Everyone and their uncle are talking about Panama, Argentina, Thailand and other exotic locales as the next safe haven for smarter investing and better living. Few, however, look towards Eastern Europe - maybe because in the past Eastern Bloc countries were not considered "sexy." But as you'll learn from Without Borders editors Fitz and Simon, that has changed drastically...

David Galland
Managing Director
Casey Research LLC

Slovakia: Fewer Castles, More Opportunity

By Fitzroy McLean and Simon Black
Editors, Without Borders

Trivia: What two national capital cities are located closest to each other?

Answer: Vienna, Austria and Bratislava, Slovakia (65 km).

"Why haven't I spent more time here? Why didn't I know about this before?" That's what Fitz kept asking Simon and himself during a recent trip to Slovakia. It just seemed to Fitz like Slovakia had continually fallen through the cracks.

From a lifestyle standpoint, Slovakia is still a bargain in euro terms. The people are friendly and there is an abundance of English speakers that by and large do not have the same anti-American attitude so prevalent in most of Europe. Almost anyone under the age of thirty speaks passable English and the older generations speak adequate German and Russian. Generally the people are very warm and welcoming to foreigners from outside Western Europe. Interestingly, there is significant resentment of tourists from Germany, France and Austria.

Why?

In the words of a very bright, young sedan driver who had a degree in history and speaks German, English, French, Hungarian and naturally Czech and Slovak, "They think we should be frozen in time, like 1989. They want to come here and get everything for free. They want us to fall all over ourselves because they are from the West. Just because we lived behind the Wall, they think we are ignorant and they are superior. They are rude and cheap."

Real estate prices in the capital Bratislava are approaching those of Western European cities, but in the second-tier cities like Zilinia, Banska Bystrica and Kosice, apartments and houses are very inexpensive and loaded with charm. You can still buy a two- to three-bedroom apartment in a classic late-19th, early-20th century building in the cobble-stoned downtown of Banska Bystrica for under US$200,000. It feels very much like Salzburg or Munich in these downtowns, with live music playing every night in the myriad cafés and restaurants.

Food and drink are excellent if you like traditional European fare. Were it not for the language, you'd think you were in Austria or Germany, except the wait staff is much friendlier and the prices are a third of what you expect to pay. For example, Fitz had a pepper steak dinner with two pints of the local draft beer and a cup of coffee for less than twelve dollars. Most menus are even subtitled in English, describing such courses as "the best part of the beef neck." We felt reassured we weren't getting the mediocre part.

The Big Picture: Macroeconomics of Slovakia

For years forgotten or at least forgone in favor of neighbors Czech Republic and Hungary, Slovakia is a real find just coming into its own. In the immediate aftermath of the fall of communism, Slovakia fell behind its neighbors in terms of the two major post-iron curtain economic development trends: tourism and foreign direct investment.

As we believe to be the case in almost every circumstance, it was an intrusive and overbearing government that hindered Slovak growth more than the lack of spas and castles. Before 1999, there were massive restrictions on foreign ownership of Slovak businesses and property. But Slovakia has made a comeback largely because the government got out of the way and left the economy alone.

While initially more open and free-market oriented, Czech Republic and Hungary seem to have adopted the worst of both the old communist Eastern Europe and the stagnant Western European societies: Bureaucracy. High Taxes. Anti-Immigration Policies. Burdensome Regulation. Social Entitlement Programs.

Meanwhile, after a neglected decade, Slovakia is making all the right moves. It has adopted a flat tax on both individuals and corporations of 19%. Not the zero we prefer, but radical enough to ire the German finance minister who recently labeled the Slovak tax regime "predatory" and "not European." This coming from a man who couldn't get his own "radical" plan to reduce German corporate tax to under 30% through the German legislature.

We like Slovakia because their federal government allows the local and regional governments to make most of the important economic decisions. Like Switzerland's Cantons, Slovakia's eight self-governing regions can negotiate directly with businesses for tax breaks, abatements and investment incentives.

For instance, in the economically depressed Presov region on the Ukrainian border, the government will grant a 15% tax waiver to businesses for every 100 jobs they create, up to a limit of 75% off their total tax liability. Create 500 jobs, pay only 25% of the 19% flat corporate tax. Try that in France or Germany.

The government has succeeded in privatizing most of the previously state-owned firms, a prominent example being US Steel's purchase of a large steel plant in the eastern region of the country. After winning re-election in 2002, the center-right government implemented ambitious reforms in the tax system, including the previously mentioned flat corporate and individual tax, and abolishing taxes on dividends, while maintaining a relatively low budget deficit. The government has also fundamentally reformed health care, social security, pension systems, and labor laws.

Our friend who grew up in Slovakia and is now the CFO of a major money manager in the City of London explained, "Some people liked the old communist ways - they pretend to pay us and we pretend to work. Only they liked the system just after communism even better, 'we pretend to want to work and you really pay us' but now the new system is more balanced."

She continued, "Unemployment is available for six months and after that only if the individual can prove they are actively seeking employment and none is available. There are only a few villages where people can't find a job pushing a broom, so abusing the system is rarer than it was a few years ago. Not gone, but rarer."

We saw very few idle hands while there this August and the Tesco supermarkets were full of high-end products and fashionably dressed shoppers filling their carts. Slovakia plans to adopt the euro in 2008 or 2009.

Major multinational companies are gravitating to Slovakia because of its low production and labor costs, strong government support, highly educated labor force, and strategic location. The country has recently won over two big investors - PSA Peugeot-Citroën and Hyundai-Kia - and is ready for more. Recent IMF and OECD reports laud the Slovak economy and rate it third-highest in business climate within the EU, just behind Ireland and the UK. According to the major rating agencies, Slovakia's credit fundamentals have improved considerably over the past few years, as booming exports have slashed the current account deficit while the government has made significant progress in implementing public finance reforms and cutting the budget deficit.

Not to paint a completely rosy picture, there are still some onerous regulations. For instance, the Slovak state is still required to have a 51% holding in companies involved in the production of natural gas, electricity, water, forestry and the postal service. Additionally, the more socialist-leaning parties are starting to gain traction after fifteen years in the wilderness.

But all in all, we are bullish on Slovakia. The people have a great attitude and the current government seems to get the freedom thing, so we're willing to put some of our chips on the table.

Moving to Slovakia?

Could we see ourselves actually moving to Slovakia? Absolutely, for at least part of the year anyhow. The cost of living is reasonable at 41% of the European average. The people are friendly, the country is beautiful and the living is easy. Well, easy in the spring, summer and fall. Winter temperatures can dip to -40 degrees Celsius. But there is always Panama, Uruguay, Thailand and other reasonably priced and cultured places to scat to during those bitter Northern Hemisphere winters.

Finding work is hard unless you either speak Slovak or work for an international company - the language of Kia and Citroën in Slovakia is English. And it's not hard to get a business visa if you are willing to capitalize a company with €50,000 and commit to hiring two part-time or one full-time Slovak within the first year. Oh, and the Irish pub is always hiring.

If you don't need to work, U.S. citizens can enter the country visa free for 90 days. For a no charge, 30-day extension visit the local police station, or leave and re-enter the country and get another 90 days. If you choose the latter, the "Vienna visa dash," make sure they stamp your passport on the way out. Unlike most countries in the EU Slovakia still has a border control with Austria, yet they rarely stamp passports and you'll likely just get waived through. So ask nicely and they'll be glad to oblige. The border-crossing site is scheduled to be completely removed in 2009.

We think Slovakia would be a great place to scratch your entrepreneurial itch if you just can't make the leap back home. If you're an accountant, attorney, truck driver or school teacher with a secret desire to own a book store, or a bar, or a coffee shop, then selling your overpriced house in Sarasota and moving to Slovakia may be the thing to do.

Investing in Slovak Real Estate

There are several ways to invest in the Slovak real estate market - what we think will be a coming boom. Boom? Yes, boom, for an often overlooked reason. Slovak expatriates are currently working their tails off in England, Germany, Austria and other Western European countries, living six to a bedroom and working double shifts. They are young and eager, and after five years the bulk of them intend on returning to Slovakia with all those pounds and euros and buy a home. Not an old communist era cement block apartment, but a flat or house like they have grown accustomed to during their years away. This is a major trend happening throughout Eastern Europe.

Additionally, in Slovakia there is a critical housing shortage and much of the existing supply... well, it sucks. In every town in Slovakia, as well as most cities that once languished behind the Iron Curtain, the landscape is blighted with really ugly concrete monstrosities. It is awful. Picture the contrast: grand cities complete with the opulent Austro-Hungarian-era downtowns, beautiful squares, opera houses, theaters, outdoor cafés and fountains; on the outskirts you have charcoal-gray cement rectangles with little windows. They are depressing to drive by at 60 miles an hour, not to mention live in. In the communist era, these were a shining... okay, not shining, but a testament to the collective economic prosperity.

Inside, the rooms are about the size of a Manhattan walkup's coat closet. Bedrooms are barely large enough to fit a bed and a dresser. Like most European apartments, they do not have closets. There is one bathroom with shower. Even though many have been remodeled with great care, there is little that can be done as most of the interior walls are 20-inch concrete, load-bearing walls, which cannot be moved or cut through. Local municipalities plan to eventually tear them down, not only because they are ugly reminders of a time best forgotten, but because they are starting to suffer with age. Although structurally sound and probably able to deflect a direct strike from a tomahawk missile, the plumbing and electrical work is starting to fail, and much of it is buried in the concrete. All of this makes for a great opportunity for the property investor.

First, let's address the cultural and historical foundation on which this boom is built. Remember that private property was a big no-no during the communist era. You had your crappy cement hovel as a kindly gesture from the all-powerful state. But tick off the wrong guy or get caught with a bootleg Mickey Mouse movie and you were out in the snow.

Then the wall came crashing down and more often than not, except where there were historical title disputes, people were simply granted the deed to the property they lived in. It took a decade or so before these properties appreciated enough for there to be any real equity in them. This equity was required in order for people to move up to a newer or larger home. Yet even as equity began to build, there was until the last three to five years no way to leverage a property purchase.

Luckily for Slovakia and most of the former Warsaw Pact countries, the mortgage market is still relatively new. We say "luckily" because there is a very limited secondary market for the loans. As such, bankers still hold most loans on their books rather than slicing and dicing them into tranches and selling them off as derivative products to hedge funds and, oh, say German banks that don't know what they are doing.

The end result: lending practices that make sense. Bankers actually know the properties they lend against and therefore no subprime mess... at least not any time soon. This is great for the market and the people as they are now ready and able to move up the property ladder. But supply is minimal and demand growing. This dynamic has resulted in 10% price appreciation per year on average for the last two years.

One way to play the property market is to simply buy a flat in either Bratislava or any of the growing second-tier cities. Foreigners cannot own property in their name, but they can own a Slovak corporation, which can own the property. Estimated fees for incorporating a company are roughly 750 euros.

Financing for foreigners is relatively easy to obtain through local Slovak banks. Banks treat resident foreigners like locals, providing loans up to 95% of the purchase price. Rates as of August were hovering around 6% for a twenty-year mortgage and 6.5% for a thirty-year mortgage. It should be noted that throughout Europe, banks don't tend to offer fixed rates over the life of the loan. Typical is a maximum five-year rate lock with most floating after three years. So unless you are a cash buyer, you are accepting interest rate risk.

Non-resident foreigners can borrow up to 85% of the purchase price of the property through their Slovak company. Interest rates for non-residents are about 50 basis points higher than for local nationals. In Slovakia, it costs more to rent an apartment on a monthly basis than it does to own it. Therefore rental properties as an investment do well.

We looked in Zilinia and Banska Bystrica, and our sampling indicated that a modest two-bedroom apartment in walking distance to the center of the city would yield about 15% if the investor used a 20% down payment. This is a rough sampling and we are confident a diligent investor could do better if they hustled, made low-ball offers, or were sharp enough to get into a corporate rental program with one of the major international companies.

Whichever way you go with real estate in Slovakia, we think as long as you avoid the priciest parts of Bratislava, you will do well. As Slovakia continues to grow faster than the rest of Europe, and it approaches adopting the euro (which we wish it wouldn't), you should see a nice pop in property values as well as a nifty yield.

Fitzroy McLean and Simon Black are the editors of Without Borders, the spirited and highly profitable monthly advisory service from Casey Research. Both are former intelligence operatives who left their cloaks and daggers behind, using their unique skills to make it big in the business world. Fitz and Simon are on a nearly non-stop quest around the world, looking for the best places to easily diversify internationally (and, in the process, enjoy the best life has to offer).

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