Nick Cotton, the managing director of the Kyiv office of DTZ Zadelhoff Tie Leung, a global real estate advisor operating in 40 countries around the world, believes that office and retail space are currently undergoing rapid development in Ukraine, but not fast enough to meet demand.

Other sectors in Ukraine’s commercial real estate market, such as logistic warehouse space and hotels, are just getting off the ground, he said, with strong growth expected throughout the country within the next three years. However, Cotton told the Post in this week’s Q&A that all areas of commercial real estate are being hampered in their growth by the problems of bureaucratic red tape, corruption and a lack of transparency that continue to plague the Ukrainian market.

KP: What has changed in Ukraine’s commercial real estate sector over the last year?

NC: The main change has been the material entry onto the market of institutional investors who previously were all but absent. Deals done last year include Piramida Center, which was bought by the Apollo Fund, Leonardo, which was bought by Quinn Group and Univermag Ukrayina, again, bought by Quinn Group. So, the large-scale entry onto the market of true foreign investors – that’s the main change.

The only deals done before that were Rodamco, which first came to the market in 1998 when they acquired an 80 percent share of the portfolio of the Dutch investor Gooioord B.V., but the economic crisis in Russia at the time basically flattened any investor interest in the country [Ukraine] for a number of years.

What we really see now is the large-scale entry of institutional investors onto the market. We see Podil Plaza almost at completion, and the Millennium building sold by NCH in January this year.

The first line of true investors is coming into the market and, this is the pattern we expect to see as the market’s real maturing steps. There is a long way to go. But this demonstrates that maturity is on the way.

KP: What changed in terms of market conditions that attracted the investors?

NC: There have been quite a number of investment funds placed around the world, and investors have been running out of destinations to place those funds, which has been driving investment yield in Central and Eastern Europe.

Presidential demonstrations, or Orange revolution, or however you might want to call it, certainly put Ukraine on the radar screen of a lot of investors, although there have been no radical changes in the legislative system of Ukraine.

The economy is maturing however.

KP: How does real estate objects development process differ in Ukraine from that in the West?

NC: The development process remains extremely bureaucratic, opaque and corrupt. [President Viktor] Yushchenko, back in 2004 [before he became president] said, as part of his presidential platform speech that the development of real estate needed to be transformed and we should have a ‘one-stop shop’ for development.

Unfortunately, there are too many vested interests in the various structures that exist and you still need around 150 permits to build a building. So, the development process really does differ from the West.

Still, there’s a lot of improvement needed towards Western norms.

KP: Can you describe some of the commercial real estate market’s other characteristics?

NC: The main trait in general is the immaturity of the Ukrainian market.

Let’s take, for example, offices, the most developed sector in Kyiv. It is at an infinitesimally small [development] level compared to Western European capital cities. The level of stock at the moment in the order of 600,000 square meters in Kyiv. We are starting from a very low base indeed. And this immaturity gives us volatility in terms of rents and vacancy rates.

KP: Which sectors of the commercial real estate market in Ukraine are currently more developed than others?

NC: In Kyiv the most developed is the office sector.

Multinationals required offices from the early days of their establishment of Kyiv as the capital of an independent country. Initially, there were diplomatic missions, and then the multinational companies. So, this market really started in 1995 with the delivery of the Kyiv-Donbass Business Centre, the Horizon Office Towers and others.

Since 2003, the office market in Kyiv has seen sustained and increasing levels of delivery.

However, talking into consideration the level and the quality of stock, there are no true A-class office buildings in Kyiv yet.

The office market is still structurally undersupplied in Kyiv. We would say that the office market in Kyiv reflects the Warsaw and Budapest markets of seven to eight years ago in terms of the quantity of stock, as well as in terms of the typical occupiers’ requirements. So, it’s not just the supply side, but the demand side as well.

Having said that, we can expect to see Kyiv make that eight-year difference up in probably five years, subject to the streamlining of the development process.

It’s the bureaucracy of the development process that is holding back the delivery of product in Kyiv. There is plenty of finance and skills available in terms of development consultants and joint venture development partners. There is unmet demand from multinational occupiers, as well as an increasing demand from local occupiers. The space should be delivered. And there’s only one reason why it is not - and that is bureaucracy. Rent levels in Kyiv are approximately twice those in Warsaw or Budapest. That’s unsustainable in the long term. It has to be changed.

KP: What about the next most developed sector of the real estate market?

NC: The next most developed sector of the real estate market would be the retail market.

True retail development didn’t really get off the ground until the year 2000. We saw the entry of Billa followed by much more active entry of Metro Cash&Carry not just in Kyiv, but also across the regions, where they have had unprecedented success. We’ve also witnessed the delivery of some small retail malls, from Globus and Metrograd to larger ones, such as Karavan.

Still, there’s no true end destination mall in all of Ukraine. IKEA have tried. They failed. Why? The bureaucracy. And the problem is not tackled about the authorities.

The other commercial market – logistics - effectively doesn’t exist in real terms in the city of Kyiv. There are several developments of 20,000 to 30,000 square meters, but these are small logistics centers. The take-up of logistics space in Poland in 2006 was on the order of around 800,000 square meters of space, and this is just in one year. The logistics market in Ukraine is embryonic.

We have now started to see some activity in hotel sector. The Radisson was delivered a couple of years ago. It looks like Hyatt will open up this year. Intercontinental signed an agreement, as well as Hilton. Also, Radisson is considering the construction of another hotel near Boryspil Airport. So, the entry of international hotel operators is expected, partnering with local developers to take the operation of hotels. So, we will see this sector make a dramatic change in terms of market characteristics.

KP: What are some possible ways of solving the problem with the bureaucracy?

NC: Cooperation between the central and city governments is needed to bring about changes in the bureaucracy…

Many companies are restricted in their business activities due to the absence of office space and escalating occupational costs on the territory of Ukraine. There are number of companies who require some very significant amounts of space to expand their businesses and they have been held back, and that’s holding back the whole economy. There are also a number of retailers who would very much like to enter the country, but as of today, the product they need to enter the market doesn’t exist.

There’s a big multiplier effect from property. If you’re holding it back, you’re holding back multinational investors.

KP: What’s your forecast for the market?

NC: All commercial real estate sectors will remain undersupplied for the next three years. The office market last year showed very disappointing levels of delivery, with around 80,000 square meters of space delivered, which is less than even in 2005. This year we will possibly have 150,000 square meters of new supply. So, offices will remain structurally undersupplied.

As for retail, there will be a move out into the regions. In Kyiv there will be many more out-of-town centers. We also expect some city-center retail malls, such as Troitsky, to be delivered within the following two to three years.

Mandarin Plaza retail centre and the properties of such quality may have to consider some form of repositioning to be able to compete with the pipeline centrally located end destination malls.

We expect the delivery of some sizable logistics [schemes] in the next three years. It’s [logistics space market] actually developing from a base of zero, and it can potentially, develop relatively quickly if the city removes the barriers.
It will take longer with delivery in the hotel sector. We would expect to see quite a considerable change in the hotel market within three years. There will be much more competition that would lead to a much higher level of service in the sector.

The source: Kyiv Post