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 KAZAKHSTAN International Business Magazine №1, 2005
 New Opportunities in Kazakhstan's Real Estate Market
New Opportunities in Kazakhstan's Real Estate Market
Oleg Batratchenko, President of THOR Group of Companies
All markets undergo short-term and long-term fluctuations. What periodically occurs in the oil, non-ferrous metals, and securities markets (where situations may change within seconds) is common knowledge, and money is earned via these markets. 
The real estate market is no exception. The evaluation approach for this market is more ambiguous due to the heterogeneity of the commodity (elite construction, business class, economy class, etc.) than it would be in the case of homogeneous commodities. This means that even a global crisis in this market would not cause a simultaneous drastic recession in all of its sectors.
Most analysts agree that real estate remains one of the most attractive investment vehicles, and real estate investment funds become an alternative to directly investing in construction projects for private investors and "open" companies.
Real estate funds can be divided into three groups: development funds, funds for commercial real estate (or rental funds), and non-public closed-end unit investment funds. Such division is simply based on the goals of the fund owners. Development funds invest in the construction of new real estate and rely on the delivery of one-time payments after the sale of each flat or building. Earning income on the current assets requires the creation of so-called "rental funds" Shareholders of such funds usually have the opportunity to obtain annual income via dividends. The rental fund owns commercial real estate, which earns its returns in the form of rental fees. Non-public closed-end real estate funds are created for tax purposes. This type of tax-planning instrument does not involve attracting outside investors or circulating its shares via securities exchanges or otherwise.
Purchasing shares in real estate funds has a number of advantages over direct investment. First of all, investment risk is lower in funds than in direct investments due to diversification. When an investor is working directly with a builder, he risks his private housing. While the number of apartments owned by the fund may reach several thousand, even the poor quality of a few of them will negligibly affect the investor. Most funds try to diversify risk by working with different contractors. Such effort is another attempt to insure against unpredictable events—if one construction company fails, shareholders will suffer to a lesser degree.
Aside from developers' risks, investors bear the risk posed by the depreciation of assets. Due to various factors, the value of any apartment or house may decline. Market conditions in general may change. Real estate funds therefore propose that private investors become owners of real estate in different cities. Diversification on the international level reduces the risk to practically zero. It is unlikely that prices will fall simultaneously in Kazakhstan, Russia, England, and the United States.
The American Financial Group THOR, operating in Kazakhstan via its Almaty representative office, proposes to create a Kazakhstan International Real Estate Fund, which is attractive and optimal from the taxation point of view for both Kazakhstani and foreign investors.
Based on extensive international experience in implementing similar programmes, the THOR Group has developed a programme to create an offshore-onshore master/feeder fund. This structure consists of three funds: a master fund that actually makes investments into final investment objects, and two feeder funds that attract finances and in due turn, purchase shares of the master fund.
Cash resources, received from the distribution of the Fund's shares, are kept in two custodian banks, one of which is located in the USA, another in Kazakhstan.
This financial tool provides a number of opportunities for both investors and construction companies.
Investment Attractiveness and Access to Western Capital Markets
In contrast to investing into single real estate projects, this proposed Fund is the most attractive investment instrument with respect to minimising risk while retaining high yields. This is achieved due to the following characteristics of this financial tool:
·          A diversified portfolio of projects and immovable property balanced by industries, types of real estate, geographical sectors, project implementation terms, and investment income sources.
·          The opportunity to make large investments in one financial instrument with a stable, high yield (e.g., comparable to the 10–12% yield of real estate investment trusts in the USA) with minimal time and money spent on legal and financial audits.
·          A transparent investment policy and professional management of invested resources, including the possibility of consultation by reputable western specialists who have proper practical experience in implementing real estate projects.
·          The high liquidity of investments due to the availability of projects with different completion terms and properties with different sale procedures in the Fund's portfolio.
·          The investment projects' approval procedures clearly stated in the Investment Memorandum, involving the possibility to arrange international financial and technical audits at the expense of the Fund.
·          The transparency of the Fund's operations, regulated by the relevant state bodies in the USA and BVI (British Virgin Islands), with periodical publication of its financial reports.
·          In due time, the investment yield history, documented and audited in accordance with international standards, will be provided by the Fund's management company.
Additional opportunities exist via the attraction of western credit resources, which differ from Kazakhstani resources in terms of credit term and cost. Thus we may speak about attracting credit financing for a 5-6 year term at a rate of 10-11% per annum. Additional leverage allows an increased yield on the investments of shareholders and, correspondingly, increases investment attractiveness.
For example, if the Fund manages assets in an amount of $20m and the return on investment of the projects is at 20% per annum, creating a 2:1 leverage (by attracting $40m of credit resources at a rate of 10%) allows an increase in investment volume of up to $60m, and triples the number of projects—thus increasing diversification and the yield on investments to 40%.
Flexibility of Infrastructure and Expansion of the Investment Base
The Fund's proposed structure allows investments into different classes of immovable property in different countries for various periods of time. Moreover, the Fund's structure is flexible and scalable, since it allows the addition of new investment strategies (private label strategies), allocating new classes of shares for them.
The flexible infrastructure of the Fund appears ideal for marketing. An individual portfolio may be compiled for each individual investor, who may have a specific risk-weighted target yield. For example, an investor making a $10m investment might prefer putting of 80% of his/her resources into short-term projects and 20% into long-term projects. Therefore, such investor is sold (for example) 80,000 shares of Class A and 20,000 shares of Class B. The proposed structure also significantly simplifies management of the assets for the manager, who knows that the asset pool formed by Class A shares is allocated for investment into short-term projects and Class B into long-term. All subsequent profits and losses are distributed proportionally among the shareholders of the corresponding classes.
Ensuring Control by the Construction Company and Satisfaction of Investor's Interests
Owners of a construction company, possessing a 100% stake in the Fund's management company and appointing its Board of Directors, will have the opportunity for total control over the investment policy of the Fund and the selection of projects and immovable property proposed for investment. The company will therefore obtain the majority of its income from the management of investment objects and, with time, will be able to create an attractive history of generated yield (a positive track record), expanding the influx of resources from Russian and foreign investors to be used for management of the company.
At the same time, the Fund will be an independent legal entity, distinguishing it from other Kazakhstan real estate funds created under management companies and deprived of legal entity status. Participation in its Board of Directors may, for the most demanding investors, ensure the ability to control the Fund's compliance with generally accepted procedures for the selection of investment projects, without the slightest detriment to the company owners' full power of attorney over project selection and obtaining payment for the Fund's management.
Achieving Tax Efficiency
Such Fund structure is generally accepted in the USA and western countries. It fully complies with the requirements of the American Internal Revenue Service and at the same time, it allows the minimal taxation of non-American investors to the Fund. This structure is capable of taking into account tax consequences for each investor class: American and non-American legal entities and individuals, including protection from American taxation for the latter.  
All transactions made using assets inside the Fund are not capital gains, property, or VAT taxed. The shareholders pay capital gains tax (income tax for individuals), but only after the management company has distributed their incomes. An unlimited number of transactions may take place inside the Fund until the moment of share repayment or payment of intermediate income from investments, and profit from such transactions will not be taxed.
These characteristics make the proposed financial tool acceptable and highly attractive for wide circles of individual investors in the USA, Europe, the CIS, Russia, and Kazakhstan. This may provide inflow of significant volumes of international capital to company-owned projects and the earning of considerable management income (up to 30% of the income from investments) from investing the Fund investors' resources into other construction and investment firms. Investments in construction projects via a real estate fund are more understandable and demanded by institutional investors as well, because the investment vehicle is both transparent and uniform and investors can acquire the title to an investment object.
According to the Managing Director of the THOR Capital Group, Roman Livson, "Attracting resources via the Fund is not a replacement of (cheaper) bank financing with (more expensive) investment. After the developer sells an investment object to the Fund, this object no longer belongs to the developer; therefore, the developer is not bearing the expenses of its financing, since the expenses of servicing the involved shareholders' resources are borne by the Fund and not by the developer. By its economic content, the resources received from the sale of immovable property to the Fund conversely reduce the cost of financing, attracted in a classical case, by the amount approximately equal to the managing company's remuneration. Thus, in addition to the apparent advantage of generating income on an object that does not belong to the construction company, there are other advantages—easier access to financing, a longer financing term (three year unsaleability period of shares), and larger amounts of financing, which, in perspective, allows the construction company to respond to tenders for the construction of much larger objects."
The situation of unit investment funds in the Kazakhstani market is quite complicated. An imperfect legislative base requires solutions to problems such as the registration of property rights by the Fund and clarification of taxation. In order to develop the market in real estate investment funds, it is necessary to resolve information transparency and risk management issues. The transparency problem also applies to information provided to the investor; this is the additional document concerning land development.
However, notwithstanding the complexity of the situation, there is an apparent growth of interest in the new opportunities presented by the Kazakhstani real estate market. The notorious expectation for a falling real estate market—more precisely, the theoretical possibility of this fall, is not fully influencing the possibility of operating and earning in this market. Even in the scenario of market stagnation or some negative adjustment, the only loss is growth, which is an additional source of profit; the main source of profit is the positive margin of the purchase and sale transactions of objects during the early stages of development.
Here is a view of the real estate market development as expressed by the Managing Director of the Russian First Real Estate Investment Fund "Concordia Asset Management", Semen Puzrin: "If treated properly, the real estate market all over the world behaves likes entropy. And we know from textbooks what happens to entropy with time—it grows."

Table of contents
Oil in the CIS: Economic and Sovereign Rating Implications  Special Report of Fitch Ratings Agency 
The Science of Selling  Harry Frisch, Michael Bang 
All People Are Different  Fatima Chapkhaeva 
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