News Analysis: Latvia ponders future of trade in residence permits for real estate amid faltering growth

Trade in temporary residence permits for investment in real estate has lately become a bone of contention in Latvia's public discourse, with some calling for its immediate and complete abolition and others touting it as one of the main tools propping up the nation's economic growth.

The issue has become so pressing that even the Latvian central bank, which normally does not deal with business issues of this kind, got involved in the debate recently, taking part in a conference, "Temporary Residence Permit: Latvia's Lost Opportunity", and analysing the residence permit program on its makroekonomika.lv website in detail.

In late January, Bank of Latvia Governor Ilmars Rimsevics admitted in an interview with Latvia's LNT commercial television that the public debate on the residence permit program lacked comprehensive and impartial information and that an in-depth analysis was needed to assess the program's impact on Latvia's real estate sector and economic growth at large.

According to the central bank's estimates, the program in which foreign investors can obtain temporary residence permits in exchange for buying properties or investing in businesses in Latvia, has contributed 350 million euros (about 399 million U.S. dollars), or roughly 1.5 percent, to Latvia's GDP, bringing 30-40 million euros to the state budget a year.

The program has also had a positive effect on Latvia's tax revenue, bringing in at least 39 million euros in taxes a year, or 0.5 percent of Latvia's annual tax revenue.

At the same time, the scheme, which was launched in Latvia on July 1, 2010, with the aim to help the economy return to positive growth after the crisis, involves several medium and long-term risks to Latvia's growth potential, Bank of Latvia economist Osvalds Bluzma warned.

The economist explained that in the long run, the program might cause economic activity and labor force increasingly gravitate towards the real estate and construction sector, leaving manufacturing and other industries expected to ensure Latvia's long-term competitiveness without the necessary resources.

Consequently, from the macroeconomic standpoint, the main objective in the program's context would be to shift its accents by promoting foreign investment primarily in manufacturing, added the expert.

Support for the real estate and construction sectors by temporarily easing the terms for obtaining the residence permits, might only be a short-term solution, applicable exclusively during the phase of economic slowdown, and it cannot by any means serve as a tool ensuring Latvia's economic growth in the long term, the Bank of Latvia economist said.

Since 2010 when the program was launched, its terms have only been made tougher. The latest amendments to the Latvian Immigration Law, which the parliament passed in May 2014 and which came into effect in September 2014, mostly affected the real estate sector.

Under the amended law, the value of a property foreign investors have to purchase to obtain Latvian residence permits must be at least 250,000 euros, and the investors are also required to pay 5 percent of the property's value in the Latvian budget.

Under the previous regulation, the minimum investment foreigners had to make in real estate in Latvia to obtain the residence permits was 143,300 euros in Riga and 71,150 euros outside the capital city.

Latvian residence permits can also be obtained by investing 35,000-150,000 euros in Latvian enterprises, depending on their number of employees and annual turnover, or against investment in Latvian banks and special government bonds.

By January 2015, the Latvian Office of Citizenship and Migration had received 6,645 requests for residence permits, with the applicants' investments totalling 1.26 billion euros under the scheme.

During the last five years, investments made by foreigners in Latvia to obtain residence permits have grown from 28 million euros in 2010 to 177 million euros in 2011, to 250 million euros in 2012, to 360 million euros in 2013 and 447.9 million euros in 2014.

Investments in real estate make up the bulk, or 83.6 percent, of this amount. Investments made by foreigners' in Latvian bank capital make up 11.2 percent, and investments in other business account for 5.2 percent, according to the Latvian migration authority's data.

From the very start, property purchases have been the most popular type of investments in the program, and demand for real estate has been growing year by year. About 63 percent of all investments made in properties under the scheme have been in the price range between 125,000 and 200,000 euros.

The foreign investors have been mainly buying properties in the capital city Riga and seaside resort Jurmala, as well as the towns of Ozolnieki, Cesis, Babite, Marupe and Saulkrasti.

Most of the applicants seeking Latvian residence permits for investments in properties, or 70 percent, come from Russia. The reasons for this might be Latvia's geographical proximity, the residence permits' comparatively attractive prices, as well as a virtual absence of the language barrier. Investors from China (8 percent) make up the second largest group of investors, and Ukrainians follow closely with 7.5 percent.

A study conducted by Re:Baltica investigative journalist centre suggests that about 10,000 Russian citizens have purchased properties in Latvia.

Over the last five years, Latvian residence permits have been issued to 13,518 foreign investors, including 10,000 from Russia. Unlike in similar programs in other European countries, 90 percent of the applicants seeking residence permits in Latvia come from former Soviet republics.

Property developers and dealers have been the main gainers from the program, as the real estate sector has received 83 percent of the roughly 1.1 billion euros invested in Latvia in the five years, 12 percent of the investments have been made in banks and less than five percent in company capital, according to the Re:Baltica study.

In 2014, the number of property transactions in Latvia rose by just 1.1 percent from a year before when the growth was 11.7 percent, shows a new report by Latvia's Arco Real Estate.

"Last year, the market was slightly more active than a year before, but during the last months of 2014 the number of transactions fell significantly. There are concerns about this year," said Arco Real Estate representative Maris Laukalejs.

Non-residents had been busily buying properties in return for the Latvian residence permits until September 2014, but as the amendments to the Immigration Law came into effect and the geopolitical situation deteriorated, affecting also the Russian economy, non-residents' activity in the Latvian real estate market plunged.

Notwithstanding the residence permit program's positive effects on the Latvian economy, particularly its property and construction sectors, employment and businesses, its opponents have been calling for even more restrictions or even the program's abolition, citing national security risks.

There are fears that insufficient control over the foreign investors' activities in Latvia can lead to a rise in organized crime and other internal security risks, and the latest geopolitical developments, particularly the Ukraine crisis, have been causing concerns about Latvia's external security as well.

Even the Bank of Latvia has admitted in its analysis that "national security definitely is more important than any macroeconomic benefit".

Climbing property prices which have made it harder for local buyers to obtain housing have also been named by the central bank as the program's negative aspect.

The residence permit program has also been increasing the proportion of people employed in Latvia's construction and real estate sector, while the number of people employed in manufacturing has been declining in recent years, which the Bank of Latvia considers a negative trend, likely to undermine the economy's competitiveness in the future.

With Latvia's economic growth slowing down amid external troubles, such as the developments in Russia and Europe's slow recovery, there is a general understanding that tools are needed to stimulate Latvia's growth.

Since Latvia lacks reserves it might spend now on warming up the economy, it has few other options but to carry on with the residence permits program, but to make it more competitive in Europe and increase demand for the permits, its terms must be temporarily eased.

This program, as well as the EU's structural funds, is among the few short-term stimulation tools available to the Latvian economy in a situation where its growth is weakening and time is needed to carry out structural reforms that would put it on the path of sustainable growth. (1 euro = 1.14 U.S. dollars) Endit