Mortgage Financed Construction

By: Sam Vaknin, Ph.D.

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The Buyers

  1. The Buyers of residential property form an Association.
  1. The Buyers’ Association signs a contract with a construction company chosen by open and public tender.
  1. The contract with the construction company is for the construction of residential property to be owned by the Buyers.
  1. The Buyers secure financing from the Bank (see below).
  1. The Buyers then pay the construction company 25% of the final value of the property to be constructed in advance (=Buyer’s Equity). This money is the Buyers’ own funds, out of pocket – NOT received from the Banks.
  1. The Buyers Association together with the Banks appoints supervisors to oversee the work done by the construction company: its quality and adherence to schedule.

The Banks

  1. The government provides a last resort guarantee to the commercial banks. This guarantee can be used ONLY AFTER the banks have exhausted all other legal means of materializing a collateral or seizing the assets of a delinquent debtor in default.
  1. Against this guarantee, the commercial banks issue 10 years mortgages (=lend money with a repayment period of 120 months) to the private Buyers of residential property.
  1. The money lent to the Buyers (=the mortgages) REMAINS in the bank. It is NOT be given to the Buyers.
  1. The mortgage loan covers a maximum of 75% of the final value of the property to be constructed according to appraisals by experts.
  1. A lien in favour of the bank is placed on the land and property on it – to be built using the Bank’s money and the Buyers’ equity. Each Buyer pledges only HIS part of the property (for instance, ONLY the apartment being constructed for HIM). This lien is an inseparable part of the mortgage (loan) contract each and every buyer signs. It is registered in the Registrar of Mortgages and the Courts.

The Construction Company

  1. The construction companies use the advance of 25% to start the construction of the residential property – to buy the land, lay the foundations and start the skeleton. All the property belongs to the BUYERS and is registered solely to their names. The Banks have a lien of the property, as per above.
  1. When the advance-money is finished, the construction company notifies the BUYERS.
  1. The Buyers then approach the Bank for additional money to be taken from the mortgage loans deposited at the Bank (=the money that the Bank lent the Buyers).
  1. The Bank verifies that the construction is progressing according to schedule and according to quality standards set in the construction contract.
  1. If everything is according to contract, the Bank releases the next tranche (lot) of financing to the Buyers, who then forward it to the construction firm.
  1. The funds that the Buyers borrowed from the Banks are released in a few tranches according to the progress of the construction work. When the construction is finished – the funds should be completely exhausted (=used).

When the Construction is Finished

  1. The construction company will have received 100% of the price agreed in the contract.
  1. The Buyers can move into the apartments.
  1. The Buyers go on repaying the mortgage loans to the Banks.
  1. As long as the mortgage loan is not fully paid – the lien on the property in favour of the Bank remains. It is lifted (=cancelled) once the mortgage loan and the interest and charges thereof has been fully repaid by the Buyers.

While the Mortgage Loan is Being Repaid…

  1. The Buyers can rent the apartment.
  1. The Buyers can live in the apartment.
  1. The Buyers can sell the apartment only with the agreement of the Bank – or if they pre-pay the remaining balance of the mortgage loan to the Bank.
  1. The Banks can securitize the mortgage pool and sell units or mortgage backed bonds to the public. This means that the Banks can sell to the public pass through certificates - securities backed by an underlying pool of mortgages of various maturities and interest rates. This way the Banks can replenish their capital stock and re-enter the mortgage market.

Leasing Real Estate in Macedonia

December 2007

The subprime mortgage crisis in the United States is spreading into Europe, notably the United Kingdom. Real estate values are deemed inflated throughout the continent. One exception may be Macedonia. Purchase prices here have stagnated in the last few years and rental rates have actually declined considerably. There is good reason to think this will change and soon: new financing vehicles are on offer and, as real incomes increase, there is a stark mismatch between geometrically-growing demand and arithmetically-increasing supply. 

Moreover, impressive improvements in the business climate led to the entry into retail, manufacturing, and services of global giants as foreign direct investors. These need or build shopping malls, office space, and parking lots.  

Peter Roth, the General Manager of Soravia Macedonia, which bought the Business Center in Skopje last year, predicted, in a statement quoted in "Vecer", a Macedonian daily: " I expect the development of real estate, bigger competition, but also higher prices. I think that in the future investments will flow not only to Skopje, but also to Ohrid, Gevgelija and other cities, near the border with Greece." "In the near future small shops in buildings will disappear, problems with parking spots would be overcome, and expensive rents would grow further," - concluded the exuberant article. 

This may all depend on the introduction of real estate leasing. Currently, it is a negligible portion of the activities of companies such as NLB Leasing and Hypo Hypo Alpe Adria Leasing. The latter's brochure doesn't even mention it.

"Under the terms of current legislation, we are able to offer leasing." - says Maja Lape Trajkova, director of NLB Leasing, which was established in 2000 and is owned by NLB Group, essentially a Slovenian bank. Gjorgje Vojnovik and Oliver Zintl, the Macedonian and Austrian managers of Hypo Alpe Adria Leasing agree. Their firm is owned and fully capitalized by an Austria (Klagenfurt) based multinational which operates in 14 countries. 

NLB Leasing offers financial and operational leases of up to 15 years to firms and individuals, on all types of properties, second-hand and new: residential, commercial, and industrial. Hypo Alpe Adria Leasing is more selective and limits its financing to new construction. Equity ranges from 10 (Hypo Alpe Adria Leasing) to 30 (NLB Leasing) percent, depending on the creditworthiness of the lessee. Financing is procured from various sources, but mostly from the mother companies, NLB and Hypo Alpe Adria Leasing, respectively. 

NLB Leasing's "typical leasing contract is with fixed rates and not with adjustable ones, (but) a change (in the) previously agreed terms is possible, of course. When it comes to being flexible and to adjusting to the client's financing needs, the whole package is considered: period, equity, rates, IR, etc."- says Trajkova. Hypo Adria Adria Leasing prefers the safer route of sticking to fixed rates exclusively. 

So, why hasn't real estate leasing taken off, as it has in many other developing countries? Macedonia's banks offer mortgage financing but under onerous terms: multiple collaterals and guarantors, high fees, and an immediate transfer of the title (and of the risk associated with it) to the client. On paper, leasing is a more attractive proposition. 

The problem is a quirk in the tax laws: lessees pay VAT up front on the entire amount of the contract, interest included. There is no VAT payable on interest payments made to banks, the leasing companies main competitors. "The law still protects the three major banks with a 75% share of the market," complains Vojnovik. Zintl concurs: "he private customer is at a tax disadvantage". 

Even worse, expounds Trajkova: as far as the VAT law goes, financial leasing is a taxable exchange of goods. While firms can deduct the VAT or reclaim it (in one year's time or longer, if the firm has just commenced doing business in Macedonia), individuals incur it as a net out of pocket expense.  

Additionally, all lessees have to pay a "real estate turnover tax" twice: once when they have signed the contract and once when they receive title to the property, having paid the lease in full. The turnover (or transfer) tax ranges between 3 and 5 percent, depending on the municipality. This and similar problems render certain types of leases (such as lease contracts incorporating leaseback or buyback options) untenable. 

Trajkova compares this costly double taxation to the situation in Slovenia, where individuals pay only a property tax once. She met with officials at the Ministry of Finance, but they had no information as to when this hindrance will be removed. She claims to have formed a joint lobby, within the Chamber of Commerce, together with Hypo Alpe Adria Leasing and others. Hypo Alpe Adria Leasing beg to differ: they decry the lack of coordinated initiative by other leasing companies and in their own meetings "with this business-friendly government", as Vojnovik puts it, they were reassured that the problem will be solved in the first quarter of 2008. 

Trajkova notes a growing awareness of leasing even among individual buyers of residential property, owing to a string of scandals involving swindlers who took advantage of Macedonia's chaotic and incomplete cadastre (the central registrar of land and real estate property). "People trust us and are willing to pay more," - she explains.  

Vojnovik and Zintl also describe an overwhelming interest: the foreign ownership of leasing companies, the fact that title (and the risk it brings) remains with them until the end of the lease, their clean record, and their plans to enter the real estate scene as contractors and financiers have drawn considerable interest from would-be buyers. 

Still, foreigners are not allowed to own land in Macedonia - I observe - although local subsidiaries of foreign firms are treated as domestic entities and can freely transact in both land and real estate.  

This renders cross-border transactions somewhat complicated - Trajkova and Vojnovik agree, though Zintl adds that "there are no legal obstacles" to cross-border financing and that such transactions have come to dominate the portfolios of leasing companies in countries such as Croatia (1.7 billion euros annually) and even Serbia (with 1 billion euros a year). 

How does one go about leasing real estate in Macedonia? - I enquire. 

The procedure is simple: the applicant must produce an extract from the cadastre (called "property list"), proof of monthly income (Hypo Alpe demands proof of the income of the entire family), and some other basic and easy to obtain documents. Companies provide business plans with detailed projections. Lessees sign promissory notes on their monthly income and on the property. This covers the leasing company in case the property's value declines, "for instance, as a result of arson," - says Trajkova. As opposed to practice in the West, in Macedonia, it is the client who must insure the property. On the bright side, these conservative practices guarantee that Macedonia will not experience its own version of a subprime mortgage crisis.

Yet, while the leasing contract itself can be signed within days, dealings with the tax authorities and the cadastre can stretch into 3 months or more. This red tape poses difficulties as "sellers want their money immediately," - sighs Trajkova.  

Moreover, only 60% of all real estate in Macedonia is registered with the cadastre. About one third of owners have no proof of ownership. Existing liens are not updated anywhere. Much of the land is owned by the state and is designated as agricultural. The processing of requests for construction licenses is tortuously long.  

Both NLB Leasing and Alpe Adria emphasize commercial, office, and industrial real-estate, but regard residential property, including single family housing, as the area of future growth. Both leasing companies embarked on their own construction projects. This spring, NLB Leasing will start constructing residential property in Skopje's coveted center. They act as principals, both in financing and in contracting the work, thus avoiding having to pay taxes. Hypo Alpe Adria Leasing has similar plans, but they intend to rent the property out. The projects will be completed in about 2 years time. 

Zintl describes the varied activities of the Austria-based Hypo Alpe Adria Leasing group in building and managing shopping malls and hotels. The availability of leasing in Macedonia will facilitate the entry of foreign investors, including his own group, replete with Austrian anchors in its newly constructed shopping malls, - he says. 

Are residential real estate prices in Macedonia inflated? Are we witnessing an American-style bubble? 

"Prices are exaggerated in terms of average monthly wages and taking into consideration macroeconomic conditions," - says Vojnovik. "Still, there is a big mismatch between demand and supply" and the scandal-ridden scene has made it difficult to find property with clean provenance and credentials. "When the leasing companies will enter, prices will go down."

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