Real estate: Tide starts turning as foreigners eye market

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Ukraine’s hot real estate market has in recent years caught the eye of investors across the globe. Surging demand has produced some superior returns over the past eight years, with annual growth in prices at double-digit rates.

Most of the beneficiaries over the past decade have been privileged domestic investors who snapped up flats and land in a frenzy, often at very low prices. Many who managed to close several acquisitions, typically with cash, turned into millionaires overnight.

Many of the commercial and residential development projects have, until recent years, been backed by domestic business groups. The tide is turning, however.

Since 2004, larger inflows of foreign investment have poured in, bringing the market its first structured investment vehicles and the first global real estate operator.

About $500m poured into the commercial real estate market last year, according to the Kiev offices of Colliers International, the property consultant.

Much of the action is still in Kiev, the capital. But activity is spreading fast to five other cities with populations of 1m or more, says Nick Cotton, who heads the Kiev offices of DTZ.

“With over $820m transacted on the investment market in Kiev, 2007 became a record year for direct investment into property. Office property preserved its leading role with the highest share of investment transactions estimated at about 60 per cent, followed by 33 per cent in retail,” says Mr Cotton.

“In 2007 strong investor appetite combined with a shortage of stock, and an improved risk weighting resulted in yield compression being demonstrated at sub-10 per cent upon the sale of prime property,” he says.

The figures are small compared with other emerging markets but mark a significant increase in activity.

“The property investment market in Ukraine, though still immature by western standards, has continued demonstrating increasing activity and is becoming more sophisticated,” Mr Cotton says.

The first structured investment instruments, such as real estate funds, appeared just last year offering international investors exposure to this fast-growing market. Private placements and IPOs by newly established real estate funds raised $664m last year, according to Tomas Fiala, head of the Kiev-based investment bank Dragon Capital.

Residential flats that a decade ago were selling for about $50,000 have reached astronomical levels, typically more than $2,500 per sq m.

Such prices are enough to make Kiev one of the world’s 20 most expensive cities in terms of property prices.

“Lack of income-producing investment grade properties in Kiev, combined with significant demand, results in vendors’ high price expectations which are often perceived as irrational.

“This forces investors to follow more diversified strategies and to consider possibilities to enter joint ventures and forward finance deals, and expand to regional centres of Ukraine and, even to the smaller cities with populations of more than 200,000,” says Mr Cotton.

Demand, particularly for quality residential and commercial space, will remain high in the near term, says Arie Schwartz, who heads Seven Hills, the Ukrainian arm of Scorpio Real Estate, founded by Benny Steinmetz, the Israeli property mogul.

In 2007, Seven Hills unveiled $1bn investment plans for Ukraine. The group has since launched construction of a residential real estate project in Kiev, and has three other projects in the pipeline for the capital, including mixed residential-commercial concepts.

“We have plans to enter each major city with more than 150,000 residents,” Mr Schwartz says.

“I’m 32 years old and I keep joking that I will probably retire here. I will be here for a long time as we plan to invest billions of additional dollars into the Ukrainian market.”

The sharp surge in purchase prices and rental rates is tapering off, but real estate experts do not expect a sharp downward correction in the immediate future. Demand consistently exceeds supply, particularly for commercial space, where the most growth is expected.

“Demand is high, but prices are not sustainable in the long term. We will see corrections in the future as more projects, particularly of higher quality, come to the market,” says Mr Schwartz.

“Do not expect a bubble-bursting situation though. It will be a gradual correction with time.”

Scorpio is, for now, the only big real estate developer on the Ukrainian market. But others are destined to arrive soon, according to Mr Schwartz.

“The market is full of scouts from leading developers and funds. Everyone is looking at the country,” he adds.

Slow to evolve because of its membership of the Soviet Union and the economic collapse that followed independence in 1991, Ukraine’s real estate market is about seven years behind its peers in central Europe, analysts say.

The stock of quality residential and commercial space remains only a fraction of that available in central European countries.

Prices are expected to come down when more commercial and residential space is brought to the market, experts say.

While the foreign investment raised thus far is small, the expectation is its growth will imitate its neighbours’.

New shopping centres, office space, warehouses and residential space continue to sprout up across the country.

Investments in both property development and property acquisition will continue to grow as local returns are much higher than on the alternative central and east European markets, says Mr Fiala at Dragon Capital.

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