View Full Version : Euro as ‘Big Smiley Face’ for Investors

11-29-2010, 03:57 PM
Euro as ‘Big Smiley Face’ for Investors (http://news.err.ee/Economy/ce054c4e-6b84-4ff7-95aa-91dc267bdc42)

Jerry Wirth has been investing in and developing real estate in Latvia and Estonia for ten years. His RBM Group has a market-leading portfolio of food-anchored shopping centers in Latvia. ERR asked him for a southern perspective on how Estonia’s adoption of the euro will change things.

Those in the Baltics often lament that more foreign investment has not found its way here. We look at Poland or the Czech Republic, understand the differences, but still ask “Why not us?” What’s your theory about Why not us?

The Baltic market is tiny and relatively unimportant for foreign investors. The size and complexity (four languages, three currencies, three legal systems, tax codes, etc.) of the Baltic market makes it less attractive than most larger markets.

Foreign investors suffer what they call brain damage when entering new markets. That is, they have to learn how to conduct business successfully, which implies learning the basics of the commercial code, the tax code, and the legal code. They need to learn about labor practices, environmental concerns, and to have a basic understanding of the political landscape. All of these things take time, money and brainpower. When it’s done for a market of 50 million people, it’s understandable. But when the investor incurs the same brain damage for a market with less than 1.5 million it feels relatively more painful.

So what do small nations have to do to overcome that?

Estonians and Latvians often overestimate the intelligence and abilities of foreign investors. In truth, many foreign investors are lazy, and often ignorant of the markets in which they choose to (and choose not to) invest in. That means they may not spend much time and effort investigating every potential market. Rather, many investors use easily accessible information to quickly “analyze” a market. In truth, most do little or no original analysis – relying instead on media reports, hearsay, Moody’s summaries, and personal experience from one or two visits.

For the lazy investor, the euro is like a big smiley face, a giant “Foreign investors welcome here” seal of approval. Gaining access to the eurozone is in itself like a reward for Estonia managing its affairs in a fiscally prudent manner. That sends a strong signal to foreign investors that Estonia has a well-managed economy.

Separately of course, using the euro can remove currency risk entirely for euro-based investors. The fixed exchange rate of the EEK, LVL, and LTL to the Euro is clearly not the same thing – as we’ve seen from devaluation rumors that crop up from time to time.

So how will Estonia having the euro and Latvia not having it play out in the near term?

The effect of the Euro on foreign direct investment may be seen in one area in the stratification of real estate pricing between Estonia and Latvia. If foreign investors really do feel more comfortable operating in a country that has acceded to the eurozone, then they will accept a lower return for their investment than for the non-euro country. This will be seen in the form of higher prices for the same kind of assets in Estonia as compared to Latvia. Put another way, investors will perceive a greater degree of risk operating in Latvia versus in Estonia, and that risk will be translated into a risk premium, or lowering of prices for assets in Latvia.

Although the assessment of that risk is subjective, if enough investors concur, prices will stratify – with the same kinds of assets selling for more money (less return) in Estonia than in Latvia.

Latvia has done well recently with its dramatic economic reforms. Hopefully, seeing the visible effects of bringing the euro to Estonia will create a healthy envy in Latvians – the kind which translates into the steely-eyed political will that will be needed to stick to their reforms in order to accede to the euro by 2014.

Despite the fact that Riga is twice Tallinn’s size, its residential real estate is still cheaper (an Ober Haus report has been quoted in the press citing 906 EUR per square meter for Riga and 921 EUR per square meter for Tallinn). To what do you attribute that difference? Has it already stratified to some extent based on factors other than the euro?

I would first of all not put much faith in the statistics often quoted. I find them often a rather poor guide to actual market based pricing. The fact that the pricing is so close would also lead one to believe any differences aren’t statistically relevant.

How do commercial real estate prices compare in the two cities?

Over the past several years there have been minor differences between Tallinn and Riga in commercial real estate pricing. But in large part commercial real estate has been priced similarly, for several reasons. First, both are often perceived to be part of a larger Baltic market – which itself is compared with markets in CEE and in Northern Europe. This is an example of foreign investors not doing their homework on each market and lumping them together because it’s easier. Second, the markets here are so small and thinly traded that there aren’t a lot of benchmark transactions against which to base pricing. As a result, investors will often benchmark between the cities. It will be interesting to see if this changes after Estonia joins the Euro.

What about Latvia’s reputation for corruption? Does this not help keep asset prices down?

Latvia’s reputation for lack of transparency may well have an impact on asset pricing. It’s a difficult one to measure accurately, because it’s only one factor of many that an investor considers when investing. Generally speaking, the rule of law in Latvia is good. So for many real estate investments, transparency may not be critically important. When one becomes involved in real estate development, however, the potential for corruption to affect the investment is much greater.

Interview by Scott Diel