Starting the countdown

The office sector in the Ukrainian capital is entering an important stage. Take-up is outstripping demand. There is a lack of quality space in central locations. Tenants are expressing the need for more office space. ?Is the Kyiv office market finally out of the woods?

The crisis wasn't exactly mild for Ukraine, a country which had a long list of problems to solve before the first bad news started to come in from abroad. The credit crunch in 2008-2009, and its repercussions, brought to a halt the rapid real estate development in the country, which had previously been noted for a number of bold projects for sleek high-rise buildings. Naturally, the crisis forced developers to put such visionary projects on the back-burner. The numbers attest to this - the Kyiv office market was one of the market sectors to take the hardest hit, with rents sliding by as much as 50-70 pct, depending on the building, over the crisis period. After a 14.8 pct GDP decline in 2009, the economy grew 4.2 pct in 2010, and posted 5.2 pct growth in Q1 2011.

Ray of light
With such a massive decline in rents, it is clear that the road to recovery will be longer than on less affected CEE markets. Last year brought some hope of improvement to the market, with recent figures confirming the positive trend. "We saw a brilliant first half of the year in Kyiv, but I prefer to remain cautious for now. The forecast is better, but still not extremely positive," comments Andrey Zhamkin of Jones Lang LaSalle's Kyiv office. "After hitting the bottom we are in the process of recovering, but not actually growing."
In the first half of this year new supply reached almost 45,000 sqm of office space, thus representing a 53 pct increase y-o-y, according to data by DTZ. Further on, over the same period some 85,300 sqm of office space was transacted in Kyiv - up by 28 pct. In Q1 the Central European Media Enterprises company, the owner of the 1+1 television channel, signed a lease for 10,350 sqm of the Shchekavytskiy Business Center. What does such a deal with a long-established company tell us? Market analysts and brokers agree that despite the recent moves on the market the crisis is not over, which means big new international tenants are not entering the market yet. Anton Andrianov, the managing director of ISTIL Real Estate, the developer of the recently delivered Rialto Business Center, summarises the current situation thusly: "International tenants were forced to downsize in 2008, but now they are starting to come back to the market, although it's a slow process. Instead, local companies are more active. The thing with these firms is that though they demand more, they are not willing to pay for it. This is why sealing the deal takes much longer."

The bargaining game
In Q2 Swedbank chose Rialto Business Center for its Ukrainian headquarters. The bank leased 4,500 sqm, thus becoming the first anchor tenant of the building, which is now 40 pct leased. Anton Adrianov is confident that by the end of the year another 30-40 pct of the available space will be leased. "As a developer we don't want to rent out our property on the cheap. So tenants are being selective, but we are also selective when it comes to the companies we are talking to." In the opinion of Mr Adrianov, the expectations of property owners and tenants will most likely meet in the middle in the last quarter of the year. DTZ data shows that in the second half of the year around 22,000 sqm of new office space is to come onto the market, with a number of brokers we spoke to expecting the occupancy rate to be at around 10 pct at the end of the year - down from 12 pct as of the end of H1 2011.
Who is active on the market? "Banks, insurance and financial companies are currently revising their office leasing plans. The time is good for this since prior to the crisis they weren't able to snatch the good properties they were looking at. Rents remain very reasonable, but tenants are being somewhat selective with a noticeable shift to higher quality office space," notes Geoff Hargreave, the head of office brokerage at DTZ Ukraine.
The difficult 2008-2009 period gave developers time to look from a distance at the problems the market experienced. The lack of finance and the slump in demand were not the only reasons why a large number of projects were put into cold storage. Some developers, lured by the booming pre-crunch market and easy cash, did not pay enough attention to the quality of their projects. As market players now agree, poor project conception was one of the reasons why development was suspended. Have developers used the time wisely to improve their projects? Not exactly. Recently-delivered properties are now facing significant difficulties attracting occupiers, basically due to their low quality.

Set for growth?
Despite steady improvements in 2011, Ukraine's recovery remains fragile. After a 14.8 pct GDP decline in 2009, the economy grew 4.2 pct in 2010, and posted 5.2 pct growth in the first quarter of 2011. In June this year, the World Bank said that it expects a continued but fragile recovery with 4.5 pct growth in 2011. Further on, growth in 2011-13 is expected to remain between 4-5 pct with widening external deficits under current policy conditions. Potential growth would be significantly higher if fiscal, structural and governance reforms were undertaken, the bank noted.
How is the market situation set to change next year, with more buildings scheduled for delivery? Some growth in rents has already been seen in H1 2011. Prime rents are in the range of USD 38-42 per sqm a month, while rents for class ?B' properties were USD 23-35 per sqm. And the market is set for further growth. According to Mr Hargreave, the capital city's office market remains structurally under-supplied. Last year brought the restarting of work on several larger frozen projects. And next year around 372,000 sqm is to be introduced to the market. At the end of H2 this year, the office stock in the city had reached 1.163 mln sqm. New development will therefore effect a 32 pct increase in Kyiv's office stock. Projects such as 101 Tower (57,720 sqm) and Mariya BC (47,300 sqm), both being carried out by local company KAN Development, should bring much needed space to the Kyiv CBD. These projects, along with a few others in the city centre, are also expected to increase the volume of class ?A' office projects in the city. At the end of H2 the vacancy rate in the CBD was 7.3 pct.
"Although companies are still somewhat cautious, there are also tenants who are starting to bulk up on office space as they are more confident that soon they will be growing," says Andrey Zhamkin. "That being said, it should also be noted that tenants are still carrying out thorough due diligence. They are not exactly in a hurry, with the deals taking up to six months to close."
The times remain challenging, especially for office developers. The list of projects scheduled for delivery this year and over the course of 2012 shows that the market is entirely dominated by local developers, with international investors still remaining concerned about the investment process in the country. At the end of 2009, Polish-based developer Echo Investment announced plans to start its first office project in Ukraine. The firm has acquired a 4.3 ha plot in Kyiv on which it is to develop a business park, eventually offering 100,000 sqm. As DTZ's Geoff Hargreave points out, the Kyiv market is now ready for such a novelty newcomer. The timing therefore seems right. Initially the first stage of the project was to be delivered in Q2 2012. Construction work hasn't started yet though. As is usually the case when it comes to international investors willing to work in the country, Echo Investment's office project in Kyiv will be carried out in a joint venture partnership with a local company.

Mladen Petrov