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    07 November 2017

    The case for institutionalization of real estate investment in Cyprus

    Around 2011, and while attending a conference about real estate in Beirut, I heard a comment that struck my attention and that I still refer to today; when asked about how to forecast future demand, one of the large developers, speaking on a panel of experts, replied using two simple words: “gut feeling”.

    It comes as no surprise that, in small and non-mature markets, where the bulk of investments in real estate is performed by local investors, who are at best organized as family offices or small investment companies with few wealthy individuals, the level of professionalism is below par. The rule of thumb in most countries is that real estate value always appreciates and is resilient to economic fluctuations, that downturns are always offset by subsequent growth cycles, and that investment in real estate is reserved for a country’s elite, thus making it somewhat monopolistic, and giving these investors the impression that they will always be able to control market prices.

    All this, obviously, is not true. Numerous examples from all over the developing world show otherwise. After seven years of fast paced growth in Lebanon, during which some residential prices increased fivefold, the market ran out of steam. And while the gut feeling of developers kept telling them to build bigger, more expensive and more luxurious apartments, market demand crumbled as prices became much higher than what the local buyers could afford, and speculators were looking to exit. Fortunately for these developers, Lebanon did not witness a bubble burst, but, despite asking prices stagnating for the past four years, actual prices have dropped by around 20%.

    Cyprus witnessed a similar situation pre-2009, which was further worsened by uncontrolled bank lending, adding more fuel to the fire. Needless to say that all parties involved got burnt when the economic winds shifted, and the market collapsed to 50% or less of its former value.

    Yet these lessons are not learnt, shared, or even taken into consideration when times are good. As soon as a hint of positivity is felt in the market, investors throw caution to the wind, plan according to their feelings and impressions, and build dreams based on wishful thinking. In Cyprus, this is called the citizenship-by-investment program, or the casino license, or oil and gas reserves. None of the above can be dismissed as a potential growth factor for the real estate sector, but surely none can be considered as a long term winning ticket for sustained growth.

    What we lack in developing countries is thorough consideration of market and economic factors, and the research and analysis that is required to build forecasts and prepare more accurate plans. No one is lucky enough to have a crystal ball to be able to know the future, but those who take the time to gather information and make analysis-based decision do have an undeniable advantage. In most cases, the only investors that need to consider each step they make very carefully are institutional investors, since they bear a higher level of responsibility both towards their investors and towards their regulators.

    Being an institutional investor, Mouflon Real Estate Fund was able to achieve better than average gross yields on acquisition of commercial real estate, through investment in fully rented prime assets, while securing leverage from local banks with favorable conditions. These conditions would have been impossible to achieve had the Fund not developed an in-depth understanding of the market in order to define its strategy, used specific and stringent criteria to identify and select assets, and performed thorough due diligence on the assets and tenants.

    On the flip side, players on the other side of the fence, being individual developers, are still behaving in their good (or should I say bad) old ways. We have been proposed investments one year ago, when we started prospecting for assets, which were offered at reasonable prices pre-negotiations, due to the perception in the market that prices were still falling. One year later, these same opportunities are being offered at 10% more expensive, non-negotiable. I am not saying that prices haven’t improved, because they have, and that the situation in the market is not better, because it actually is, but I find such propositions unreasonable. Nothing can justify a 10% increase in one year. There are no indicators that show that prices have increased by that much; the Cypriot economy as whole grew by an encouraging 2.8% in 2016, and the latest RICS price index showed around 3.3% overall increase since the bottoming out of prices. The only reasonable explanation is that this is just the wishful thinking and greedy behavior which the usual suspects are falling right back into all over again. Fortunately these cases are still the exception and not a rule, except perhaps in the Limassol high- end residential bubble, but that is a topic on its own.

    Thankfully for the sector, banks in Cyprus are also getting on the bandwagon and using more scrutiny when lending for real estate projects, albeit being overly cautious at times, due to the huge blow they were dealt in 2013, the consequences of which they are and will still be suffering from in the near future.

    Hopefully, banks will be playing a more constructive role this time around by sanity checking investments into real estate, and not getting overly excited by positive developments, both macro and micro.

    That being said, one of the best ways to achieve sustainable growth in the industry, and attract more and more foreign investment into real estate, is the institutionalization of the sector. Institutional investors bring more structure into the game, along with an increased level of professionalism. They also limit the effects of speculation, while enabling a broader base of investors to enter the market, thus fueling new investments, and injecting a much needed flow of fresh capital into the economy in general and the sector in particular. The AIF law in Cyprus can be used as a medium for these types of investments, particularly when they bring along foreign investors, and many stakeholders - including the CIFA - can assist in the successful penetration of these investors into the market. However, these elements are not sufficient without a better understanding of the needs and requirements of institutional investors by local players, who will need to be educated about the modus operandi of these investors, as well as recalibrate their expectations in terms of dealing with such investors.

    Author: Mr. Jad Wakil, co-founder and Executive Director of Mouflon Real Estate Fund Ltd

    Mr. Jad Wakil is the co-founder and Executive Director of Mouflon Real Estate Fund Ltd, an Alternative Investment Fund licensed and regulated by the Cyprus Securities and Exchange Commission. Mr. Wakil is also the co-founder and Managing Director of Tangent, a strategic and financial advisory company operating in both Cyprus and Lebanon.Mr. Wakil has a wide ranging experience, having worked in in the insurance, banking and financial advisory sectors. He was involved in numerous M&A and private placement transactions, as well as strategic development projects, in diverse sectors including retail, hospitality, logistics, technology, infrastructure, and real estate. He was also involved in the structuring of private investment funds.

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