Cover Story (#9 September 2020)

Lucrative Investment

The real estate and construction market has undergone changes worldwide. COVID-19 has not only changed our everyday lives but also led to mass reconsideration of investment strategies and lease market. However, foreigners have found Ukrainian real estate to be quite a lucrative investment.

Odesa Region has its own unique specifics, and enjoys steady investment from abroad, especially into residential premises. We asked Gryhorii Tripulskyi, managing partner of De-Jure Law Firm, to tell us how the real estate market operates in the current Ukrainian realities, and what happens in Odesa and south Ukraine.

UJBL: What factors affect the attraction of investment into real estate and construction in Ukraine?

Gryhorii Tripulskyi: Investment in this area is driven by two factors political and economic. From the political point of view, each new president and Parliament is a chance for the country and an opportunity to change something, and, accordingly, it is a positive signal for investors. However, unfortunately, over time, these ideas are broken in our reality.

But there is also the economic factor. The fact is that the entrance to real estate, from the point of view of investment, is quite small. The issue here is investment in large construction projects as well as investment in residential real estate, such as flats and apartments. In other words, medium-sized businessmen can make such investments. At the same time, according to Western investors, our market is quite undervalued. We have a small margin between the cost and the sale price, which is usually not typical for real estate.

In addition, foreign investors expect that the mortgage lending market, which currently does not exist, will start to operate in our country. This is quite a weighty argument after all, as soon as it works, real estate will begin to grow in price. Therefore, I believe that the market is quite promising from an economic point of view.

UJBL: Does such a small margin apply to residential real estate?

G. T.: Yes. In comparison with world practice, the price difference is USD 150-250 (per square meter). These are very small numbers.

UJBL: How has the situation changed since 2014, when we had political upheavals and an economic crisis arose?

G. T.: 2014 was a year of crisis for everyone. The market has grown quite slowly to date. This has applied to both the rent and the cost of real estate.

Unfortunately, the coronavirus pandemic has also affected the real estate market, primarily office and partly commercial. If we talk about other areas, they are quite stable. The residential real estate market has slumped by about 10% but is now making a comeback. Rents have dropped by 10-20%, but they are also returning to previous indicators quite steadily.

UJBL: During the lockdown, many foreigners were forced to leave Ukraine in one way or another. Are they now somehow showing interest in real estate in Odesa?

G. T.: If we talk about foreigners who have invested in commercial or residential real estate, they are definitely out of the market now and are waiting for the borders to open. We have quite a lot of clients, for example, from Israel, and they are all waiting. Everyone understands that the quarantine may continue for some time, but then the borders will open, and our market is quite interesting for them. Those who already have some projects here believe, on the contrary, that now is the time to buy and so continue to purchase.

UJBL: What are the specifics of investments made by non-residents individuals and legal entities?

G. T.: It all depends on what non-residents invest in. Legal entities usually invest in commercial real estate and construction projects. Individuals are mostly interested in certain individual facilities: apartments, shops and shopping centers.

Depending on this, the approach also differs. For example, legal entities here need other support accountants, accounts, correct registration of representative offices and taxation in Ukraine. Individuals are concerned about the calmness of the facilities, understanding their purity, proper conduct of due diligence, as well as the cooperation of Ukrainian lawyers with lawyers of the country from which the money is being invested.

UJBL: Do you conduct due diligence when foreign citizens purchase apartments?

G. T.: Yes, absolutely, and we highly recommend it. This is a common practice for foreigners, as they are used to involving lawyers in transactions. In our country, people think they know everything. At the same time, there is a huge number of cases when apartments are bought in houses with huge debts, bad reputation, burdened by some previous mortgages and court proceedings. And, often, this is found out after the settlement. Therefore, I always advise our and foreign investors to entrust the case to lawyers to find out the history of the facility in question.

UJBL: If were talking about non-residents, they need to open bank accounts in Ukraine, which is also a fairly long procedure. How does this happen in practice?

G. T.: Now there are different ways. Indeed, non-residents need to open accounts. But now its easier. A foreign citizen can easily open an investment account in Ukraine by translating his/her passport and obtaining a tax identification code. For a foreign company, the procedure is more complicated: you need to get a certificate from the State Tax Service, register, and prove to the bank that the company is not an offshore company. This is not simple, but quite a workable procedure.

UJBL: How willing are non-resident individuals to invest in projects under construction, such as housing complexes?

G. T.: Willing enough. If we are talking about Odesa Region, it is mainly Israelis and Turks. By way of exception, French and Americans.

For Israelis, Odesa is interesting economically and mentally, it is quite close and convenient from the point of view of logistics. At the same time, when events occurred in 2014 and the war began, they were not afraid of these events at all. In addition, buying an apartment for USD 50,000-70,000-100,000 is a fairly low entry threshold, since in Israel the cost of real estate starts from USD 150,000. The second argument is the fairly high level of profitability from 5% per annum.

We participated in the creation of several products where Israeli citizens could buy apartments in houses under construction. These were facilities fully verified by Ukrainian and Israeli lawyers, the so-called controlled sales scheme. In Kyiv, one such complex has already been commissioned, and in Odesa, it is currently under construction.

UJBL: Recently, there are many different kinds of scandals with developers. The most resonant one this year is UkrBud. What legal mechanisms exist to protect a client, including a non-resident, from such stories?

G. T.: The developers that this happens to are divided into two categories. The first includes outright scammers, as was Elita Centre in its time. For example, in Odesa, there were such houses when apartments were sold 2 or 3 times. The second category includes those who were caught in the economic crises of 2008 and 2014 when customers stopped paying.

The mechanism that we have chosen for foreign investors is gradual financing, which is linked to the stage of completion of work. We have several such projects when we agree with the developer that the financing will be received as the work is completed. There is a special company that monitors the progress of work every month. This helps to minimize the risks of investors because if at some point the work ends, there is money to finish the building of this facility. This is so-called controlled construction. Our legislation provides for this idea in the form of financing funds, which should monitor where the money is sent. Unfortunately, they dont work for us.

UJBL: Have you ever had disputes in your practice between an investor and a developer? What are the most typical cases, and in whose favor do Ukrainian courts decide?

G. T.: We have faced different situations. For example, when an apartment did not match what was stated, had defects, other materials during construction, etc. In most cases, we still had settlement agreements and sought compensation from developers.

There were cases when nothing could be proved. For example, if a person bought an apartment in a building that promised a swimming pool, gym, but the contract did not specify this. Unfortunately, quite often the maintenance cost is not specified. We have a number of disputes when residents of the house are surprised to learn that they have a tariff three times more than is generally accepted for some reason. The problem is that this is not specified at the beginning. For objective reasons, it is often difficult for a developer to calculate what the rates will be in 2-3 years. And many developers use this as a source of additional income.

UJBL: Which investors are currently prevailing in the commercial real estate sector in Odesa?

G. T.: In fact, these are mostly local investors. For foreigners, commercial real estate carries more risks. This is due to the need to work more quickly with such real estate, which is quite difficult due to the fact that it is not located in Ukraine. Therefore, there are quite a few foreign investors in commercial real estate at present.

UJBL: What is the approximate profitability for commercial real estate?

G. T.: Lets just say that for a good market it is 10% per annum. More liquid facilities are sold with a profit margin of 6-8%. Facilities with a profit margin of 10% or more either with some bad history or require additional effort.

UJBL: Have there been any cases in your practice when due diligence showed serious problems? If so, what were they about?

G. T.: Yes, of course. For example, there were disputes around the facility related to it or the previous owner; the land plot was not properly registered; the facility has state acts cancelled by the city council and a claim can be filed against the bona fide owner at any time to have the property confiscated.

UJBL: Now many people are saying that so-called stress assets may arise in the real estate sector. How do you evaluate such prospects in Odesa Region?

G. T.: There were quite a lot of them in 2014, but now there are almost none. Quarantine is certainly a problem for the country, but given what we experienced in 2008 and 2014, it is not so terrible. Yes, there is a decline in activity and profitability. But there is no global panic for investors to sell off their assets en masse.

UJBL: How common are transactions with collateral assets now? At what discount, as a rule, do banks sell this type of facility?

G. T.: Yes, such transactions are quite common. There are certain groups of people who buy them, such as law firms. Thus, the discount can be up to 50%. They buy such facilities at auctions, clear them of problems, and sell them. But for a foreign investor such assets are too toxic.

UJBL: Some time ago, there were many publications about the raiding of commercial real estate in Odesa. How true is this? Have you ever experienced this type of action?

G. T.: I have, but I would not say that this is very common. As a rule, when a client buys something without consulting a lawyer, then there are such double sales, difficult situations, and, as a result, conflicts. This happens when the property is purchased at an auction. We have almost none of that real raiding which took place in the 2000s.

UJBL: The quarantine has significantly affected office real estate. For example, in Kyiv, a lot of office space is simply idle, as a large number of companies have switched to remote working and either refuse to have offices or find premises that are smaller and cheaper. How are things going in Odesa?

G. T.: Yes, in Odesa, too, there is a drop in demand for office real estate, but not as big as in Kyiv. As far as I know, prices in Kyiv have sunk by 30%, and there is quite a lot of vacant space. In Odesa, there is a big problem with offices. That is, there are very few good office buildings, so there is no mass outflow of tenants. There is some reformatting, there is a 10-20% drop in prices, but there is no mass outflow because the market is not yet full. By the way, we dont have any Class A offices.

UJBL: Do you predict that in the near future there may be large developers of office and commercial real estate in Odesa?

G. T.: We calculated the construction of such buildings for our clients. The main problem is that our developers are used to working with other peoples money. They build residential properties and sell them gradually. This does not work with business centers, because you need to immediately invest a large amount of money. Few developers have such a large cash reserve. Yet again, the banks are now reluctant to give loans for such projects.

UJBL: What is your forecast for the future development of this market? What will be in demand and why?

G. T.: In my opinion, commercial real estate will be in great demand due to the fact that it is more profitable. It is now easier for foreigners to open accounts and withdraw money. At the same time, residential real estate is now at the start. As soon as bank mortgage lending opens, residential property prices will rise quite sharply. I am sure that this will happen, because it has always been the foundation of the banking business, and this is how it works around the world. Now is a good time to invest in it.

UJBL: How is this sphere being popularized among foreign investors?

G. T.: We planned to hold a certain event, but quarantine prevented it. We had held a meeting with the City Council earlier, which was attended by a large bar association from Israel. The Deputy City Mayor presented Odesa at it.

UJBL: A small clarification are the local authorities doing anything to promote this sphere, including among foreigners? Do you remember how at one time commercial and residential real estate in Batumi (Georgia) was advertised?

G. T.: Unfortunately, no. We still have no additional benefits, goodies or nannies for foreign investors.


KEY FACTS
De-Jure Law Firm

Year of establishment: 2011

Location:Odesa, Ukraine

Number of partners/lawyers: 1/17

Core practice areas:

  • Real Estate and Construction
  • Medical Law
  • Corporate Law
  • Tax Practice
  • Judicial Practice
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