy over the
medium to long term remains very
mixed. GDP growth is expected to
average less than 2.0% a year until 2009
– only Germany has weaker prospects
amongst the larger European
economies. By contrast, employment
growth is sustained at more impressive
rates, despite Italy’s unfavourable
demographic outlook. Overall,
considerable structural reform effort is
still needed to boost performance over
the longer term.
Italian property has weathered economic
weakness fairly well. Rental growth was
reasonably buoyant during 2004, led by
increases in the retail sector. Markets are
forecast to suffer a relapse in the current
year, with offices particularly badly hit.
Thereafter rental growth is forecast to
gradually build, with average increases
just under 1.5%. Returns were a healthy
9.5% last year. An office-led decline is in
prospect over the next two years,
Italian performance isclose to the Europeanaverage and there is alsopotential upside, givenunder-capacity anda rapidly developinginvestment market.
PricewaterhouseCoopers Global Real Estate Now November 2005 EYE ON EUROPE46
though a recovery brings medium term
averages up to around 8%. Italian
performance is close to the European
average and there is also potential
upside, given under-capacity and a
rapidly developing investment market.
Spain
Spain has performed strongly in
recent years relative to other Eurozone
economies. Since a dip in 2001-2,
activity has gradually picked up and
exceeded 3% last year. Domestic
demand continues to drive growth with
net trade remaining a drag, which has
led to concerns that the expansion is
unbalanced. Moreover, consumer price
inflation continues to run at 1-1.5
percentage points above both the
Euroland mean and the ECB target.
Demand has held up in early 2005 and
GDP is forecast to rise by close to 3%
this year and next. Thereafter, Spain
continues to out-perform EU growth
averages, though the lead is slightly
less pronounced, while employment
increases are predicted to slow. But a
better balance between domestic and
external demand is in prospect, as
consumer spending and the housing
markets cool. Despite this, inflation is
expected to remain high and will
continue to undermine competitiveness.
Spain’s commercial property markets
have remained amongst Europe’s
strongest, experiencing rental growth
of over 3% in the last 12 months. This
strength is sustained over the medium
term. Retail and industrial markets are
expected to cool slightly, but this is
offset by the steady revival in offices.
Spain is expected to be one of the top
performing investment markets over the
short to medium term, with double-digit
returns projected in all sectors over the
next 5 years.
Netherlands
The Dutch economy has shared in the
economic malaise of its German
neighbour. After dipping into recession
during 2003, GDP growth picked up last
year, though it remained well below
trend, with consumer demand static and
employment contracting. Export-led
growth has continued into the current
Spain’s commercialproperty markets haveremained amongstEurope’s strongest.
year, though activity has been
significantly slower than in 2004. Inflation
has also accelerated faster than in many
other European economies, though it
remains below the EU average.
In 2005, GDP growth is expected to
drop to an anaemic 0.5%, with
consumer spending contracting.
An even bigger slump in household
demand is in prospect next year, but
this is largely due to a reallocation of
health care spending to government
consumption, while GDP growth is
predicted to pick up. Over the medium
term, the Netherlands regains some of
its vigour, but, with output increasing
less than 2% a year and employment
growth only 0.3%, it remains one of
the Eurozone’s laggards.
Poor economic performance has
undermined Dutch property markets in
recent years. Offices have been
particularly badly hit and all other
sectors have experienced slowing rents.
No strong upsurge is in prospect, but
after bottoming out over the next year or
so, rental increases revive steadily (albeit
averaging only 1.2% in the 5 year
period). The outlook for returns is
healthier, with continued improvement
across the sectors and medium-term
averages of over 8%, not far off the
EU mean.
Belgium
In 2004, the Belgian economy recovered
strongly to record growth of just under
3% on the back of strong exports. But
conditions have deteriorated this year
and, although consumer demand has
held up, the latest figures point to
stagnation in the manufacturing sector,
while unemployment has edged higher.
At the same time as demand has
weakened, oil prices have pushed
Belgian inflation well above the ECB’s
2% target.
GDP growth is forecast to dip to just
over 1% in 2005, though a steady upturn
is expected over the following 12
months. Thereafter, unspectacular
activity of between 2 and 2.5% a year is
projected (close to EU averages).
Consumer demand is underpinned by
respectable employment creation of
around 0.5% a year and by income tax
Commercial propertydemand has dippedduring Belgium’seconomic downturn.
PricewaterhouseCoopers Global Real Estate Now November 2005 EYE ON EUROPE 49
reforms. This outlook is, however,
contingent on an improvement in the
external environment, given the
openness of the economy.
Commercial property demand has
dipped during Belgium’s economic
downturn and rental increases are
expected to remain subdued in all
sectors during 2005. Thereafter, a slow
recovery is in prospect in line with
economic trends, though five-year
averages show annual rental growth
of only 2% a year. Total returns have
had a more even performance in the
recent past and are projected to
edge up to 9% by the end of the
forecast period.
Portugal
Portugal has faced a difficult post-EMU
adjustment, largely as a result of fiscal
problems. Activity revived last year,
although even a turnaround in consumer
spending could not push growth above
1%. In 2005, indicators point to
a slowdown, in line with most other
EU economies. This softness has helped
subdue inflation in recent months,
although recent indirect tax increases
are expected to bring a rebound later
in 2005.
No immediate rebound in activity
is in prospect this year, but Portugal’s
GDP growth is forecast to improve to
1.8% in 2006 and averages around 2%
a year thereafter. Employment prospects
are expected to gradually revive, but the
expansion is set to be less than 0.5 per
cent annually. Overall, performance is
well below the EU averages and is
much less impressive than in the heady
pre-EMU days of the mid to late 1990s.
Progress in Portugal’s commercial
property markets is expected to stall this
year (retail aside), though the upturn
resumes next year and is sustained over
the forecast horizon. Total returns are
expected to steadily improve and
compare with European averages,
though a sizeable gap is maintained
between the subdued office sector and
the buoyant retail market.
Portugal has faceda difficult post-EMUadjustment, largely as aresult of fiscal problems.
Ireland
Ireland’s economic renaissance has
continued, with the economy recording
one of the EU’s most impressive growth
rates again last year. Momentum has
been led by consumer demand,
investment and exports, though there
is evidence of a deceleration in recent
quarters and the latest indicators have
been less positive. Consumer price
inflation has been steady at close to
2% in 2005, after a long period
of running at rates well above the
Eurozone average.
Irish GDP growth is expected to reach
5% this year and then averages about
4.5 per cent over the medium term.
This is accompanied by employment
and consumer spending growth that are
also well above the western European
average, although Ireland’s lead is less
marked than in the previous decade.
Although the outlook is both balanced
and sustainable, there remain potential
external downsides for the highly open
economy and the lingering risk of
a crash in the residential market.
Ireland’s commercial property markets
have had a very mixed performance.
The retail sector has boomed, while
office rents have slumped. Strong rental
growth is predicted to resume in all
sectors by next year and prospects are
for a steady improvement over the five
year forecast period. A more balanced
profile of returns is also expected,
as offices recover and retail cools.
A forecast average return of 11%
suggests that Ireland will be one of the
EU’s strongest investment performers.
Sweden
The Swedish economic recovery
delivered growth of over 3% last year,
the strongest since 2000. Evidence
suggests that there has been loss of
momentum during 2005, although the
slowdown has been less marked than in
the core EU economies. Meanwhile,
inflationary pressures have remained
subdued, with price increases averaging
less than 1% in recent months and
providing no immediate threat to the low
interest rate environment.
Output is forecast to grow less rapidly
this year, as external demand weakens
and domestic spending cannot bridge
the gap. GDP increases then average
2.5% a year over the medium term,
with annual employment growth
of around 0.4%. EMU entry is
ruled out in the near future, so
Sweden will continue to exploit its
strong links to Europe without the
monetary constraints.
Swedish property markets have
recovered slowly. Rental growth rates
are projected to recover, with increases
averaging about 2.3% a year over the
forecast period, led by the retail sector.
Total returns also pick up, with the
industrial sector’s double-digit
outturns most buoyant, but offices
trailing well behind.
In Ireland strong rentalgrowth is predicted toresume in all sectors bynext year.
PricewaterhouseCoopers Global Real Estate Now November 2005 EYE ON EUROPE50
Andrew Burrell can be reached via email at [email protected]
PricewaterhouseCoopers Global Real Estate Now November 2005 EYE ON EUROPE 51
Overview
In the 2005 Emerging Trends Real Estate SurveyMoscow, along with Istanbul, was identified as one ofthe two most promising real estate markets fordevelopment. Consistent with this view, in recentmonths there has been a significant shift in interest inthe Moscow real estate market.
For many years foreign investors have
been looking with interest at the
Moscow real estate market but very
few deals were concluded. This was
due largely to the lack of supply of
suitable investments as well as
competition from Russian investors
flush with cash, willing to accept lower
yields and with the ability to move more
quickly in the market.
However, in recent years there has been
a significant increase in the supply of
real estate on the Moscow market in all
sectors. In the office sector more than
3.5 million sq m of office space (1.5
million sq m owner occupied) was put
into operation in the period 2000 to
2004. In addition, in 2005 more than
500,000 sq m of retail completions are
planned and over 250,000 sq m of
logistics and warehouse properties.
Investors are showing a greater
acceptance of the risks in Russia and an
understanding of how these risks can
be managed. In addition, yields are
moving downwards but are still attractive
when compared with other markets in
Central Europe. For example, yields in
the Class A office sector space are
around 12% whilst yields in warehousing
are close to 15%. According to certain
market forecasts it is expected that
yields will have decreased to around
9-10% by 2010.
For any potential investor it is important
that they familiarise themselves with
the local situation. It is not just from a
market sector perspective, where they
need to understand the development in
each of the sectors, but they also need
to obtain a thorough understanding of
the legal, tax, other local political and
planning environments as well as
understanding the sources of financing
available to them.
By Steven Snaith, Tax Partner,PricewaterhouseCoopers, Moscow
Russia real estate – movingfrom looking to investing
Types of investor and assets
Recently the types of investors working
in the market have also changed.
Previously most of the deals being
transacted involved Russian money but
increasingly foreign investors are looking
to invest. Such foreign investors include
a number of foreign funds. Nonetheless,
while interest has certainly increased,
there is still much room for growth –
of the estimated more than $2 billion
directly invested in Central and Eastern
Europe, it is estimated that less than
$100 million found its way to Russia
despite more attractive fundamentals
than some of the other Central and
Eastern European markets.
In 2004 some of the first foreign fund
real estate investments took place with
Eastern Property Holdings’ acquisition
of Berlin House and Fleming Family
Partners Real Estate fund’s purchase of
Gogolevsky Boulevard No 11 and, in
2005 its purchase of an office building
at Lesnaya street No 3.
However, other foreign investors are also
looking to be involved, including some of
the large real estate investment funds as
well as an increasing number of
entrepreneurial investors. Many such
entrepreneurial investors have already
done deals in Central and Eastern
Europe and are now looking to move
further East.
Often such investors are willing to look
at a wider asset class as well as different
types of investment. In addition, a
number of investors are looking to
partner with local Russian companies.
Increasingly investors are finding that it
is becoming easier to raise money to
invest in Russian real estate. One such
example is Raven Group which recently
completed a listing on the AIM in
London and has announced it is looking
to invest over $500 million in Russian
real estate.
Until recently, foreign investors were
mainly looking to acquire Class A office
properties, but now they are now
considering a wider range of assets and
there is increasing availability (although
the market is still tight) of different types
of properties. Many investors are now
considering retail space and hotels, as
well as warehousing and logistics
Increasingly investorsare finding that it isbecoming easier to raisemoney to invest inRussian real estate.
PricewaterhouseCoopers Global Real Estate Now November 2005 EYE ON EUROPE 53
together with office buildings. The
likelihood is that there will be an
increasing number of deals in these
areas as opposed to the more traditional
office transactions because of the
increased range of acceptable product
available on the market.
With the improved legal environment,
more foreign investors are considering
either buying or leasing land plots in
Russia and investing in greenfield
developments in all of the above market
areas. Joint ventures with Russian
partners for development purposes are
not uncommon, but proper structuring of
such arrangements requires careful
planning of a long term relationship and
exit strategies.
Nonetheless, challenges still lie ahead
and specific aspects of the market
need to be carefully managed, such
as the inability to directly acquire land
in Moscow (the norm being 49 year
land leases) and often a lack of
transparency and comparables making
valuations difficult.
Structuring the deal
One particular feature of the Russian
real estate market is that virtually all of
the deals being considered involve the
acquisition of a company owning the
property, usually as a single asset
owning entity, as opposed to the
purchasing of the property asset itself.
There are a number of advantages to
such corporate deals, principally for
the seller, as often it may be possible
for the seller to achieve an exit from the
transaction without incurring Russian tax
if the entity being sold is held from an
appropriate foreign jurisdiction. Whilst
there are also some advantages for the
buyer, principally around there being no
VAT on the purchase of shares as
opposed to the purchase of property
and there being no need to re-register
title to the property, there are also a
number of disadvantages.
These disadvantages are wider than the
fact that a corporate deal brings with it
all the previous operating history of the
company and legal deficiencies
embedded in it, and often include
Virtually all of thedeals being consideredinvolve the acquisitionof a company owningthe property.
significant tax disadvantages. These
arise primarily as a result of uncertainties
and frequent tax changes in the past
legislation which meant structuring any
real estate transaction at that time was
difficult to do tax efficiently, as well as
because the asset is denominated in the
books of the Russian entity at its historic
rouble cost.
With the significant rouble devaluation
that took place between 1998 and
2000 this means older buildings are
often sitting in the books of Russian
entities at amounts significantly below
current market value. Even for newer
buildings, due to recent market
conditions there is often a large
difference between the book value of
a building and its market value. As such,
the purchase of a property these days
often involves acquiring a company with
a large future potential gain embedded
in the company.
In addition, being able to tax efficiently
finance any acquisition is difficult in
Russia. As it is usually the company
being acquired, it is often difficult to
push down the debt into the entity owing
the real estate such that interest on the
debt can be used to offset rental
income. In an ideal scenario it should be
possible to structure investment into
Russian real estate such that Russian
corporate tax has only a minimal impact
on the overall yield.
However, this would mean being able to
structure financing tax efficiently, which
is difficult due to the way the companies
owning the real estate were previously
financed and the lack of group relief or
tax consolidation in Russia. Often the
companies being acquired have only a
minimal amount of existing debt or, due
to the increase in the value of the
property (real or through rouble
devaluation), the debt may be only
a small part of the market value of the
property. Whilst it may be possible to
substitute existing debt, it is often very
difficult to increase the level of debt in
a Russian company tax effectively, and
standard structures used elsewhere in
the world often do not work or are
extremely difficult and/or aggressive to
use in Russia.
It is, therefore, extremely important when
modelling any potential yields to ensure
the tax situation and the current
structure of the target company is fully
understood such that the impact of
Russian tax on the post tax yield is fully
taken into account. It is not possible
generally to model on a “consolidated”
basis as in practice it may not be
possible to achieve such consolidation.
There is a big difference between a 15%
and an 11.4% yield. This also means
certain companies (properties) on the
market may be more attractive than
others due to the way in which they
are structured.
Tax is not the only driver when looking
at acquiring a company as clearly a full
financial and legal due diligence will be
required. This will be to ensure that the
asset has the correct registration and
approvals from the various city and
federal authorities as well as ensuring
the validity of leases and other contracts
and absence of bad debts in the
company. In addition, since many
company sales are structured from
a pricing perspective as an asset sale
based on yield there needs to be a
comprehensive understanding of the
sustainability of the yield going forward
not just in terms of income but also
whether post acquisition the costs will
remain the same.
Being able to taxefficiently finance anyacquisition is difficultin Russia.
PricewaterhouseCoopers Global Real Estate Now November 2005 EYE ON EUROPE54
Fund Structuring
As has been mentioned already, Russia
is becoming attractive as an investment
target for real estate funds. At present
much of the investment has been by
country specific funds investing
exclusively in Russia, although other
opportunistic investors are also starting
to look at Russia as well.
The starting point in looking at the tax
implications of investment in real estate
in Europe is the nature of the vehicle
investing. From an investor’s tax
perspective, it is important that profits
received by the fund are not subject to
tax, either in the fund vehicle itself or by
withholding tax on distributions made
by the fund. In order to achieve this,
funds are typically structured as tax
exempt (e.g. in a tax haven) or as a tax
transparent (e.g. limited partnerships or
contractual vehicles).
Such vehicles are not generally entitled
to the benefits of double tax treaties and
it is therefore necessary to have an
intermediate holding company in a
jurisdiction with an appropriate double
tax treaty with Russia, a participation
exemption that exempts from tax capital
gains and dividends in respect of the
underlying SPV and a means of
mitigating withholding tax on dividends
out of the holding company. Cyprus is
one, but there are others and the choice
will ultimately depend upon the tax
requirements of investors.
The starting point inlooking at the taximplications of investmentin real estate in Europeis the nature of thevehicle investing.
Steven Snaith can be reached via email at [email protected]
Tech Corner
PricewaterhouseCoopers Global Real Estate Now November 2005 TECH CORNER 57
Real estate companies face many challenges withrespect to the budgeting, forecasting and planningprocesses. Though these processes are allinterrelated, they typically are performed by disparategroups including leasing, property management,property and corporate accounting. Technologyvendors have strived to provide solutions forcomponents of the processes, but no solution existsto support the end-to-end collaborative planninglife cycle.
In this article, we will explore some of
the key trends related to budgeting,
forecasting and planning within the real
estate industry, as well as some of the
technology options currently available.
Financial planning tasks typically have
been divided into the categories of
“property” budgeting and forecasting,
and “corporate” budgeting. Property
level budgeting and forecasting focuses
on the anticipated net operating income
at the asset level. Corporate budgeting
focuses on the non-asset specific
costs such as general and administrative
costs. Outputs from these functions
must be combined to provide overall
corporate plans. Since the information
required and techniques used in
property vs. corporate budgeting are
very different, a key challenge in overall
corporate planning is the ability to
combine information from each process,
and model various permutations of
property and corporate scenarios.
Many organisations continue to use
spreadsheets and other offline solutions
to manage their budgeting, forecasting
and planning processes. While these
tools are intuitive and easy to use, they
have little or no integration to underlying
property management and financial
systems and generally require manual
re-entry of necessary data. Such
processes are inefficient and prone to
error and make it very difficult to keep
the budget models synchronised with
By David Yakowitz, Director andKurtis Babczenko, Director,PricewaterhouseCoopers Advisory, Chicago
Budgeting, forecasting andplanning: process andtechnology trends in the realestate industry
up-to-date leasing and financial
information. Such a situation can easily
impede an organisation’s ability to look
forward and consider continuous
planning approaches such as
rolling budgeting.
As a result of these challenges, many
organisations are evaluating new
organisational models and technology to
address the inefficiencies in the planning
function. The concept of creating a
single corporate planning function is
gaining momentum within the industry,
and corporate planning departments are
being evaluated as the mechanism to
oversee the overall budgeting,
forecasting and planning processes.
Key roles played by this group include:
ownership and management of the
planning process, providing necessary
“top-down” guidance for key budgeting
and planning parameters, determination
of appropriate mix of property/asset
level assumptions, and definition of
general business scenarios. These
groups require the ability to consolidate,
view and analyse data from multiple
sources, the ability to define and
measure key performance indicators,
and the ability to model all business
segments using methodologies that are
appropriate for that segment. Table 1
summarises some of the key elements
we see considered in efficient corporate
planning functions.
Clearly, the ability to leverage technology
is critical in developing an efficient
corporate planning process. While there
has been a category of technology
providers targeting solutions in the
budgeting and planning area for some
time, this group has been relatively
non-existent in the real estate sector.
The solutions from this group, referred to
as Business Performance Management
(BPM) vendors, allow for consolidation
of underlying operational and financial
system information, and provide
modelling and collaboration tools which
are layered on top. These providers have
built their solutions based on general
planning requirements and tend not to
have real estate industry specific
solutions such as functionality for
property budgeting.
As BPM tools gain momentum, vendors
of property management and financial
The concept of creatinga single corporateplanning function isgaining momentum withinthe industry, andcorporate planningdepartments are beingevaluated as themechanism to overseethe overall budgeting,forecasting and planningprocesses.
PricewaterhouseCoopers Global Real Estate Now November 2005 TECH CORNER 59
While there has been acategory of technologyproviders targetingsolutions in the budgetingand planning area forsome time, this grouphas been relativelynon-existent in the realestate sector.
Table 1: Key elements of an efficient corporate planning function
Linkage of budget development to Corporate objectives
business strategy Portfolio objectives
Asset plans
Tie incentives to performance measures – Asset quality
“balanced scorecard” Tenant satisfaction
Profitable growth
Incorporation of cost management into Product type/submarket benchmarks
budgeting process Service contracts
Purchase contracts
Reduction of planning complexity and Minimise data collection, reconciliation,
and cycle time and integration efforts
Leverage technology to automate
and collaborate
Continuous planning and forecasting Monitor significant changes
Model business opportunities
Leverage technology
Source: PricewaterhouseCoopers
systems, including both Enterprise
Resource Planning (ERP) vendors and
niche real estate vendors, have also
entered the budgeting and planning
space in recent years. As such, their
products tend to be less mature from
a functional perspective but they often
have advantages from a data integration
perspective. They also provide more
specialised functionality for the real
estate industry including the ability to
leverage underlying contractual lease
information on a real-time basis and
track both budgeted (projected) numbers
and actuals (i.e., what was actually
spent) at the space or lease level.
Despite the advances we have seen
from a technology standpoint, there
remain a number of “opportunities” for
the technology providers. One of the key
challenge areas that remain is the ability
to effectively incorporate the leasing
pipeline into the budgeting process.
While the property budgeting solutions
provide mechanisms for assumptions
to be maintained, there is generally
o good integration between
CRM/deal-flow information and
assumptions in the budget. As a result,
if a leasing agent is tracking two
potential deals for a space, there is no
easy way in the budgeting system to
identify them and simply assign
probabilities. Instead, leasing would
need to re-enter deal terms as a leasing
assumption in the budgeting system.
The ability to leverage technology in the
budgeting and planning area helps to
enable implementation of many of the
best practice ideas discussed above.
For example, the ability to leverage
existing data reduces the need for data
collection and reconciliation and helps
minimises errors. Utilising business rules
and workflow technology helps
automate the review and approval
procedures, reducing overall cycle time
and enabling a more repeatable process.
However, technology is only one
component of the puzzle needed to
drive efficiency into the planning
process. Critical to a successful process,
and often the most difficult to
implement, are the organisational and
While the propertybudgeting solutionsprovide mechanismsfor assumptions to bemaintained, there isgenerally no goodintegration betweenCRM/deal-flowinformation andassumptions inthe budget.
PricewaterhouseCoopers Global Real Estate Now November 2005 TECH CORNER60
cultural changes required. Appropriately
linking incentives and performance
measurement to the process requires
top-down commitment and often causes
the greatest amount of resistance.
These changes will not happen overnight
and require strong leadership and a clear
vision of the future state efficiencies.
The future of corporate planning in the
real estate industry holds much promise,
and will mature significantly in the
coming years due to the specific
needs of the industry to combine real
estate-specific modelling with general
business modelling. The ability of
technology to support adaptation of
corporate planning best practices
continues to progress and should be a
key enabler. Capabilities we could only
imagine in the recent past are now
realities. For example, the ability to
automatically incorporate the latest
signed lease deals, and the ability to
reforecast by automatically incorporating
year-to-date actuals into the budgeting
process already exist today. Existing
applications also allow us to complete
5-, 10- and up to 15-year forecasts
using a combination of existing
contractual lease data and assumptions
maintained within the budgeting
tools. With integration and some
customisation, the ability to mix
property budgeting scenarios with
general business models can also be
accomplished. As technology continues
to improve, it will allow real estate
companies to implement even
more progressive ideas in the
budgeting, forecasting and corporate
planning areas.
The future of corporateplanning in the real estateindustry holds muchpromise, and will maturesignificantly in the comingyears due to the specificneeds of the industryto combine real estate-specific modellingwith general businessmodelling.
David Yakowitz can be reached via e-mail at: [email protected]
Kurtis Babczenko can be reached via e-mail at: [email protected]
Real EstateInsights, observations and research
from PricewaterhouseCoopers
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tax and business advisory services
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Disclaimer:PricewaterhouseCoopers has exercised professional care and diligence in the collection and processing ofthe information in this report. However, the data used in the preparation of this report (and on which the reportis based) were provided by third-party sources and PricewaterhouseCoopers has not independently verified,validated or audited such data. This report is intended to be of general interest only, and does not constituteprofessional advice. PricewaterhouseCoopers makes no representations or warranties with respect to theaccuracy of this report. PricewaterhouseCoopers shall not be liable to any user of this report or to any otherperson or entity for any accuracy of information contained in this report or for any errors or omissions in itscontent, regardless of the cause of such inaccuracy, error or omission. Furthermore, to the extent permittedby law, PricewaterhouseCoopers, its members, employees and agents accept no liability and disclaim allresponsibility for the consequences of you or anyone else acting, or refraining to act, in reliance on theinformation contained in this report or for any decision based on it, or for any consequential, special,incidental or punitive damages to any person or entity for any matter relating to this report even if advisedof the possibility of such damages.
Global Real Estate Leaders
Frank van ZelstGlobal Real Estate Tax Leader
Amsterdam, The Netherlands
Tel: [31] (20) 568 6872
Email: [email protected]
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San Francisco, United States of America
Tel: [1] (415) 498 7405
Email: [email protected]
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New York, United States of America
Tel: [1] (646) 471 8877 or
[1] (646) 471 2666
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Asia Pacific Real Estate Leaders
Robert GromeAsia Pacific Investment Management
& Real Estate Leader
Hong Kong
Tel: [852] 2289 1133
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Sydney, Australia
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Hong Kong
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European Real Estate Leaders
Henrik SteinbrecherEuropean Real Estate Leader
Stockholm, Sweden
Tel: [46] (8) 555 330 97
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Frank van ZelstEuropean Real Estate Tax Leader
Amsterdam, The Netherlands
Tel: [31] (20) 568 6872
Email: [email protected]
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Rotterdam, The Netherlands
Tel: [31] (10) 4008 414
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Berlin, Germany
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Europe and CIS
Prague, Czech Republic
Tel: [420] 251 152 619
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United KingdomReal Estate Leaders
John ForbesUK Real Estate Tax Leader
London, United Kingdom
Tel: [44] (0) 20 7804 3161
Email: [email protected]
Angela Crawford-IngleUK Real Estate Assurance Leader
Real Estate Leader
London, United Kingdom
Tel: [44] (0) 20 7212 5225
Email: [email protected]
United StatesReal Estate Leaders
William E. CroteauUS Real Estate Practice Leader
US Real Estate Assurance Leader
San Francisco, United States of America
Tel: [1] (415) 498 7405
Email: [email protected]
Gary CutsonUS Real Estate Tax Leader
New York, United States of America
Tel: [1] (678) 471 8805
Email: [email protected]
Patrick LeardoUS Real Estate Advisory Leader
New York, United States of America
Tel: [1] (646) 471 8877 or
[1] (646) 471 2666
Email: [email protected]
Latin AmericaReal Estate Tax Leader
Alvaro TaiarLatin America Real Estate Tax Leader
Tel: [55] (11) 3674 3833
Email: [email protected]
Marketing and Editorial Contacts
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London, United Kingdom
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Global Real Estate Now
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