With 12-percent yields — twice higher than in European Union countries — investing in Ukraine’s commercial real estate can be very profitable.
But there are also serious risks. To avoid a financial disaster, any investor in Ukraine should check everything before buying or developing a real estate property by conducting detailed legal, technical and market due diligence.
“Once you are spending $50 million, which is a quite a large amount of money, it means that you have make sure that you’re not buying a problem, but you rather purchasing an asset,” said Alexander Nosachenko, managing director at Colliers International Ukraine, the local branch of global commercial real estate services company Colliers.
In 2005–2007, real estate properties sold like hot cakes across Ukraine and the market was unreasonably overheated. During these wild years, buyers simply were not interesting in doing the digging required to gather all the necessary information about their purchases.
“People were paying too much for assets largely because they were all on a roll and they were almost of a herd mentality: ‘We have to get into the market, we have to buy something, it’s going somewhere,’” said Nick Cotton, managing director of the Kyiv office of Cushman & Wakefield, a U.S.-based commercial real estate services company.
The market has changed since then, as has the attitude toward doing due diligence.
“Today, mostly local (developers) already act properly, structuring everything in the right way from the very beginning so they can sell it to a foreign investor in the future without any problems,” said Nosachenko.
Market force to obey
The Ukrainian real estate market has a few very interesting features, which directly influence the demand for due diligence.
Firstly, the development sector of Ukraine’s real estate market is mainly driven by local investors. It is largely closed to foreigners because it requires collecting tons of permits and very few of foreign players can get past this barrier.
In contrast, buying already completed real estate projects in Ukraine — for example, business centers that already generate rental income — is a popular sphere for foreign investors.
These investors all ask the right questions, and without the right answers, they won’t buy.
“Since we have a large share of foreign capital and any transaction where foreign capital is involved requires a due diligence, it must be done properly,” said Roman Gerasimchuk, director of City Development Solutions, a real estate consulting company.
Under the microscope
In Ukraine, legal due diligence is in particularly high demand. This is a direct result of the country’s weak rule of law and its dysfunctional court system, which can create enormous risks for investors.
“The rules are not transparent here, the legislation is problematic and, more importantly, the court system is not transparent at all,” said Nosachenko.
In developed markets like the EU countries, where legislation and courts work correctly, it is relatively easy to evaluate risks and possible outcomes.
On the Ukrainian market, no one can give any guarantees.
“Why? Because somebody is just paying bribes for the court decision they want,” Nosachenko said.
Land rights, building permits, and ownership rights for property pose particular challenges.
“There are numerous cases related to a vindication of land plots due to their initial unlawful allocation. As a result, it may even lead to the demolition of buildings constructed on such land plots as well as criminal proceedings against the involved parties,” said Oleksandr Melnyk, an attorney at GOLAW firm.
Additionally in Ukraine, there is no public record of what has been purchased and at what price, according to Cotton.
“In the U.K., you’ve got full transparency in relation to capital market transactions. That is in the state land registry. Here you have nothing,” he said.
Another headache is tracing all the transactions made with the building in question. Just one past bad deal can lead to significant legal trouble in future deals, says Gerasimchuk.
Technical due diligence is also a key preparation for a real estate transaction, particularly in Ukraine, where the construction business is far from transparent. It can reveal serious engineering flaws, even if the seller’s documentation looks fine.
“There was a case where a construction crack was found going through the entire building, and it had to be completely dismantled, although originally there were plans to reconstruct it. This led to serious financial losses,” said Gerasimchuk.
Taken together, all these concerns paint an unfortunate picture: 95 percent of all projects in Kyiv are far from being risk free, Nosachenko told the Kyiv Post.
Power of banks
Banks are another reason why due diligence is a must for real estate projects. They simply do not want to finance purchases of commercial property.
Even in neighboring Poland, when somebody purchases a building for $1 million, chances are high that he or she will borrow 70 percent of the money from a bank, Cotton says. And the buyer will borrow at a lower rate than in Ukraine — for example, 4 percent.
“In the EU, banks are happy to issue loans for real estate because it is always a profitable story. But banks have one of the highest requirements for due diligence,” said Gerasimchuk.
He is convinced that, if Ukrainian banks would finance real estate transactions and give money for the development of commercial real estate, it
would stimulate the market to create a roadmap for proper construction.
Worth it
In Ukraine, doing legal due diligence is not cheap.
The price can vary from $5,000 to $50,000, depending on how much needs to be done, according to Colliers. For technical due diligence, the price starts from $2,000 and can reach $10,000 or higher.
Not doing it can cost millions of dollars, however.
In Odesa, a factory was bought out through the purchase of corporate rights. The purchasers planned to construct commercial property in its place.
Gerasimchuk’s company was involved at the stage when the deal was almost complete. But then a final check revealed that part of the building did not have confirmed property rights.
“A large discount was made for this part of the building,” Gerasimchuk said. “These are the results of legal and economic due diligence, which saved hundreds of thousands of dollars.”
