Assessing Investments in the Cypriot Property Sector
9 December 2015 | Philip Ammerman
Evidence of the Cyprus Property Boom and Bust on Bar Street, Paphos
The Cypriot property sector has been extensively affected by the Cyprus financial crisis and by the impact of capital controls, as well as the wider European and global environment.
Cyprus property values remain, in general, at the bottom of the valuation cycle. Investors with the resources available for cash deals and with the patience to negotiate can achieve significant valuation bargains depending on the asset in question, the location and owner priorities.
This article reviews the general state of the Cyprus property sector and discusses key drivers and influencers on property valuation. There are different investment strategies available in such a client, but investors are advised to maintain a skeptical approach to future valuation targets and implement detailed due diligence prior to completing any transactions.
Chronicles of the Last Boom
In 1936, John Manyard Keynes used the term “animal spirits” to describe the instincts and emotions that govern human behavior. Sixty years later, US Federal Reserve Chairman Alan Greenspan used the term “irrational exuberance” in a speech at the American Enterprise Institute in 1996 to illustrate the difficulty of understanding when asset values have become overinflated. Both terms are perfectly appropriate in describing the boom in property which occurred in Cyprus between 2000 and 2013.
In 1999, the Cyprus Stock Exchange achieved an eye-watering increase in the general index of 836% in six months, before plunging by 71% over the next year. This massive loss in equity values and affecting poorer households, which had borrowed funds to invest in the market, disproportionately.
The response of many Cypriot investors at this time was to switch their focus from equities to property. This transfer of attention and capital occurred for a variety of reasons, but one main reason was the hypothesis that “property in Cyprus has never lost value”. Another factor was the impending Cyprus accession to the European Union in 2004, which prompted significant overseas interest in investing in Cyprus properties as a second vacation home and a source of capital gains. This tendency was particularly pronounced among English investors, who promptly turned Paphos and western Cyprus in general into an El Dorado for villa and holiday home investments.
The housing mania, when it occurred, affected everybody:
Owners of desolate plots on the hills above Limassol or Paphos, which were formerly used to graze sheep or grow crops, suddenly found themselves to be millionaires.
First-time property buyers found that they had to jump on the property bandwagon in order to cope with rapidly rising prices.
Existing owners of property found their net worth increasingly rapidly as prices rose, leading to conspicuous consumption financed by a feeling of high net worth. Vacations in Bali, Louis Vuitton bags, expensive smartphones, and extravagant dinners in mediocre restaurants became the norm.
The Cypriot banks fuelled the property binge, offering 100% financing for property projects of every conceivable type, including to applicants who had no knowledge of development but who approached them with a viable “project.”
The Cypriot government and Central Bank appeared to relinquish its role as a regulator to become a cheerleader of the boom. After all, higher property prices automatically means higher tax income, as does higher spending on property construction and maintenance. There is no clearer example of the public sector failure to act as a regulator than the Title Deeds Scandal, whereby tens of thousands of Cypriot property owners could not claim the title deeds, i.e. the actual record of ownership of the property, because the developers had used these deeds to guarantee mortgages for the construction of other property units.
The Residential Property Price Index of the Bank of Cyprus indicates the magnitude of the boom-bust cycle. Average residential prices reached a high point in 2008, when the index hit 105.7. Since then, it has fallen to 74.8, a decline of 29%.
Yet all good things must come to an end. For the Cypriot property sector, this process began in 2008, and accelerated with the global financial crisis and then its specific variant in Cyprus in 2013.
Key Demand Drivers
Today, demand for Cypriot property has fallen dramatically due to the financial crisis as well as a range of other factors. As such, I believe that the fall in values has not yet reached its fullest expression. There are significant possibilities today to negotiate better property valuations, particularly for cash investors. Of course, all property valuation is local, so it is important to keep track of regional variations in pricing.
The key demand drivers are the following:
1. Cyprus Investor Residence and Investor Citizenship Programmes
In 2013, the government of Cyprus passed incentives relating to the Investor Residence and Citizenship Programme as a means of attracting foreign direct investment into Cyprus. This programme offers long-term residence permits or outright citizenship in Cyprus to investors who purchase a minimum of:
Residence: Investors are granted permanent residency upon purchasing Cyprus property with a minimum value of € 300,000, not including VAT.
Citizenship: Investors are granted citizenship upon purchasing property with a minimum value of € 500,000, not including VAT, as well as / or € 5,000,000 in property or other projects. For depositors haircut by the Cyprus depositor bail-in, the latter amount falls to € 3,000,000.
The success of this programme has been attested by officers of the Cyprus government, who claimed in May 2015 that this programme has attracted over € 2 billion in investment.
This programme has help up demand for luxury properties. Many golf course properties, for instance, owe their success specifically to this category of buyers. Marked interest has been seen by Chinese and Russian buyers.
2. Higher Returns in Traditional or Newer Safe Havens
The Cyprus property crash has convinced a number of investors who might otherwise have invested in Cyprus to seek higher or safer returns elsewhere. London remains a safe haven for a large number of Cypriot investors at all valuation levels. The German property boom, which has seen property in cities such as Berlin or Hamburg see a significant rise in value, is also a magnet for Cypriot investors.
3. New Housing Stock replacing Older Stock
Approved prior to 2013, a number of new housing projects have come onto market, offering consumers the chance of replacing older stock with rental or purchase contracts.
4. Regional Variations and Developments
There are a number of regional issues affecting property valuations. The expansion of the Technical University of Cyprus (TEPAK) for instance, has led to an increase in prices in the surrounding area of Limassol. In Paralimni, the launch of the Paralimni Marina project is driving an increase in relevant property values.
5. Investors seeking Safety or Higher Margins (or Retaining Property)
A particular issue in Cyprus is fear of banking deposits following depositor bail-in in March 2013. As with the 1999 CSE crash, depositors are in many cases avoiding deposit saving accounts in favour of more tangible investments. In other cases, they are hanging on to property, waiting for higher returns, or avoiding transactions due to deposit flight.
6. Investors buying Distressed or Lower-Value Properties
Some properties are changing hands at distressed prices. Foreign investors are also seeking to purchase non-performing loan portfolios, but few transactions have been recorded to date.
Key Supply Drivers
The following key supply drivers are seen affecting the Cyprus property sector:
1. High End Golf and Marina Development
Cyprus has been following a strategic plan to diversify its tourism product by investing in golf courses and marinas. These all have associated property developments, which are increasing the supply of high-end properties available to foreign investors as well as Cypriots. While Limassol Marina, Minthis Hills and other major projects continue, Cyprus is also licensing several interesting new projects, including the Paralimni, Ayia Napa and Larnaca Harbour development projects.
2. Completion of pre-2013 Projects
Despite the Cyprus bail-in, some properties that were begun or licensed prior to 2013 have been completed or are underway. Nicosia commercial property in the central business district, for example, has seen several new building starts as well as completions. These have increased the supply of property, although in many cases this has acted as a cannibalisation factor, attracting residents from older properties.
3. Cancellation of pre-2013 Projects
Acting to restrict supply, a number of projects started before 2013 have been idled or cancelled. Examples of this include the Shacolas Group’s Limni development in Polis Chrysochous or the Lakatamia Mall.
4. European Interest Rate Policy
With the US Federal Reserve set to start tightening interest rates this fall, and with the European Central Bank committed to a zero interest rate policy (but so far without many indicators of success), a key factor affecting supply will be interest rates. Should the ECB decide to start tightening interest rates mirroring the Fed, this will make property development more expensive.
Other Key Issues
There are a number of additional issues affecting property supply and demand in Cyprus.
1. Prospects for a Cyprus Settlement
President Nikos Anastasiades and Mustafa Akinci, “President” of the Turkish Cypriot community, have been making significant progress on a settlement of the Cyprus issue. Advanced negotiations are underway on the issue of property rights. The restoration of Famagusta and similar issues will have a catalytic effect on property prices and activities in certain areas of the Island, depending on what form of solution is reached.
2. New Legislation on Non-Performing Loans
Non-performing loans (NPLs) account for a major share of Cypriot bank portfolios. New legislation passed this year establishes a procedure for loan restructuring and foreclosure for private mortgages. At the same time, progress is being made on restructuring or recapitalising loans owned by large developers. The Shacolas Group’s recent sale of its 2 Nicosia Malls, for instance, indicates the steps being taken.
3. Low Residency in Established Projects
Many projects have very low residency. An example includes a high-profile residential tower in Limassol, which has commanded peak prices but is currently unoccupied on many floors. While we can understand the justification of purchasing property hoping for a capital appreciation, in many cases rental income is an important factor in overall property yields. If rental prices are low and occupancy not as high as planned, the overall attractiveness of higher profile investment projects is affected. While similar issues are seen in properties in London or New York, the market is much deeper and broader there than in Limassol or Nicosia, and overall valuations have been rising steadily.
4. Title Deed Payments
Cypriot legislation has now forced developers to issue title deeds. However, many Cypriot residents are now being asked to pay for their issue. The issue is a function of construction value, so many middle-income households are being hit with payments of € 9,000 – 15,000 for an average Nicosia apartment. This is a factor that needs to be taken into account when planning for mid-level residential property or tourism property.
The unraveling of the credit-driven Cyprus economic boom is continuing. Most objective industry sources believe that property prices still have the potential to fall before recovery, although as recounted here, there are significant differences in valuation depending on the location. Investors interested in Cyprus property should undertake careful negotiations and extensive due diligence to ascertain the valuation and return potential. The next two-three years are likely to present significant opportunities for investment in Cyprus at valuations which will hopefully reflect economic reality rather than over-inflated expectations.
 Further information on the first and second Cyprus stock market crashes will be forthcoming in a separate article.