Let's Be Clear
Market transparency varies massively in the former eastern bloc countries. Andrew Jackson of insurer First Title looks at the pitfalls awaiting investors
Central and eastern Europe's property markets have changed rapidly in the last 10 years. Visit any capital city in the region, and it is hard to imagine that only 20 years ago these countries were centrally controlled, planned economies where property was largely under state ownership.
The remnants of this system can still be seen in communist-era apartment blocks and socialist architecture. But thanks to the pace of development across the region since the end of the Cold War, these buildings are no longer such a prominent feature.
Buying property in central and eastern Europe has always been seen as a risk compared with buying in western Europe. While some risks have decreased, primarily as a result of countries' recent or forthcoming accession to the European Union, there are still peculiarities in these markets that stem from a history of nationalisation, state ownership, and subsequent privatisation and restitution.
Part of the Union
The countries with the most advanced property investment markets are the eight that joined the EU on 1 May 2004: the Czech Republic, Hungary, Poland, Slovakia, Slovenia, and the Baltic states of Latvia, Lithuania and Estonia. Property laws in these countries are nearly up to EU standards, although there are considerable variations in risk profile.
Romania and Bulgaria - the newest EU members, which joined on 1 January 2007 - are considered riskier markets. The riskiest markets in the region are those that have yet to join the EU, such as Croatia, Serbia, Montenegro and Albania, but the consensus is that conditions across central and eastern Europe are improving.
The risks to property ownership in the region can be broken down into four overlapping areas: restitution issues, land registries, rules governing the privatisation of former state-owned land, and warranties.
At best, restitution claims can lead to expensive legal costs and time delays. At worst, they can pose a serious challenge to title.
Risks arising from restitution claims remain greatest in Poland, Romania and Slovakia. Poland has no restitution legislation to limit claims or to define a compensation scheme. This means new claims are always possible and restitution or compensation is not standardised.
Although Romania has passed such legislation, there remains an enormous backlog of complaints waiting to be heard by the courts from people whose land and property was expropriated by the state (see box). In Slovakia there is no central database of claims that are pending, and claims can be filed in any court or municipalityin the country.
The generally poor state of national land registries is also a source of uncertainty for investors and lenders, as countries' registries vary greatly in their levels of sophistication and reliability. Hungary has an electronic land register that allows straightforward public scrutiny of property history and serves the due diligence process well.
However, significant parts of the Polish and Romanian land registries are still kept in antiquated hard-copy format and have to be checked manually, giving rise to the risk of mistakes, omissions, unverifiable gaps in the chain of ownership, missing documents, fraud and human error.
Other countries in the region do not provide state guarantees or indemnity in case of error - unlike in western Europe, where this is standard.
Another risk in the region is connected with the privatisation of former state-owned land.
This land, having been privatised in the 1990s, is now being sold to new owners and investors.
During the course of due diligence it is not uncommon to find instances where the strict requirements of the law were not followed to the letter. The flaw is typically something minor, such as the failure to adhere to public notification requirements, the lack of a required power of attorney or an incorrect composition of the public tender committee.
These kinds of mistakes could allow an interested party to challenge the sale of the land. A successful appeal can invalidate the transfer of the property to the current owner, as well as any future owners. This means new investors have to deal with layers of bureaucracy and complex administrative processes to rectify past procedural errors which, if neglected, leave the title open to challenge. This can tie up the owner for years in expensive litigation or force it to seek an early resolution by paying a settlement.
Defect to the east
A traditional form of risk mitigation open to buyers is to demand representations, warranties or guarantees from the seller to cover identified title defects. Some of the opportunistic funds that were among the first wave of investors in central and eastern Europe are now exiting the market and liquidating their funds. The fund managers do not want any contingent liabilities and often turn to title insurance as a tool to replace title warranties - thereby permitting the fund to dissolve and return money to investors.
From the seller's perspective, bank guarantees are expensive to service, typically expire after a couple of years, and can impact negatively on its credit profile.
Commercial lenders, property investors and developers use title insurance to complete transactions. Lawyers also use it to save their clients time and money on due diligence. It can prove useful in securitisations, where credit rating agencies view it as strengthening the transaction and mitigating against potential loss of the land. Fund managers use it to replace representations and warranties, leaving them with no contingent liabilities when they sell the property.
When a third party challenges the title, the title insurer steps in at the first notification from the insured party and takes steps to resolve the challenge. This may involve defending the insured party against the challenge to its title, hiring lawyers as needed and covering all defence costs.
Investors should conduct due diligence of the country, as well as of the property, in which they hope to invest. However, international investors who have been in the region for 10 years or more know that these risks are manageable with title insurance and sound legal advice.
Central and eastern Europe: Title holders take a beating
Two recent cases highlight the impact title disputes can have on property transactions. In both these cases title insurance was used to protect the investor and cover their potential losses.
Slovakia: In good faith?
The land planned for a logistics facility in Slovakia had been assembled by the local municipality several months before the current seller's purchase of the land. The municipality declared around half of the land assembled for the facility as 'land acquired through adverse possession' - in short, that it had held the land openly and conspicuously for at least 10 years in good faith, believing that it was the rightful owner.
In the course of due diligence, however, it became clear that there were some real doubts about whether the city had met the 'good faith' requirement, and this cast serious doubt over the legal title.
Romania: Whose land is it anyway?
A real estate company was buying land and buildings in the Romanian capital, Bucharest. A previous owner had acquired the land through a restitution decision issued by the Bucharest municipality. As is often the case, this owner was the heir of the original (now deceased) owner.
Despite the municipality's decision, a further examination of relevant documents revealed some uncertainty about whether the land expropriated from the former owner's relative was the exact same land that was transferred from the municipality. There was a real risk that the municipality had no right to dispose of the land and that the restitution decision, which was the basis for the title, could be invalidated.