Estonia

Mention Tallinn and the chances are that people will immediately think of stag weekends. Every Friday evening the streets of Europe’s newest party capital fill with crowds of young British men - and a few women - drawn not so much by the glorious medieval architecture as by the more predictable pleasures of cheap booze and the wild nightlife. Yet there is far more to the Estonian capital, which makes it of considerable potential interest to the foreign investor.

The northernmost of the three Baltic states, Estonia is one of the most dynamic and investor-friendly of the 10 new members which joined the European Union in May 2004. Linked closely ethnically and linguistically with the Finns, whose country lies just 50 miles away across the Gulf of Finland, the Estonians have always had a Nordic air of efficiency about them – even during the half a century after they were forcibly annexed by Stalin’s Soviet Union. The smallest of the then 15 Soviet republics, Estonia was always one of the most affluent and well run. I was always amazed by what I found whenever I visited the city while based as a foreign correspondent in Moscow in the late 1980s before the fall of Communism. Not surprisingly, since winning independence in 1991, the Estonians have quickly swept away the last remaining vestiges of Communism, embracing liberal, free market ideals with gusto.

The results speak for themselves. Estonia was badly hit by the Russian economic crisis in 1998, but has since reoriented its economy more firmly to the west, and for the last few years has notched up impressive annual growth rates of more than 6%. Although it cannot continue growing indefinitely at such a speed, there are no immediate signs of a slow-down, giving the country a well-deserved reputation as a Baltic Tiger. Inflation, which dropped below 2% in 2003, moved back up towards 5% in 2005, but should be brought back under control, while salaries are rising at around 10% a year. Interest rates have tumbled from double figures in the mid-1990s down to euro-zone levels. The currency, the kroon, first fixed to the Deutschmark in 1992, is currently pegged to the euro at the rate of one to 15.6466 (don’t ask me why they didn’t go for a slightly rounder number!). Estonia is hoping to be among the first wave of new EU members to join the single currency in 2007.

Much of all this success is due to the bold decision in 1994 of the country’s then prime minister, Mart Laar, to introduce a flat tax of just 26% on incomes. The International Monetary Fund warned against it, but Laar, aged just 34 at the time, pressed on regardless, laying the groundwork for the rapid growth and prosperity that his country has enjoyed for much of the time since. A number of other countries in the region have since introduced flat taxes of their own – albeit with lower rates – and the Estonians have responded by announcing their intention to cut their rate to 20% in 2007.

In a sign of the openness and transparency of its economy, Estonia ranks fourth in the world, behind Hong Kong, Singapore and Luxembourg (and well ahead of Britain and America) in the US Heritage Foundation’s so-called Index of Economic Freedom. The legal system is commendably efficient, while when it comes to indicators of modernity such as mobile phone and internet usage, the country is well ahead of most of its Eastern European neighbours and almost up to Western European levels. Although their native language is almost completely impenetrable, a gratifyingly large number of people in Tallinn and other large cities are able to speak good English (and Finnish, German and Russian).

The real estate market, needless to say, has been surging in the last few years. Prices have in most cases doubled since 2000, with especially sharp rises in the run-up to EU membership in 2004. The reason is not just the rapid increase in incomes, but also the fall in interest rates. As recently as 2002, an average mortgage cost 9%; it can be now be as little 4%. Estonians are consequently rapidly acquiring an appetite for debt. The economy had been expected to grow a little more slowly in 2005, cooling the housing market in the process. In the event, prices in Tallinn and the surrounding area grew an impressive 11% in the first half of the year and perhaps even faster in the second six months, with many new developments selling out within weeks of coming on the market.

All this makes Estonia an interesting place for investors in search of capital gains. Mortgages are readily available for foreigners, with banks typically offering 75% loan-to-value on old buildings and 85% on anything built within the last five years. They are also cheap at around 1.5% over six-month euribor, which at the time of writing was equivalent to a rate of just over 4%. The tax system is fairly advantageous, too. When you come to buy, you will be pleased to see that stamp duty as such does not exist, while land registry registration fees and other administrative charges could come to as little as £100. Rental income and capital gains are taxed at 26%.

Tallinn A good place to start a tour of the city is Raekoja plats, the main square. The glorious Old Town (or Vanalinn in Estonian) around it has been transformed since the Estonians kicked out the Soviets in 1991, and smartened up with chic cafés, bars and restaurants. Towering above it is Toompea Hill, the birthplace of the city, where the Knights of the Sword first built a fortress in 1229. This is the site both of Toompea Castle, the seat of the Estonian government, and the Alexander Nevsky Cathedral, the giant 19th century symbol of the Russian Tsar’s power over the country.

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