You're reading: Business Sense: Where real estate market is heading after its big crisis

Sergiy Sergiyenko writes: Retail, office buildings may provide best bets for investment in sector

With the word “crisis” going well out of use, the Ukrainian real estate market is starting to pick up steam for the upswing ahead. The question that remains to be answered is: Have the lessons of the last cycle been learned?

Looking back at the recent cycle of 1999 – 2009, one can hope that the first generation of development or the first part of the learning curve has been completed. Analyzing the outcome of the recent bust-boom-bust, many problems come to the surface.

Most of the completed developments were low-to-average quality, and most of them were carried out by first-time developers who generated the funds in typically commodity trading businesses.

There were virtually no professional development organizations operating in either Kyiv or nationally, and most companies were operating one or two properties.

Most pre-crisis projects were of overblown and unrealistic proportions, none of which materialized. For example, several international $100 million-plus investment acquisitions took place typically at overpriced levels before the economic downturn.

Most prime projects were sold to international investors pre-crisis. The portfolio of the few companies which completed or planned international public offerings were mostly comprised of unrealized projects. Moreover, land speculation was the fad of the time.

The ensuing downturn resulted in vast increase in vacancies in the three main commercial segments: office, retail and warehouse. It also led to low-to-moderate vacancies in the prime segment due to extremely short supply.

It also led to demand for exclusively prime properties, but none trading, as oftentimes they were nearly the only source of stable income for their holders, and the sales price was at typically 50 percent of the cost and way below the mortgage debt.

The present-day reality is this:

– Virtually no prime product available for sale due to a continued disparity of cost and present-day valuations;
– First post-crisis development projects in offices likely to continue in secondary market, with retail likely to be in prime;
– Very few international developers operating and little chance for new entrants pre-2012 (a handful of entries is expected in 2012);
– Little chance for international investment pre-2013 when new quality product enters the market;
– Much focus on hospitality segment which was nearly non-existent pre-crisis but which showed strong resilience during the crisis; and
– Emergence of a handful of powerful developers backed by cash rich oligarchs.

The good news for most players in the market is that this time it appears the recovery will be much quicker than in the aftermath of the 1998-99 downturn.

With the economy at large much stronger, the financial sector much more developed (although still licking its wounds) and the real estate market noticeably more populated, the pace of recovery is showing signs of unexpected acceleration.

In particular, it is noticed in the retail segment, where consumers are growing accustomed to the modern concept of shopping experience.

The government took a few meaningful steps to improving the playing field, although by and large no needed revolutionary steps were undertaken to making the market transparent and predictable.

On the surface of things, looking at the opportunities ahead, one can identify prime retail and office development as areas of strategic opportunity. These segments are evidently leading the pack due to the following advantages:

– Stronger resilience during economic downturns;
– Stronger occupational and end user (latter in case of retail) demand;
– Higher rental rates;
– Low supply;
– Low competition;
– Quality aware occupiers in case of offices, where the market is becoming more sophisticated as a result of occupier size;
– Virtually guaranteed prime yield exit, as there is always a buyer for a properly concepted, built and populated property; and
– Still relatively moderate entry cost due to a limited amount of borrowed [read: speculative] funds in the market.

A particularly important element to succeeding with a quality scheme is the ability to deliver quality product from the very first stages of project realization.

With development funds available for the “primest of the prime” only, the developer must demonstrate the ability to secure a site in a prime location, develop the proper international grade project concept, documentation and a set of quality permits versus questionable arrangements, with all of it backed by its own portion of equity capital.

Sergiy Sergiyenko is the managing partner in Ukraine for CB Richard Ellis, a global leader in real estate services.