In 2009, office market rents declined by 10 percent globally, the first global drop since 2003. Markets in Central and Eastern Europe came down by 20 percent, but Ukraine was hit hardest, with a 50 percent fall.
Greed, freely available capital and no fiscal oversight were commonly blamed for the bubble that eventually burst. These were definitely contributing factors, but they were also the culprits all over the world. Why is it that some countries escaped relatively unscathed, while rents in Ukraine plunged more than 50 percent?
To understand Ukraine’s debacle, we need to look into the pre-crash years and go beyond greed and incompetence. We need to identify the reasons behind prime office yields in Ukraine reaching 16 to 18 percent in 2008, while other Central and Eastern Europe yields, with the exception of Russia, were less than half of Ukraine’s. Was it just foolishness to blame for the fact that class A office space in Kyiv costs twice as much as in Prague or Warsaw, or most of Europe’s other capital cities for that matter?
Before the crash, Kyiv was ranked the 12th most expensive office market in the world, when Warsaw was ranked 19th, Prague 26th, Budapest 36th, Bucharest 38th and Bratislava 44th. In addition to Ukraine’s soaring real estate rents and prices, the number and size of real estate transactions was also going up. During Ukraine’s heydays, well-known and respected European companies were eager participants in multimillion-dollar transactions. These were the same companies that did business in other Central and Eastern European countries, applying lower market valuations there.
So what was so unique about Ukraine that drove prices high? The answer is the supply, or rather the scarcity of it.
Kyiv’s modern office stock is barely more than 1 million square meters. Prague, with a population size half of Kyiv’s has 2.5 million square meters and Bratislava, with population less than one-fifth, has over 1.2 million. According to our calculations at Invest-Ukraine.com, Kyiv is the most undersupplied among Central and Eastern European countries.
That explains why even moderate demand drives prices and rents up. Large banks, Western accounting and audit firms and other big businesses require modern corporate office space. That is why rents in Kyiv skyrocketed to above $70 – $80 per square meter per months, whereas they stayed at $20 to $30 in other, smaller capitals of the region. It was not simply greed – it was a supply and demand imbalance that drove prices up.
Ukraine’s highest dependency on capital inflow is by far the largest among Central and Eastern European countries, in some cases by a magnitude of 10. So when the recession came, the sensitivity and dependency on the outside capital played a key role in the overall sharp decline in rent.
Almost overnight the capital markets seized up and many companies ended up holding assets that no longer supported yesterday’s valuations, including construction projects. Suddenly, there were no financing options. At the same time, Ukraine’s banking sector came to the brink of collapse and gross domestic product posted a double-digit decline, so demand evaporated quickly, too.
Everything came to a standstill as markets turned illiquid. When there are no buyers, prices have only one direction – down, and some companies were forced to sell at distressed levels. More “fortunate” companies were able to place projects on hold. Unlike in other nations in Eastern Europe, where construction did not come to a standstill, Ukraine’s developers were simply unable to continue, and buildings remained only partially completed.
Ukraine’s misfortunes were additionally magnified by elections, political instability and sharp currency fluctuations. Given all these conditions, it’s not surprising that Kyiv’s rents came down sharply, and every other city followed. Kharkiv, for example, also experienced significant rent decreases and an increase in halted constructions.
It’s been proclaimed in recent publications that Ukraine’s property markets reached bottom. We would like to believe that, too, but at the moment it appears that limited supply will prevail over minuscule demand and occupiers are likely to retain the upper hand through at least 2010.
However, let’s not forget that imbalances in Ukraine’s office market did not disappear due to this recession. If anything, buildings placed on hold during the downturn will only add to future shortages. Thus, even a slight increase in overall business and investor activities may result in an abrupt shift towards rent increases, and this is not a farfetched scenario for 2011.
So, when future demand picks up, builders and investors, as well as city and state authorities, should learn from past mistakes and work together to prevent rental markets from overheating.
It’s easier said than done, but imbalances should be addressed from both supply and demand sides, allowing supply to become more competitive with pricing and demand more informed in making decisions.
Igor Korsunsky is a managing partner for Invest-Ukraine.com, a U.S.-based partnership investing in real estate and technology in Ukraine. He can be reached at [email protected].
