global realestate now

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

[email protected]

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


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


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


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


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


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


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.


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.


Vivek Mehra can be reached via email at [email protected]

Akash Gupt can be reached via email at [email protected]


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.


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.


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.


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.


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.


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.


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.


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.


Andrew Burrell can be reached via email at [email protected]


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.


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.


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

international real estate accounting,

tax and business advisory services

professionals and clients.*

PricewaterhouseCoopers real estate

network comprises highly skilled,

experienced professionals including

accountants, surveyors, lawyers,

analysts, consultants, tax and corporate

finance specialists as well as senior

executives with hands-on experience

at the very top of the industry. We offer

in-depth experience in a broad range

of financial accounting, auditing and

reporting issues, tax advice for

transactions, investment fund and

carried interest structuring,

securitisations, asset due diligence,

transaction support, valuation

management, corporate finance,

M&A and finance-raising.

PricewaterhouseCoopers regularly produces surveys, newsletters and brochures on

real estate industry issues as well as hosting a variety of client-focused events.

• Global Real Estate Now (published three times per year).

• Global Real Estate CD Rom containing material on tax and legal implications

of investing in real estate in 60+ countries around the globe (published yearly

in March).

• European Investment Management/Real Estate Newsletter (published quarterly).

• Asia Pacific Investment Management/Real Estate Newsletter (published twice

per year).

• Brochure on PricewaterhouseCoopers’ Real Estate Calculation Models service

(published June 2005).

• European Real Estate Products and Solutions information folder (available in

September 2005).

• Emerging Trends in Real Estate® (US), published yearly in conjunction with the

Urban Land Institute.

• Emerging Trends in Real Estate Europe®, published yearly in conjunction with

the Urban Land Institute.

• Korpacz Real Estate Investor Survey® (quarterly).

• PricewaterhouseCoopers Real Estate Newsletter (US), published quarterly

in .pdf format.

• European Real Estate Client Conference, to be held in Barcelona, Spain,

in November 2005.

• Asia Pacific Real Estate Client Conference, to be held in Tokyo, Japan in

December 2005.

If you would like to view or download one of our publications please log onto our

website www.pwc.com/realestate

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]

William E. CroteauGlobal Real Estate Assurance Leader

San Francisco, United States of America

Tel: [1] (415) 498 7405


Patrick LeardoGlobal Real Estate Advisory Leader

New York, United States of America

Tel: [1] (646) 471 8877 or

[1] (646) 471 2666


Asia Pacific Real Estate Leaders

Robert GromeAsia Pacific Investment Management

& Real Estate Leader

Hong Kong

Tel: [852] 2289 1133


James DunningAsia Pacific Real Estate Assurance Leader

Sydney, Australia

Tel: [61] (2) 8266 2933


Kwok Kay SoAsia Pacific Real Estate Tax Leader

Hong Kong

Tel: [852] 2289 3789


European Real Estate Leaders

Henrik SteinbrecherEuropean Real Estate Leader

Stockholm, Sweden

Tel: [46] (8) 555 330 97


Frank van ZelstEuropean Real Estate Tax Leader

Amsterdam, The Netherlands

Tel: [31] (20) 568 6872


Kees HageEuropean Real Estate Assurance Leader

Rotterdam, The Netherlands

Tel: [31] (10) 4008 414


Jochen BrückenEuropean Real Estate Advisory Leader

Berlin, Germany

Tel: [49] (30) 26 36 1149


Glen LonieReal Estate Leader - Central & Eastern

Europe and CIS

Prague, Czech Republic

Tel: [420] 251 152 619


United KingdomReal Estate Leaders

John ForbesUK Real Estate Tax Leader

London, United Kingdom

Tel: [44] (0) 20 7804 3161


Angela Crawford-IngleUK Real Estate Assurance Leader

Real Estate Leader


Tel: [44] (0) 20 7212 5225


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


Gary CutsonUS Real Estate Tax Leader


Tel: [1] (678) 471 8805


Patrick LeardoUS Real Estate Advisory Leader


Tel: [1] (646) 471 8877 or

[1] (646) 471 2666


Latin AmericaReal Estate Tax Leader

Alvaro TaiarLatin America Real Estate Tax Leader

Tel: [55] (11) 3674 3833


Marketing and Editorial Contacts

Merryn StewartGlobal Head of Real Estate Marketing


Tel: [44] (0) 20 7804 3844


Mark CharltonEuropean Editor of Global Real Estate Now


Tel: [44] (0) 20 7212 6263


Thomas DerrUnited States Editor of

Global Real Estate Now


Tel: [1] (646) 471 8268


If you would like further information regarding our Real Estate services, please contact one of our PricewaterhouseCoopers

representatives below, or your usual local PricewaterhouseCoopers contact.

PricewaterhouseCoopers (www.pwc.com) provides industry-focused assurance, tax and advisory services for public and private clients. More than 120,000 people in139 countries connect their thinking, experience and solutions to build public trust and enhance value for clients and their stakeholders.

© 2005 PricewaterhouseCoopers. All rights reserved. PricewaterhouseCoopers refers to the network of member firms of PricewaterhouseCoopers International Limited,each of which is a separate and independent legal entity. *connectedthinking is a trademark of PricewaterhouseCoopers LLP. Designed by Court Three (10/05)

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