Investing in real estate in Croatia – tricks and traps to avoid

October 2016 | EXPERT BRIEFING | FINANCE & INVESTMENT

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With GDP growth of 1.6 percent in 2015 and 2.7 percent in the first quarter of 2016, following six consecutive years of declining economic activity, the Croatian economy appears to be growing. The real estate sector follows in these footsteps; having emerged from the crisis and its aftermath, it shows modest signs of recovery and is expected to expand further.

Even though now it seems to be the right time for investment, certain challenges remain and caution urges successful ventures to be well prepared in advance, to overcome administrative obstacles and legal traps inherited by the ex-communist regime.

Despite beautiful scenery and an excellent geographical position that makes Croatia easily accessible from all the major European cities, the lack of foreign investments in the country’s real estate can be attributed to overregulated administration, tax instability and legal insecurity owing to a backlog of judicial cases. Still, certain improvements within the last couple of years, primarily in the field of registering property and dealing with construction permits, have been noted.

According to the World Bank’s ‘Doing Business’ report, in 2016 Croatia managed to improve its business regulatory environment by taking 60th place in registering property (compared to 109th in 2010) and 129th in dealing with construction permits (compared to 144th in 2010), ranked as the 40th economy in the world by ease of doing business.

When investing in real estate, every diligent investor should try to identify the risks of a venture from many sides. In Croatia, the risk of investing in real estate may have many faces, but the most significant one relates to legal insecurity, the origins of which can be traced back to the Second World War. In the 40-year post war era, the majority of real estate was socially owned, making acquisition of real estate by private individuals and entities an exception.

Besides, registering ownership in the land registries was not possible unless the land transfer tax had been fully paid. As a consequence, for years land registry data has been inconsistent with actual property transactions, and to certain extent continues to be inconsistent.

Generally, land registries enjoy public faith and have the strength of public deeds. It is assumed that land registries fully and accurately present the factual and legal status of the real estate. In practice, this means that a person who acquires real estate in good faith by relying on the authenticity of the land registry will enjoy protection insofar as nobody can challenge the validity of the acquisition of the respective right upon expiry of the statutory three-year term for filing a claim for the deletion of a predecessor’s ownership right.

However, speaking of formerly socially owned real estate, due to inaccuracies in the land registry data, the law provides for a temporary suspension of the described principle of reliance on land registry data, which means that any person acquiring formerly socially owned property cannot rely on land registry data as being truthful and accurate.

Another obstacle is that the ‘Law on Restitution of Property Confiscated During the Yugoslav Communist Regime’ grants the former owners of real properties, expropriated during the socialist regime, restitution claims in relation to certain types of real property. Even though the deadline for filing restitution claims has expired, a potential investor needs to be careful since registration of pending restitution claims in the land registry is not mandatory.

Generally, acquisition of real estate may be structured as a straightforward asset deal or a share deal. Choosing the right structure depends on the quality of the owner and the buyer of the property (whether an individual or legal person, a foreigner or a Croatian or EU national), the applicable tax regime and possible regulatory constraints. Depending on the type of the property and the quality of the seller, the simple purchase of real property (asset deal) triggers a real estate transfer tax of 5 percent or both, a value added tax of 25 percent that is calculated on the value of the building, and a real estate transfer tax that is calculated on the value of the land. Exempted from the real property transfer tax are: (i) contributions of real estate in kind during the foundation of a company; (ii) contributions of real estate in kind to an existing company in the course of a share capital increase; and (iii) real estate transfers in the course of mergers, spin-offs or share deals.

Any natural person or legal entity may acquire ownership and other real rights on the real estate. The Law on Ownership and Other Real Rights conditions that an acquisition of real estate by a foreign natural or legal person must be preceded by approval obtained from the Ministry of Justice. Approval is a condition precedent for the validity of the respective purchase agreement, meaning that such acquisitions are provisionally invalid until final approval is issued. The procedure for obtaining an approval can last several months.

The restriction does not apply to the EU nationals and legal persons seated within the EU. In general, these persons may not acquire ownership of certain real estate such as agricultural lands, forests and protected parts of nature. Granting approval to non-EU nationals and legal persons seated outside the EU for the acquisition of the real estate is conditioned with the reciprocity principle.

Restrictions apply only to direct acquisition of the real estate (asset deal) whereas a foreign national acquiring a Croatian company that owns the real estate (share deal), or buying the real estate using a Croatian subsidiary, does not trigger any restrictions.

Despite the illustrated obstacles and challenges, the Croatian real estate market seems to be on the rise. The average property price is expected to increase due to the improving economic situation and a greater interest in investing in tourism and hospitability projects. Properties along the coast, especially in Istria, Dalmatia and Dubrovnik, are in particularly high demand due to the growing tourism potential.

The continuation of the real estate sector’s expansion is the key to the economic recovery of Croatia. As a result, further improvement of the business climate will remain one of the key goals of the Croatian government in the coming years.

Hrvoje Vidan is a partner and Mihaela Malenica is a senior associate at Vidan Law Office. Mr Vidan can be contacted on +385 1 48 54 071 or by email: hrvoje.vidan@vidan-law.hr. Ms Malenica can be contacted on +385 1 48 54 071 or by email at: mihaela.malenica@vidan-law.hr.

Hrvoje Vidan and Mihaela Malenica

Vidan Law Office