Property Czechs

A hitherto overlooked area of Czech law, recent changes will ensure that real estate becomes an important investment opportunity in the country. Tomas Bettelheim reports

Real estate has largely a been neglected area of law in terms of new legislation in the Czech Republic, particularly legislation aimed at creating more investor-friendly conditions. However, a few recent changes, as well as laws currently in the pipeline, redress this situation.

An overview

Czech law is based on the Continental model of a codified system. All Anglo-Saxon concepts of common law, equity and binding legal precedent are unknown to the Czech legal system. The law of the land is contained entirely in legislation passed by parliament or in supplementary regulations issued by ministries or similar authorities. Court decisions have a merely persuasive power and, while they may occasionally seek to fill gaps left in legislation, it is not safe to rely upon them absolutely.

With regard to real estate, the only form of legal title that is recognised is ownership. Leases of real estate are not regarded as title, but merely as a contractual relationship. Consequently, it is not possible to register leases as title or as an encumbrance on title.

Recent developments

Although residential mortgages have been available in the Czech market for several years, relatively few people were able to take advantage of them until now. Things began to change, largely due to the introduction of new legislation targeted at encouraging mortgage lenders to lend more readily. One of the improvements was to give lenders simple and effective means of recourse against defaulting borrowers. Before this change, the cost and delay in taking legal proceedings made lenders reluctant to lend money under any but the most severe and restrictive conditions.

Another eagerly awaited change has been in relation to the Czech law on commercial leases. The previous law, which was among the first to be passed in 1990 after the overthrow of the Communist regime, was never intended to be more than a stopgap measure. But it remained in place, largely unchanged, for 15 years. During that time, a vibrant market in commercial letting emerged, which the act was ill-equipped to regulate. While the act was silent on many aspects of the landlord-tenant relationship, allowing landlords a certain amount of freedom in imposing commercial terms and conditions, it was very restrictive in other respects.

The most significant restriction was a provision that, in effect, prevented the parties from terminating a lease on any grounds other than those set out specifically in the act. This meant not only that landlords could not expand or vary their rights of termination, but it also meant that tenants’ rights, some of which were quite wide-ranging, could not be varied or excluded. The latter was a particular problem for institutional investors. Although a completely new act on commercial leasing has been eagerly awaited for many years now, in the end a substantial amendment of the existing act, which came into effect last year, had to suffice. Among the more welcome changes brought in by this amendment was the removal of the restrictions on termination. Parties to a commercial lease are now free to agree their own grounds for termination, among other things.

Special Real Estate Fund

Possibly the most significant new development is one that has not yet taken full effect. During the course of 2004 an amendment was passed to the existing Act on Collective Investments, which sought for the first time to introduce to the Czech Republic the concept of property investment funds. Unfortunately, the amendment was on the one hand too general to be put into immediate practice, while on the other it imposed restrictions, such as a minimum investment of CZK2m (£48,000), that effectively excluded small investors.

A new amendment to the same legislation is now being prepared and is currently in the final stages of being passed through the Czech parliament. If passed, this amendment will have several characteristics similar to the Real Estate Investment Trust (Reit) concept used in other countries. Among other things, it will do away with the minimum investment limit.

The current draft amendment seeks to set up, among other things, a Special Real Estate Fund (SREF), which could only be set up in the form of a mutual open-ended retail fund. The fund itself would have no legal identity and so would need to be set up and managed by an entity holding the necessary authorisations, namely an investment company.

The SREF will be able to invest mainly into real estate with long-term yields (shopping centres, office buildings) and also into more speculative investments at a value of up to 25 per cent of its portfolio. The SREF will also be obliged to invest in liquid assets such as shares and securities, at a value of not less than 20 per cent and not more than 49 per cent of its portfolio. The SREF will also be able to invest in so-called ‘real estate companies’, which are essentially companies engaged predominantly in the business of property investment.

The main advantage of SREFs will be the ability to offer stable yields independent of the stock and securities markets. Furthermore, SREFs would enjoy a lower rate of income tax, at 5 per cent, as opposed to the current standard of 24 per cent. This is the same tax treatment afforded to all collective investment funds qualifying under the 1998 act and it is not, therefore, a special tax treatment reserved for SREFs.

Also, at an albeit reduced income tax rate of 5 per cent, SREFs will not enjoy absolute fiscal transparency. In some circumstances, the SREF may also be exempt from paying withholding tax on dividends payable to its parent company. SREFs will not be exempt from the payment of the 3 per cent Real Estate Transfer Tax (the equivalent of the English stamp duty) on the sale of real estate.

Generally speaking, the introduction of the amendment is being greeted as a positive measure and some parts of the real estate investment industry estimate that SREFs may attract as much as CZK10bn (£240m) in their first year of operation.Tomas Bettelheim is a partner at Lovells