Topical issues

Development and financing of the Baltic RE industry

The three Baltic countries Estonia, Latvia and Lithuania are considered developing economies. As the name suggests the development of asset and financial markets is of particular importance in countries of such economic stage. In this research we mainly focus on real estate market, to be more precise: our interests are to investigate, what are the trends of the real estate markets in Baltic states, what impact does this market have on the financial markets of these countries as well as how could the development of Baltic financial markets be spurred by an introduction of real estate investment securities.

Since real estate markets are capital intensive, nowadays the significant part of financing still comes from a mix of equity and bank loans. However, with Basel III and Solvency II banks and other financial institutions are expected to operate under much stricter capital requirements and risk management; therefore, financing long term capital intensive projects might be harder due to increase in required returns and stricter covenants. Up to this point it is clear that a development of capital markets and inclusion of real estate investment options for wide public is necessary.

Fundamentally most of the nation’s money is held by households, though in different forms. Growing availability of private pension funds and insurance companies as opposed to banks increases the amount of capital that can be invested through financial markets. In particular, pension funds are often oriented to real estate market and fixed income assets, this is mostly due to the fact that these funds have long horizon and long term liabilities that are mostly fixed. Such investment risk profile must be met by less volatile long term investments, which provide an income based return. However, domestic capital is not always up to the tasks of real estate financing.

Real estate sector require large investments, thus capital markets must be developed to attract foreign investors. It is highly important to identify what particular financial assets would be attractive to foreign as well as domestic investors. Such securities have to be defined in their legislative position, maturity, exposure to risk, down payments and other quantitative and qualitative characteristics. Upon the introduction of right investment options, a high probability of increasing investment flows is created due to diversification possibilities for foreign investors and high returns for less risk averse investors focused on developing economies.

We plan to begin the investigation by reviewing the existing literature on similar research and gaining a deeper understanding on the relationship between real estate sector and capital markets. The analysis of RE demand and supply trends in Baltics should follow to grasp a current situation of two markets and their future. The analysis will be focused on commercial real estate, mostly on office and retail RE markets, which are the dominating real estate in Baltics.

Subsequently, the research will try identifying what problems there are in attracting foreign capital, with a perspective of legislative, taxation and risk profiles. What types of financing could be introduced with particular focus on debt financing and which of them would be most effective and attractive

In addition, the topic of the prospects of health-care/age-care industry expansion in Baltic countries will be reviewed. Since today it is relatively scarce and undeveloped it creates a perspective for new potentially profitable investments.

To sum up, with this LFMI research we will try to answer to the questions: what is the situation in Baltic real estate markets today, what difficulties arise in the financing of this market and could these difficulties be solved by the development of capital markets and introduction of more financing options for potential investors. After all, the attraction and widening of liquid accessible capital through capital markets is one of the primary goals of Lithuanian Financial Markets Institute.

Research assistants:

Kostas Feruliovas

Ċ½ilvinas Jusaitis