Ukraine: A sellers' market

Author: | Published: 1 Jul 2008
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The Ukrainian real estate market is benefiting from robust development – but with some handbrakes on. The market has continued to grow over the last 10 years but still supply does not meet demand. The Ukrainian real estate market is a landlords' and a sellers' market in all asset classes, and thus prices continued to grow in 2007, although at a slightly lower pace than in previous years. Vacancy rates for class A office space are below 2%, a rate which might merely be lower for technical reasons, and office landlords in Kyiv can ask for prices of $90 per square metre per month, and in some cases, more. Retail space is also in shortage, although in 2007 a couple of larger shopping malls opened and 2008 will see the opening of additional shopping malls. The warehouse market seems to have calmed down a bit, with 2007 seeing several large western-style developed warehouses beginning operation, in addition to more warehouses scheduled to open in 2008. Finally, the residential premises market continues to grow with rising incomes and the steadily growing middle class. Despite a slowdown in the growth of prices in 2007, the acquisition of an apartment remains increasingly difficult for many families.

As the real estate market is far from saturation, market participants expect further price increases in 2008 and over the next couple of years, especially with regard to office, retail and warehouse premises.

Lingering Soviet influence

Unlike in most western countries, buildings and other structures are not treated as essential elements of a parcel of land in Ukraine, and may be subject to different laws. In this regard, the ownership of land and the ownership of buildings or structures thereon may be treated separately. However, circumstances exist in which Ukrainian law does adhere more to the western model, with land and buildings considered collectively.

Due to the lingering influence of the previous Soviet legal system, buildings are still given more significance than the land itself in the Civil Code. Land is treated like a component of a building, particularly in cases where the land belongs to the building owner. As a result, ownership of a parcel of land on which a building is located transfers to the purchaser of the building where the seller has ownership of both the land and the building.

If the area of the land transferred to the purchaser of a building is not specifically agreed upon in the sales contract, the buyer also acquires ownership of the area of land on which the real estate stands, as well as those parts that are essential to the building's use. However, where a purchaser acquires ownership of a building located on the land of another owner, the purchaser can only acquire a right-of-use on the part of the land on which the building is located and which is needed in order to make use of the building.

Foreign ownership

In Ukraine, the free transfer of real estate is permitted, with the exception of a handful of restrictions, such as that on the permissibility to purchase agricultural land. A moratorium currently prohibits legal entities or natural persons from selling off agricultural land designated for agrarian use, or those who acquired it through privatisation (defined in the latter case as so-called Paj land). In addition, until that time, it is neither permissible to change the designated purpose of Paj land, nor can agricultural land for agrarian purposes be transferred into the capital stock of a business corporation.

Additionally, in accordance with Ukrainian law, land listed as agricultural cannot become the property of foreign natural persons or legal entities. However, agricultural land may be leased by natural persons and foreign legal entities for the purpose of engaging in agricultural activities over a period not to exceed 50 years.

Foreign legal entities may acquire property rights to non-agricultural land within city, town, or village limits, if as they acquire property rights to real estate objects on the land (buildings or other structures) or wish to erect the same for the purpose of conducting business activities in Ukraine.

A particular and somewhat unclear legal situation exists for domestic legal entities held partially or entirely by foreign persons. Ultimately, better arguments support the possibility for the capacity of domestic entities owned entirely by foreign capital to acquire property. Land outside of city, town, and village limits can be acquired by foreign legal entities only to the extent they purchase realty erected on the land.

For foreign legal entities, the purchase of municipal or state property is only permissible if they have a registered representative office in Ukraine.

Disconnected government authorities

Ownership and other immovable property rights, as well as their creation, restriction, transfer, and dissolution, must be registered with government authorities. For example, mortgages are recorded in the Real Estate Registry as real rights. The procedures for registering rights to real estate are prescribed in the law of Ukraine On State Registration of Real Rights to Immovable Property and Restriction of these Rights enacted July 1 2004 (RegRR).

The purpose of the RegRR is to establish a unified registry of rights to real estate, including any restrictions thereto. All previous registries will be amassed in this central registry, which will contain all information pertaining to land and buildings throughout the country. Practice will show whether this central registry will fill the same functions as real estate registries do in some countries (various County Recording Systems in the US and the Grundbuch in Germany, for example).

However, until the Real Estate Registry is established, registration remains in the hands of several disconnected government authorities. Thus, data concerning rights to real estate are recorded in the following state registries:

  • Registry of Real Estate Ownership (but not land ownership)
  • Land Cadastre (registry listing the rights to parcels of land)
  • Registry for Mortgages
  • Registry of Instances where Sale of Real Estate Objects is Prohibited
  • Registry of Legal Transactions

Land designations

A special designation purpose is assigned to every plot of land in Ukraine, meaning that the particular land is zoned only for a specific use. In practice, one must differentiate between the designated purpose of a plot of land and the designated purpose (so-called designated function) of a plot of land in the general plans of the towns and cities.

As treated in general plans (urban planning), land may not have a fixed designation use prescribed by the Land Code, but is categorised according to the designated function prescribed in the ordinances of the building and development committee on a national level. Here, land is divided into three categories: residential, industrial, and recreational, with all the permissible construction objects specifically listed for each of the three categories.

The existence of a designated function means that specific plots of land can only be developed with objects allowed under the general plan. For example, if the Land Cadastre lists a certain piece of land under the category Areas for Residential Complexes and Apartment Buildings and the general plan only refers to the construction of residential complexes, there can only be a residential housing development. In this regard, before an office building can be erected on residentially-designated property, the designated function of the land would have to be revised. This would require adherence with the procedures prescribed for revising the designated purpose of a parcel of land. The respective city council would have to issue a resolution to that effect.

State or private

In Ukraine, the distinction between the primary market (purchase from the state or municipality) and secondary market (purchase from other private entities) is important because different rules apply.

As a matter of principle, municipal or state-owned property is sold by auction procedure, with one exception applying to land encumbered by buildings owned by the buyer, in which case the buyer is entitled to acquire the land directly without an auction or tender procedure. Moreover, after recent changes in the legislation, even lease agreements need to be granted by auction, save for very limited exceptions, for example when the buyer owns a building on the land, or if the buyer holds mining rights with respect to the land plot, for social needs and other.

For foreign legal entities, the purchase of municipal or state-owned property is only permissible with the establishment of a tax-registered place of business for the practice of commercial activity in Ukraine. Moreover, the sale of municipal or state property to foreign legal entities, or to domestic legal entities that have foreign investments, is only permissible with the prior consent of the Cabinet of Ministers and/or the Ukrainian Parliament.

The land price is determined through a land assessment by an authorised land appraiser. The assessment procedure and methods are prescribed in orders issued by the Ukrainian Cabinet of Ministers. Contracts for the transfer of ownership of land must be formulated in writing, notarised, and then registered with the state authorities.

The acquisition of land from other private entities is less restrictive, and the principle of freedom of contract applies.

Whoever gets there first

An agreement conveying a right to possess and use land must be finalised in a lease contract. The lease contract must be in writing and subsequently recorded in the State Registry, with the contract not going into effect until it is recorded in the State Registry. Any use of the land is prohibited prior to completion of the registration process.

A lease contract must address several essential contractual elements, including identification of the lease object, duration of the contract, lease payment terms, conditions and designated purposes allowed in the use of the land, and conditions regarding maintenance of the leased object, among others. Moreover, the lease agreement must contain a couple of attachments, such as a metes-and-bounds diagram of the leased land, a cadastral plan, a survey certificate delineating the land boundaries and a transfer protocol for the leased object. Failure to include mandatory essential elements in the lease contract may lead to a refusal to register and/or to annulment of the lease contract.

The encumbrance of land by mortgage is treated comprehensively in the Law of Ukraine on Mortgages. Land can only be pledged as collateral in a mortgage with a simultaneous pledge of the buildings or unfinished construction objects on the land that is also the property of the mortgagor. Where buildings on the encumbered land are not owned by the mortgagor and a creditor forecloses on the mortgage, the new landowner must honour the building owner' rights-of-use just as they were allowed by the mortgagee.

A mortgage contract must be certified by a notary public, and the mortgage must be recorded in the State Registry. However, until the system is set up completely, these records go to the Registry for Mortgages. Ukrainian legislation adheres to a pure competition theory, whereby the first to record a mortgage has priority. Where a mortgage is not entered into the Registry, the mortgage contract remains effective, but the claim of the mortgagee creditor will not have priority against claims by other persons who have first recorded their interests in the State Registry in the particular piece of land.

Unlike the legal systems of most European countries, under Ukrainian law a pledge at maturity can also be agreed upon, with the result that the mortgage object can fall to the mortgagee creditor on expiration, or that the mortgagee creditor may sell the mortgage object in the name of the owner. A contract agreement on a pledge at maturity, or for private sale, can be arranged in the interim until there is a court decision to enforce foreclosure rights on the land.

Taxation

Land ownership is taxed in Ukraine. Land taxes (literally a land levy and, in an extended sense, a land tax) are prescribed in the Law On Payments for Land, and are payable by the legal entities and natural persons owning the land. The tax rate depends on a formula that is determined annually for a particular land unit (1 square metre or 1 hectare), with the unit used depending on whether a valuation of the land has been performed.

If valuation of the land has been performed, the tax value of the land is calculated according to the size of the area measured in hectares.

Revenue derived from real estate (rental payments) is subject to the general individual income taxation rates. In accordance with income tax law in Ukraine, the income of a natural person is subject to a flat tax rate of 15%. The income of non-residents is taxed at 30%, while the tax on capital income (interest) gains by non-residents is often calculated differently due to international conventions for avoidance of double taxation.

Profit earned by Ukrainian legal entities is taxed at a rate of 25% according to the Profit Tax Law. Revenues of foreign companies are subject to taxation in Ukraine if their activities in the country are permanently established. A permanent establishment of a foreign company is always assumed if it owns real estate in Ukraine.

Gains from real estate transactions are taxed differently for natural persons and legal entities. The income of natural persons from sales transactions regarding residential premises is not taxed, as long as they do not execute more than one sale transaction per year and the total area of the building does not exceed 100 square metres. If the total area exceeds 100 square metres, income from the sale of the property in excess of 100 square metres is taxed at a rate of 1%. If more than one piece of real estate is conveyed within a year's time, any additional revenue will be taxed at a rate of 5%. The income of legal entities from real estate transactions is taxable according to the general provisions of the Profit Tax Law in Ukraine.

In Ukraine, the rate of VAT on sales transactions is generally 20%. There are special rates and exemptions for certain types of merchandise. The alienation of buildings is principally subject to VAT tax in the amount of 20%, although residential property is an exception. It is not subject to VAT except the first time it changes hands after building or restoration.

The transfer of land ownership is not subject to VAT if the land is not transferred as a component of the building. The latter does not occur in real practice, because properties are registered under different regulations.

Fees and levies

The government takes a fee on real estate transactions subject to the notary's certification. In principle, these fees are paid by the natural person or legal entity benefiting (that is, the purchaser), and it is not permissible to formulate a different agreement on this in the contract.

  • The notarisation of contracts involving the sale of houses, apartments, vacation and garden cottages, garages, and other real estate objects that are the property of natural persons is levied with a fee of 1% of the contract value, but not less than the income tax free minimum (Hrn17, about $3).
  • The notarisation of contracts involving the sale of a plot of land owned by a natural person is levied with a government fee in the amount of 1% of the contract value, but not less than the income tax free minimum.
  • For notarisation of a contract on land lease (sublease), a government fee is levied in the amount of 0.01% of the declared land value. Where the value of the land has not been assessed, a government fee is levied in the amount of 1% of the value of the contract, but the fee may not be less than the minimum basic personal allowance.
  • For notarisation of a mortgage contract, a fee is levied in the amount of 0.01% of the value of the mortgaged object.
  • For notarisation of a lease on real estate (sublease) a government fee is levied in the amount of 0.01% of the contract value, but the fee may not be less than five times and not more than 50 times the minimum basic personal allowance.
  • For notarisation of a pledge contract, a government fee is levied in the amount of 0.01% of the pledged object, but the fee may not be less than five times and not more than 50 times the minimum basic personal allowance.
  • For notarisation of a contract on the purchase of property from a government-owned business, a government fee is levied in the amount of 0.1% of the purchased property.
  • A real estate auction (but not a foreclosure auction) of property belonging to a natural person is levied with a government fee in the amount of 1% of the sales value of every real estate object that is auctioned off, but not less than one minimum basic personal allowance.
  • On acquisition of a building, a fee that goes to the nation's Pension Fund is charged in the amount of 1% of the contract value in addition to the government fee.
Author biography

Dr Julian Ries, Partner

Beiten Burkhardt Kyiv

Dr Julian Ries joined Beiten Burkhardt's St Petersburg office in 2004, his practice focusing on corporate and commercial law. In 2006 he moved to the firm's Kyiv office, where he leads the firm's real estate practice group. Julian's professional experience before Beiten Burkhardt includes tenure with Blaum Dettmers Rabstein in Bremen, Germany, between 1999 and 2004.

Dr Ries has substantial experience advising large international companies on transactions in the CIS, including corporate, M&A and tax structuring projects. He completed a doctoral thesis on Russian corporate law, during which he enhanced his knowledge of law in emerging markets through internships with Andersen Legal, Moscow in 1999, and Clyde & Co, Hong Kong, in 2000.

Dr Julian Ries is fluent in German, Russian and English.