You're reading: Real Estate Investment: where the stable and changing meet

With 25 years of real investment under the belt, the Ukrainian real estate market is a case study of an accelerated boost-and-bust model. Whereas real estate is a typically long term, stable income industry, the Ukrainian experience shows quite different facets of the business. In an emerging economy where old school local business has its roots in the soviet past and international business’ mindset focused on best international practices, the marriage of the two contrasting cultures has produced some interesting examples.
In the mid-nineties (1994-1998) the professional real estate market began in the office segment, with conversions trending. The first newly delivered business centers were conversions of historical communal apartment buildings, previously unfinished apartment construction (where government financing was drained due to change in political landscape), a factory canteen and public baths. Except one, all developments were funded by the international capital and were mostly done as best they could be, given physical limitations of the old structures.
Office stock has now grown more than 10X since 2000. The max supply growth of 52% was recorded in 2007, when 269,000 sqm were delivered (largest was Parus 53,000 sq m GLA). The development pace declined in 2008-2010, while the construction activity recovered in 2011-2013 (101 Tower, Toronto-Kyiv, Gulliver, Senator, Silver Breeze, SP Hall). Latest large addition to the stock was IQ (30,000 sq m GLA) in 2014. The years of 2015-2016 were marked by building extensions and small-scale BC construction, as war prevented large scale systemic investment. Astarta BC (38,000 sq m GLA in 3 phases – 2017/2018) is currently the only large-scale project under way. Otherwise the currently prevailing trend is redevelopment (Unit City) and growing number of reconstructions in CBD, as ground-up construction remains prohibitively expensive due to low rents and no debt financing. With virtually no new A-class CBD supply in the last 3 years, a new bottleneck is in the cards. Once rental rates reach sustainable level of $25 psm/m, new development will resume.
An overall trend to note is the evolution of demand alongside the evolution of supply. Quite likely all pre-2009 developments are bound to lose out in the mid to long run, as new development hits the markets within the next 3-5 years. The average tenant has grown significantly in size and expectations. In the late 90’s and early 2000’s, a 500 sqm occupier was a hot target for brokers and landlords alike, and requirements were limited to good looking renovated building, nice lobby and a fairly flexible layout. Nowadays, the hunt is on for a 2,000-5,000 sqm innovation-minded company, where office requirement is closely connected to employee retention in a highly competitive environment. Modern occupier is looking for ‘iBuildings’ of real estates, and not a ‘12-button-and-a-screen’ version. Therefore, old stock is clearly out of fashion, and the demand is there for modern, international quality space, with large shared spaces in highly spaced main lobbies, plentiful amenities inside and immediately outside the building, large, well lit atriums, LEED & BREAM certifications, walking distance to subway, and large flexible floor plate with easy expansion/contraction flexibility. In 5 years, there will be almost no industry leading international companies in buildings developed pre 2009 by non-real estate developers.
Also trending:
• Emerging demand for HQ identity buildings of ca. 10,000 sqm
• Low interest of international developers towards Ukraine in the next 5 years
• Lviv is emerging as an international service and manufacturing hub, creating more demand than supply can match primarily among IT companies, shared service centers, and manufacturers (primarily auto industry).

Office Market Fundamentals%d1%80%d0%b8%d1%81%d1%83%d0%bd%d0%be%d0%ba1

lhs – left hand side; rhs – right hand side
Source: CBRE Ukraine

Then retail market began with the first generation development schemes in early 2000’s. Some were conversions (factories or unfinished construction) and some were new construction. 1st generation schemes, usually delivered before 2008, have tenant mix dominated by a food anchor (usually a large-scale hypermarket) with an adjacent shopping gallery, in total less than 20,000 sqm. About 15% of shopping center stock in Kyiv is represented by such schemes. Some of these first generation properties are hugely successful due to their novelty, location or properly developed concept. Unlike in the case with the first office development, almost no international capital was involved in the first wave of shopping center development or subsequent development cycles. Due to the fact that most international brands operate primarily via local franchisees, developer roles are also more natural for local players.
second generation SC are shopping centers where fashion & service variety is bigger and leasable surface is between 20,000 and 40,000 sqm. Currently some 34% of the shopping center stock falls into this category. 3rd generation schemes have the strongest and most complete tenant mix, they are much larger and usually GLA>40,000 sqm), and have a strong emphasis on entertainment & leisure components (cinema, bowling, billiard, children’s playground and extensive food-court options). Currently 50% of SC stock is in 3rd generation in 7schemes.
Similar to the office trend, shopping centers are adapting to tenant trends, and those, in turn, are formed by shopper requirements. By the end of 2020, the market is expected to be dominated by large-scale entertainment-based SC and will account for 65-70% of total stock, with this number ever growing. Indoor experience vs a need to buy is and will continue to drive shopping center development the way it is doing so in the US and Europe. E-commerce is forcing substantial shifts in shopping center size, function mix and shopper experience. Shopping centers and retailers in Ukraine will be bound to compete with European outlet centers, as €19 airplane connections to ever more European cities are becoming available from major cities nationwide.
The warehouse market began in the mid 2000’s, with construction booming in the hay days of 2007-2008. With debt financing plentiful, time short construction, and a general business boom, both international and local developers poured into the segment. As a market did not exist prior to that time, all properties were newly built, albeit the quality varied depending on developer experience. Demand was outpacing supply, and contracts were often signed on high expectations and non-typical terms. When the market crashed in 2008-09, development stopped, vacancy soared, and rates plummeted. With the on-and-off market during the 2009-2016 period, relatively little new supply was added, vacancy stayed high, and rates remained low and mainly UAH denominated.
With a sluggish supply and economic recovery, 2017 will most likely see most leftover supply being taken up, and rates will start to rise. New development, however, will be quick to catch up, and no significant bottlenecks are expected. The market is due to stay dynamic on both demand and supply side, with retail and logistics operators currently taking up lion’s share (ca. 88%)of the stock.

Warehouse Market Fundamentals
%d1%80%d0%b8%d1%81%d1%83%d0%bd%d0%be%d0%ba3lhs – left hand side; rhs – right hand side
Source: CBRE Ukraine

The investment market began at around 2005 and pretty much ended in 2008. After a protracted pause due to financial and political crises of 2008-2015, investment market started its rebirth in 2016. With international community shunning Ukraine wholesale and MIPIM trips being for Ukraine’s representatives more of early spring sunny break rather than trade expos, a large real estate cycle can be considered closed as of 2015/2016, with some important and interesting conclusions to be drawn.

Investment volume in 2007 – 2017

%d1%80%d0%b8%d1%81%d1%83%d0%bd%d0%be%d0%ba4Source: CBRE Ukraine

In the years following the development boom of 2006-2008 had left a lot of leveraged developments in the red zone. As banks were busy foreclosing on apartments and cars and in general learning to deal with massive foreclosures, the real estate market was grappling with a new reality too, trying to fill the vacancy and buy time from the lenders. And whereas some managed to fill vacancies, the rental rates hardly ever permitted to keep pace with mortgage payments, and LTV ratios were always in the default zone. From 2012 onwards, the lenders started losing patience, and as rates stayed low, economic forecasts bleak, banks, not willing to accept partial loan write-offs, started foreclosing. As a result, as of 2015, banks became owners of a sizeable chunk of professional real estate.
2005-2007 saw a number of high price investment transactions throughout Ukraine, where mostly private international investors were venturing into a new then-high yielding market, with opportunities in more developed markets that were hard to come by, where cash rich funds were outbidding smaller players for best assets. A number of first generation properties thus changed hands at values not to be expected in a lifetime. In 2016 those early investors joined the banks in creating a window of opportunity for value driven investors. Deal flow for bank-owned, value added real estate thus began in 2016 and picked up speed in 2017. It can be expected that by the end of 2018 most bank-owned professional real estate will be traded, and classical investment market will start to renew.
Large international players either on development or investment market should not be expected in Ukraine in near turn future, so smaller private groups are bound to dominate the field either directly or via proxy fund managers. Exit is thus best planned for medium size, modern property that can cater to primary occupier audience in its segment. All three segments will remain equally attractive to investors, with value based on quality of occupier contracts. Kyiv is bound to dominate investment-scape, with Lviv second in line.

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