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Thursday, January 11, 2007

Ukrainian Real Estate Law: the Trends

Ukrainian Real Estate Law: the Trends

By Rysbek C. Toktomushev
Partner with Shevchenko Didkovskiy & Partners law firm


During the period in question the development of real estate law was not at the top of the agenda of Ukrainian legislature, like many other things, with the exception of the parliamentary elections. The period under review did not see many legislative changes in the realm of real estate and construction. But some of the changes and novelties are worth mentioning.

First of all, real estate mortgage legislation has undergone certain positive modifications. At the end of 2005 the Mortgages Act of Ukraine was amended to allow the pledge of land lease, as well as to streamline the mortgaging of unfinished construction. In December 2005 the Ukrainian Parliament adopted the On real estate mortgage bonds Act of Ukraine. Mortgage legislation still has a long way to go before it becomes an efficient and user-friendly set of rules. Many legal professionals believe that legal rules regarding mortgage of land leases and unfinished construction are of questionable enforceability. Therefore, the prevailing view is that for the purposes of financing property development a comfortable mortgage is one that is based on pledge of equity of a company that holds a land lease and a building permit.

In February 2006 the Land Code was amended to tighten illegal [agricultural] land trade. The moratorium on agricultural land trade should expire on 31 December 2006. Further extension of this moratorium is bound to become quite an issue in the near future. The probability exists that the moratorium will be extended. Apart from the communist/socialist lobby, there are land speculators that may be interested in extending the moratorium. Despite the mentioned moratorium the stream of supply on the land market is fed from the bank of agricultural land: vague rules regarding change of use provide highly speculative margins.

As regards construction law, in October 2005 the Minbud (Ministry of Construction, Architecture and Housing Economy) issued a model contract for capital construction Although legally this model contract is a voluntary standard, it would be fair to expect it to guide contractual practice in construction in the future.

In February 2006 Minbud amended one of its regulations to soften rules on the remodeling of residential apartments. Basically, the scope of the legal definition of illegal construction has been limited to any changes regarding the size of living area or any changes regarding bearing walls.

The Elita Center construction scam in Kiev triggered several legal acts to step up state control over residential development financing: Presidential Decree of 3 March 2006, as well as a number of Kiev City legal acts.

There were no critical changes to tax legislation. Unless the legislators further extend the moratorium on introduction of personal income taxation on the sale of real estate, as of 1 January 2007 proceeds from the sale of real estate will be subject to personal income taxation. Residents are going to be taxed at the rate of 15%, with non-residents to be taxed at the rate of 30%. Non-resident taxpayers should be careful with assignment of investment contracts regarding residential apartments. The current wording of the legislation is such that if a non-resident assigns an investment contract regard¬ing a residential apartment, such a non-resident would have to pay tax of 26% on the gross amount of the proceeds. This is obviously outrageous discrimination of non-resident taxpayers, which needs to be addressed and rectified.

Investors seeking to buy development sites designed for high-rise construction (i.e. construction of buildings more than 73.5 meters high) should note that in May 2006 the Kiev City State Administration imposed a temporary ban on high-rise development in the so-called central planning zone of Kiev. In February 2006 Minbud basically introduced a de-facto moratorium on issuing building permits for high-rise construction, limiting high-rise construction to those already under way.

The On state registration of property rights on real estate objects and encumbrances Act of Ukraine ofl July 2004, still needs a lot of fine-tuning by the appropriate by-laws to develop the system of state registration of real estate rights and encumbrances.

The legislative defect of Article 82 is still there, which prohibits 100% foreign owned Ukrainian companies to own land. Due to this flaw many foreign investors have to establish two entities instead of one so that a foreign company owns a Ukrainian company, which in turn owns another Ukrainian company, with the latter owning the land.

Investment environment

Despite the recent political turmoil in Ukraine, the real estate market saw many acquisitions of both investment properties and development sites. Surprisingly, foreign investors appeared to be more active than local ones. In light of political uncertainty, many locals seemed hesitant to invest, while many westerners were reading the recent political events in Ukraine positively.

The Kiev market seems to be under money pressure. At the end of July 2006 the Kiev City authorities announced an 18-month moratorium on the supply of new development sites. The formal explanation for this moratorium is that the Kiev City authorities need to fine tune the General Plan of Kiev, as well as town planning rules and regulations.

As Kiev appears to be somewhat overheated many investors are turning to Kiev Region, which can offer sound opportunities to invest in warehouses and industrial real estate. The deals to acquire greenfield and brownfield development sites in Kiev Region were plentiful dur¬ing the second half of 2005 and first half of 2006.

Many players realize that it will not take that long before institutional and semi-institutional investors arrive on the Ukrainian real estate market. Many players realize that it would be these in¬stitutional or semi-institutional investors who would pay top rates. The smell of big western money seems to be starting to put some positive pressure on the legal and transactional culture on the Ukrain¬ian commercial real estate market. Both the quality of legal documentation and the transaction culture seem to be gradually improving.

The use of questionable transactional techniques seems to be gradually reducing. The level of deal transparency is growing, with one of the indicators being the rising number of asset deals, though an equity deal remains to be the dominating transaction structure. Local sellers are seen to widely appreciate and use offshore vehicles in equity deals.


No dramatic changes in real estate law should be expected in 2007. With various elections over, it might be fair to expect more active and more consistent development of real estate legislation.

We would expect land to rise to the top of the agenda of legislative activity in 2007. So may real estate financing issues, including mortgages. Various imperfections of the mortgage laws are a factor that really impedes investment in real estate.

We believe that the market can count on steady (though slow) development of construction law and zoning law. What the real estate market needs badly is market-friendly and transparent rules regarding change of use in respect of both land and improvements, with change of use being the main tool to replenish the bank of greenfield and brownfield development sites.

Kiev focused developers should probably expect more municipal legal acts prohibiting development.

The general trend seems to be one whereby the legislation is gradually becoming more mature as the investment return becomes more humble.

The Ukrainian Journal of Business Law | October 2006