Broken Eastern Promises

The Alternative Investment Market (Aim) eastern European real-estate sector is so complicated, it could be deemed a specialist subject on Mastermind. Analysts claim there are too many companies to mention, often with confusingly similar names, and many more that vanished without a trace after failing to raise capital.

"For every one that made it to the market, there's at least four that were stillborn," says Blue Oar Securities real-estate analyst Ian Wild. "Far too many were done far too quickly."

Blue Oar research shows that since 2005, Ј9bn in new equity has been raised on Aim for real estate - mostly for for overseas property funds (OPFs). Of the total Ј12.25bn current market capitalisation, those focused on eastern Europe account for 17 per cent - the highest proportion.

In the early days, investors bought into property funds targeted at emerging economies with booming gross domestic product (GDP) growth that was expected to not only attract business, but also fuel consumer and residential demand. For the accession states poised to enter the EU, the prospects of yield compression were even greater. This led to a slew of Aim floats focused on Bulgaria, Romania and the Balkans.

Today, only a handful of these funds bother paying to list themselves in the Financial Times register. A cynic would argue this is because they don't wish to draw attention to their plummeting share prices (see table below). The eight stocks we've picked have fallen by 37 per cent, creating a yawning average discount to net asset value (NAV) of 35 per cent, which has attracted activist investors to the sector.

Walls come tumbling down...

COMPANY Price (p) 12M chng (%) Discount to NAV*

Equest Balkan Properties 79p -31 39%
Bulgarian Property Developments 60p -10 20%
Bulgarian Land Development 74p -33 43%
Fabian Romania €1.23 -9 20%
Engel East Europe 67p -52 na
European Convergence Property Company €0.24 -79 na
Lewis Charles Sofia 66p -27 36%
Black Sea Property Fund 8p -57 50%
AVERAGE - -37 35%

*Based on last reported headline NAV

The residential sector has a unique set of problems, but the commercial sector is currently in a period of adjustment with funds originally set up to invest in property turning to development.

For example, the European Convergence Property Company was launched in 2005 to focus on property investment. At the end of last year, it decided to sell its four Romanian and Bulgarian properties, close the business down, and return cash to shareholders. In its place, it has launched the European Convergence Development Company to target development projects.

Equest Balkan Properties originally targeted income-producing property assets that it could buy at a price low enough to produce a lip-smacking rental yield of about 10 per cent. "Yield compression [due to rising property prices] in Romania and Bulgaria happened quickly, moving to 7-8 per cent," explains director Petri Karjalainen.

Deciding not to compromise the company's yield target, Equest maintained it by acquiring assets that were cheaper because of higher letting and development risk.

Profits from development take longer to realise, but Equest was also caught out by the credit crunch. This has not only slowed the sale of two prime retail assets, but has delayed further debt financing of its assets which led to February's announcement that payment of future dividends would be postponed. A generous discount to NAV has attracted activist investor Carrousel, which has acquired just under 20 per cent of the shares.

This is not the first instance of activists entering the sector. In January, commercial property developer Bulgarian Property Developments saw off a takeover bid from currency speculator Joe Lewis. And last month, Terra Catalyst Opportunity fund, run by much-feared activist Laxey Partners, obtained a 14 per cent stake in Bulgarian Land Developments (BLD).

BLD's broker Collins Stewart says this is due to a stock swap with an investor, who has used the shares to buy into Terra Catalyst. Sources say up to half of the float was funded in this way, with another significant 'swap' happening at Northern European Properties, a separate Aim property company that is targeting development projects in Russia and the Baltic states.

Across the eastern European property sector, the uniformity of NAV discounting worries analysts. "It's the same whether a company is an investor or a developer, which I can't for the life of me believe is correct," says Mr Wild.

"The reasons for the discounts vary from company to company, but the important thing to remember is that there is no evidence at all of a yield shift reversal (valuations falling rather than rising)," says Mike Foster, real-estate analyst at KBC Peel Hunt. The value of assets is under pressure in the UK and western Europe, where property valuations have fallen as a result of the credit crunch, putting pressure on pricing and calling generous broker NAV forecasts into question.

"There is an element of yield reversal in the C3 countries of Hungary, Poland and the Czech Republic, but this is drawing investors to Bulgaria, Romania and Serbia," adds Mr Foster.

However, the low level of transactions means the situation is hard to monitor.

The vogue of shifting to development increases the investment timeframe, which could also lead to a reduction in what valuers believe developments are worth. The often exorbitant fees of Aim fund managers are under shareholder scrutiny as a result.

However, analysts are still confident about established developers including Dawnay Day Carpathian, Plaza Centers and Atlas Estates, which have projects spread across the region, as they are already trading assets they have built. As the newer crop of developers ascertains how to fund its projects, starting a tandem listing in a local market is set to be a new trend.

One could argue that the short-termism of Aim investors is partly to blame for the discounts. Although they were initially happy to fund property developments that replicate the shopping malls and office buildings of the western world, they are not willing to provide the stable investor base these emerging economies clearly require. There are clearly opportunities in the sector but tread carefully.novinite.com