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Sunday, December 23, 2007

Ruslan Oleksenko - Commercial Real Estate Investment Prospects

Ruslan Oleksenko - Managing Partners, DEOL Partners

1. Is it the truth that commercial real estate is much more attractive for investment objectives rather than residential real estate?

It is difficult to compare the attractiveness of commercial real estate and residential real estate as these two real estate segments have different peculiarities of investment and ROI. So residential real estate development provides formation of investors' assets on the prime stage of building. That is why residential real estate projects are characterised with shorter period of payback (payout) and have higher rate of internal profitability. At the same time commercial real estate has more attractive future in long-term period of investment. Nowadays the situation that commercial real estate is more attractive for western investors is determined by these factors while the Ukrainian developers are still the main players at the residential real estate market.

2. Is it true that the opportunities for high returns have reduced?

It is quite an interesting question, but I would like to interpret it differently. There is a good English proverb: «No free lunches». The level of profitability of investment nearly always has the straight proportion to the level of risk which an investor is ready to take. With the other equal conditions, as less the risks of an investment, as less the profitability the investor could count on. Ukraine offers reasonable balance between the level of risks linked with the investment and the level of expected profitability or capitalization rate. This is the reason of the foreign investors' interest to the Ukrainian market of real estate. Thus the rates of capitalization for all kinds of commercial real estate in Ukraine at the end of the second part of 2006 were twice higher than the average European index: for office and trade real estate at the level 11-12% compared with 5-6 % in European countries. For warehouse estate - 12-15 % compared with 7-8 % in European countries. Development and saturation of the market rings appropriate capitalization rates reduce: for the present moment they are 8-10 % and in the nearest future they will decrease till 7-8 %. At the same time investment interest to the Ukrainian market of real estate from the side of the most successful businessmen and structures will gradually reduce.

3. Which kind of commercial real estate is easier to purchase?

The question is not about what kind of estate is easier to buy but what kind of real estate can bring the expected profitability to the investor. According to our forecasts during the short-term period land speculations will stay one of the most profitable businesses on the real estate market. The internal rate of profitability within the purchase and sale of land will vary from 40 % to 90 %. DEOL Partners recommend to clients that 60 % of all their investors profiles to be land deals. At the same time with the long term period (2010-2013) investors will be forced to redirect do the projects of strategic development because in some period land speculation will lose their investment attractiveness. In 3-4 years the interest of land operations will not exceed 10% in portfolio of investors while the part of projects of strategic development will increase from 30 % to 80 %. Moreover the increasing competition on the market will be conducive to develop projects in spare niches. As the examples of niche positioning on the market of office real estate can be Business Parks, Research and development complexes; Regional Shopping Malls - in trade segment; Flex Spaces, Self Storage is some kinds of warehouse and logistic real estate) - in the industrial segment; Master Planned Communities (some kind of cottage towns) - at the residential real estate market; Corporate Houses (service apartments) and Extended Stay Hotels (long-tern living hotels) - at the hotel market.

4. What amount of money should an investor need to purchase commercial real estate in the capital city?

Major investors, such as investment funds and companies are interested in projects which are valued from 30 to 100 m. US dollars. Moreover purchasing of land for building of large office, trade or warehouse premise should constitute 10-15% of its value. An essential sum of investment depends on lots of factors including of course size and lay-out of real estate project. However in commercial real estate the concept «price for 1 sq.m» is rare for project value definition in general. The main factor for definition of real estate value is net profit which characterize the ability of the object to generate cash flow. So, the average lease rate for Shopping Malls with total area of 10 000 sq.m can be 120$ for 1 sq.m, while larger units of real estate - 15-20$ for 1 sq.m. 5. Is it cheaper to purchase commercial real estate in the regions? Nowadays Kyiv, like other large capitals all over the world is like a magnet for foreign investors in spite of lower prices for commercial real estate in regions. The fact is that building costs in the regions will be the same as in Kyiv. It will be cheaper for investors to buy the ground area only. However, in the capital it is possible to lease the object of commercial real estate in a shorter period and at a higher price after finishing building. In addition while purchasing of functioning object of real estate in Kiev its rate of capitalisation is 8-10% but in the regions is from 14 to 17%. As a result of selling of commercial real estate object the developer can lose from 40 to 70 % of profit in regions in comparison with Kyiv.

6. Are there any hazards while purchasing commercial real estate?

How long is the process itself? Of course, there are a lot of questions while purchasing commercial real estate. First of all they are regarded to financial, commercial and legal audit. All these spheres need much attention, competence and professionalism as well as flexibility from the investor, customer and transit manager. So, real estate deals are connected with lots of risks. Some of them can be acceptable, some not. If nevertheless risks are unacceptable, chances for concluding a bargain are minimal. Inability to make a concession can cancel all the efforts of partners to conclude the deal. The process of structurization of a deal with amounts from $50 m. can take 3-5 months.

7. Foreign investors who enter the Ukrainian market maintain that lease rates are exorbitant in our country. Does the quality of office and trade real estate objects correspond to present prices?

Are there any differences between other European countries? In fact, in comparison with other Eastern Europe markets the leases rates in Ukraine are a bit overpriced. However simple economy laws allow this phenomenon to be proved. High tempos of lease rate increase mean the initial phase of development of real estate market and that there are no critical mass of areas on the Ukrainian market which could satisfy the requirements of all potential clients. Also when demand exceeds supply it goes to that the market is in the hands of owners of real estate who, in their turn, do not feel the necessity to make extra investments for improving their own commercial real estate. The process of saturation of the market and a large quantity of offers will stimulate developers to plan and build more qualitative premises and lease them at lower lease rates.

8. How much does the management of commercial real estate in Ukrainian conditions differ from the western «rules of the game»?

Both quality of the real estate objects and professionalism of the Ukrainian companies, which deal with the management of the commercial estate, characterize this level of the market development. It is not a secret that a lot of owners face with the lack of high-quality proposals when choosing the managing company to which they are ready to hand over all the volume of responsibility for the effective usage of their real estate. That's why we can state that future of the Property Management products presupposes the essential increase of professionalism.

9. How can the level of competition among real estate companies be determined?

To my mind, now it is too early to speak about the competition among the current real estate companies. Developing, a rapidly-moving market is able to ensure every player with a great deal of work. That's why I think that vice verse at the moment one can feel the lack of professional companies which can manage with the professional services demand in Ukraine. Competition exists only on the coordination level with the most prestigious real estate objects.

10. What factors does the profit of the managing company depend on?

Surely, the profit of the managing company depends on the volume of the accomplished work. Experience and professionalism allow the managing company to set the higher price for their services in comparison with the less professional players. Nevertheless, a more expensive solution is not always a loss for an owner of real estate according to the proverb which says that the cheapest things are not always best. That's why from the professional point of view it is more prospective to pay a high price but to get an expected and best result.