Investors Yield To Profit Potential Of Ukraine - From The Wall Street Journal

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By Sara Seddon Kilbinger, The Wall Street Journal

Ukraine has caught the eye of real-estate investors chasing higher returns. Roughly $293.75 million in commercial real-estate deals were transacted in the country in the first half of 2007.

Almost all -- $231.25 million -- were office sales, with retail accounting for the rest. This compares with $497.2 million in deals for all of last year and $22 million in 2005, according to real-estate advisory firm Jones Lang LaSalle. More than 90% of this year's deals were in the capital, Kiev.

One of the most active buyers is London & Regional Properties. The London-based real-estate investor and developer has acquired three properties in Kiev -- an office, a shopping center and a warehouse - since entering the market in March. It also intends to develop real estate there.

"Central Europe has got very expensive, which is why we started looking at Russia last year. Our presence in Ukraine is an extension of that strategy," says Max Fowles-Pazdro, head of Central and Eastern European acquisitions at London & Regional, based in London. "We've invested $2 billion in Russia in the past 18 months and would like to do the same in Ukraine."

London-based real-estate asset manager Invesco Real Estate is also looking to invest in Kiev, says Paul Kennedy, head of European real-estate research at Invesco.

The firm would like to buy two or three Kiev properties in the next 18 months for its Central European Fund II. Invesco will also consider buying developments before they are completed as well as joint ventures with local partners, says Dr. Kennedy.

The yields are tempting. Good-quality office and retail properties can generate as much as 10%, says Jones Lang LaSalle, compared with less than 5% in many Western European markets. (The yield is the annual percentage return, expressed as the ratio of annual net income to the capital value of a property.)

But the high yields in Ukraine reflect the higher risk, due to political instability and continuing problems with corruption. Last year, former Prime Minister Pavlo Lazarenko was sentenced to nine years in prison by a U.S. court for extortion, fraud and money laundering through U.S. banks.

According to Mykola Orlov, a partner in Kiev-based law firm Sayenko Kharenko, foreign investors are often better off working with a local consultant than joining forces with a local partner. A local partner can take advantage of a foreign investor in a number of ways, he says, including by siphoning off funds.

Another obstacle for investors is the market's opacity, with many deals completed off market for undisclosed sums, says Nick Cotton, managing director of real-estate advisory firm DTZ Holdings PLC in Kiev.

Such challenges aren't deterring many would-be investors. Asset-management firm Catalyst Capital LLP intends to enter the Ukraine market this year in conjunction with a local partner whose interests range from brick making to insurance, says Kean Hird, managing partner of Catalyst Capital's emerging-markets arm in London.

The firm's push into Ukraine is "a natural extension" of its activities in Central Europe, he says. Catalyst Capital will focus initially on Lviv - because it is near the Polish border -- before moving onto Kiev, he says. "It's a very good time to go into the market as it is still very undersupplied," says Mr. Herd.

"While we don't have a target in terms of how much we plan to invest there, we will initially develop industrial stock, such as sheds near the airport or major roads. We are also interested in developing supermarkets, ideally with international anchors. While consumer spending is still quite low, it is increasing all the time."

Private consumption -- the main driver of economic growth -- rose 18% last year, up from 12% in 2005, according to DTZ. As a result, international retailers are starting to consider Ukraine. German retail giant Metro AG opened five cash & carry stores last year, according to spokesman Martin Brüning.

"What we see is a growing middle class with more disposable income, which is the driving force behind our expansion into Central and Eastern Europe," he says.

Metro has opened 13 stores in Ukraine since it entered the market in 2003 and intends to open more this year, he says. Turnover in its Ukraine stores reached Euro615 million ($837 million) last year, almost twice the Euro338 million of 2005. The company is also considering launching its Real supermarket chain in Ukraine next year, he adds.

Retail space is still thin on the ground, making the market ripe for development: Kiev has just 290,000 square meters, similar to Warsaw in 1999. There are a number of plans in the pipeline, according to DTZ, including a 130,000-square-meter store that will mark Ikea AB's foray into Ukraine.

The hotel sector, while fledgling, is also growing. Hilton Hotels Corp. will arrive in Kiev in 2009 and is exploring opportunities in several other cities according to Nicola McShane, Hilton's European communications director.