Dangerous liaisons

Author: | Published: 1 Aug 2007
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As a result of its rapid democratization (both political and economic) and its incentives to attract investment on a scale never witnessed before the 2004 Orange Revolution, Ukraine has become a highly attractive market for investments with foreign capital, particularly investment in real estate. Russian, Austrian, British, Irish and German investors have already discovered the benefits (and drawbacks) of investing in Ukrainian real estate. The real estate sector is the second largest sphere of investment in Ukraine, with $385.3 million of direct investment in 2006. (Investment into financial activities was the largest, amounting to $993.9 million in 2006.)

Real estate investment in Ukraine shows a specifically urban pattern: over 90% of foreign investment in real estate was concentrated in urbanized parts of the country: 24.3% in Kyiv, 10.5% in Dnepropetrovsk, 3.7% in Donetsk and 2% in the western Ukrainian city of Lviv.

Within this concentration of real estate investment in and around Ukraine's main cities, a distinct set of real estate properties that attract foreign investments can be determined. Investment is directed primarily towards:

  • Office space, in particular in Kyiv, as western-style office real estate in Kyiv and other cities is scarce.
  • Residential (apartment) space, due to the high and ever-increasing return on investment;
  • trade centres and shopping malls.
  • Hotels.
  • Warehouses, especially on the peripheries of the main cities.

The availability of real estate properties in Ukraine, in particular western-standard commercial and residential space in the main cities, remains low, but demand from local and foreign investors is rising, resulting in a steady increase of real estate prices.

Land is still a highly complicated object of investment, especially due to some recent legislative amendments directed at retrenching illegal (agricultural) land transactions involving, for example, the illegitimate change of the purpose of the land from agricultural to construction in contravention of the related moratorium. In an attempt to remedy these illegal practices, the moratorium on the sale of agricultural land was widened and extended in 2006, the result of which is the complete prohibition of the sale and purchase of agricultural land that is state (municipal) property, as well as the complete prohibition of the alienation and change of the purpose of agricultural land in private ownership. This moratorium will be lifted on January 1 2008, on condition that a new act on the land register comes into force and the establishment of a land market accommodating the circulation of agricultural land. (The new land register should provide detailed information regarding registered land plots. However, it is still under formation.)

In practice, investments in real estate in Ukraine may be undertaken by means of:

  • Direct acquisition of real estate.
  • Investment in a building.
  • Acquisition of shares in a legal entity that owns real estate.

Direct acquisition of real estate

A characteristic of the Ukrainian legislation on real estate is the absence of the common legal principle of superficies solo credit. So the owner of a building may be different from the owner of the land on which the building stands. It is in the light of this characteristic that the real estate legislation clearly distinguishes between real estate in the meaning of buildings (or parts of buildings) and that in the meaning of land, each adhering to a distinct regime of acquisition and governance.

While foreign individuals or legal entities enjoy the same rights as Ukrainian individuals or legal entities with respect to the acquisition, ownership, use and disposal of buildings, the rights of foreign individuals or legal entities to land are limited. As a rule, foreign individuals or legal entities may not acquire or own agricultural land. With respect to non-agricultural land (such as land for construction or other purposes), foreign individuals may only acquire property rights to land: (i) within the boundaries of urbanized settlements; and (ii) outside the boundaries of urbanized settlements, on which a building or other construction that they already own is situated. Similarly, foreign legal entities and legal entities with foreign capital (that is, an enterprise whose registered capital is made up of at least 10% foreign capital) may only acquire property rights to land: (i) within urbanized settlements if the purchase or construction of buildings is destined for the commercial activities of the foreign legal entity or legal entity with foreign participation; and (ii) outside the boundaries of urbanized settlements, on which a building or other construction they already own is situated.

Real estate is most commonly acquired in Ukraine on the basis of a civil contract, that is, for instance, a sale-and-purchase contract. According to Ukrainian legislation, a sale-and-purchase contract of real estate must be concluded in written form and is subject to notarization and state registration. Upon notarization, a state duty of 1% of the total value of the contract (but not less than Hrn17) must be paid to public notaries. Private notaries tend to request substantially higher notarization fees.

Before the acquisition of real estate, the buyer is highly recommended to conduct real estate due diligence pertaining to the object, by researching and gathering as much information as possible concerning the object, and assessing the full extent and scope of the transferable property rights. Obtaining this information is often difficult and cumbersome in Ukraine. Due to the lack of publicity and accessibility of the two existing registers (that is, the register for land and the register for other real estate such as buildings), the seller's cooperation regarding the verification of all required information on the real estate object is in practice essential, as only the owners of real estate, authorized state bodies, notaries or other officials who require the information to provide professional activities have access to the registers.

A characteristic of the risks in the Ukrainian real estate market is the remaining doubtfulness of many property titles on real estate objects. Among others, despite the fact that the 1991 Act on the rehabilitation of victims of political repressions in Ukraine asserts that real estate that was lawfully acquired by an investor may in principle not be restituted and that applications for restitution should have been filed within three years a of the adoption of the 1991 Act or as of the rehabilitation of the natural person, and the fact that the Land Code provides that persons (or their successors) who owned the land before 1992 may not claim restitution of that land, the risks of restitutions (or similar claims) cannot be fully excluded (for instance, due to the possibility to initiate a lawsuit regarding the determination of the property rights to an object of real estate).

It is crucial that the seller provides the buyer with the following documentation concerning the real estate to be purchased:

  • The deed of property title, confirming the seller's rights of ownership to the given real estate. For land, the deed of property title takes the form of a (properly registered) state act issued by the state committee of land resources and established in a form specifically prescribed by the legislation. Legislation does not provide the specific form that deeds of property title on buildings should bear. Consequently, the property title on buildings may be found in a diverse range of documents, including sale contracts, deeds of gift, barter contracts, judicial decisions on the recognition of ownership, certificates of ownership issued by local authorities, and certificates of acquisition of real estate by public tenders.
  • An extract from the Register of ownership rights to real estate (for buildings), which must be produced before the notary public when concluding the sale-and-purchase contract concerning a building. The extract from the Register of ownership rights to real estate contains detailed information concerning the building and its technical characteristics (for example, condition of the premises, dimension of the habitual and non-habitual areas in the premises, or information about the eventual reconstruction of the premises). Although the extract from the Register and the deed of property title might contain the same information, their function is different: the deed of property title represents the title of ownership of a given person or entity on a given real estate object, but the extract from the Register contains the specific technical characteristics of the real estate object. No extracts from the Register of ownership rights to real estate may be issued for land.
  • A certificate from the State Register of mortgages or a certificate from the Unified Register of prohibitions of the disposal of immovable property, as the case may be. These certificates confirm the absence of mortgages, arrests, liens and other encumbrances on the real estate and may only be obtained through the notary public for a certain fee, varying between Hrn40 and Hrn100. The certificate from the Unified Register of prohibitions of the disposal of immovable property may be obtained from the State Information Centre (an enterprise owned by the Ministry of Justice of Ukraine) for a fee of Hrn34.

Upon the notarization of the sale-and-purchase contract, the notary retains the initial deed of property title to ensure that the seller does not enter into any further sale-and-purchase agreements for the same property. The signed and notarized sale-and-purchase contract will serve as the new deed of property title, which will only come into effect and be valid upon the state registration of the real estate. State registration for buildings is undertaken by the Bureau of Technical Inventory and for land by the State Centre of Land Cadastre. The duty to register the new deed of property title lies with the buyer, who will become the new owner of the real estate from the moment of registration of the deed, that is, the date the Bureau or State Centre applies the stamp of registration.

The acquisition of real estate owned by the state or municipal bodies, that is, privatization, is governed by specific rules, including the Act on privatization of state property, the Act on the lease of state and municipal property, the Commercial Code and the Land Code.

Investment in real estate projects

Investment in real estate projects by foreign investors in Ukraine is increasing. As an alternative to the acquisition of existing real estate objects, foreign investors are building commercial or residential buildings on their own initiative. Investment in buildings through their construction avoids some of the risks connected to the lack of information on existing real estate that is being purchased, but the development of real estate projects places other burdens on the investor, especially foreign investors.

Before starting building plans for commercial or residential building projects, it is highly recommendable to thoroughly analyse and study the urban and territorial planning and zoning plans, to determine whether it is possible to build a certain type of building in a certain urban zone, the maximum number of storeys, the distance to be observed between adjacent buildings, the architectural style, and whether it is possible to construct parking lots.

Construction may only commence subject to the obtaining of the following permits:

  • A zoning permit is a permit by which the competent public authority approves the future construction on a given land plot. Contrary to some other countries, the zoning permit is not connected to or issued for a given construction but represents the public authority's general consent to a construction project being realized on the given land plot. The zoning permit does not confirm property title to the land for the investor and does not authorize the investor to initiate building work.
  • A construction permit constitutes a right for a given developer to build a given construction on the land plot. The competent authority issues the construction permit to an individual developer on the basis on its examination of the technical and architectural specifications of the intended construction, as described in the detailed technical documentation. Upon the approval of the technical and architectural specifications and the issuance of the construction permit, the specifications must be complied with throughout the construction. Foreign entities may only receive a construction permit upon the establishment of a branch office or any other kind of commercial representation in Ukraine.
  • An occupancy permit is an authorization allowing for the use of the building under certain given conditions and for certain given purposes, and serves as a basis for the registration of the ownership rights and for the use of the building. The occupancy permit is issued on the basis of the work documentation that the developer must elaborate and that the State Technical Commission must approve. Upon approval, the State Technical Commission issues a technical passport for the building.

Due to the lack of available land in urbanized areas, foreign investors investing in commercial building projects face a number of specific issues.

Land plots that are suitable for commercial building projects in urbanized areas are either owned by private owners or by municipal bodies. This results in increased prices for land, due to the great demand for and low availability of land on with a commercial building may be erected and the thorny negotiations needed to free up the land for a private building project.

Municipal bodies not rarely refuse to issue a zoning permit on the basis of the intended general characteristics of the building, even though the private developer duly purchased the land on which the building should be erected.

Also, agreements pertaining to commercial building projects concluded with municipal bodies are relatively difficult to enforce and their execution is, to a certain extent, unforeseeable.

A common, and less risky, involvement of foreign investors in Ukrainian commercial building projects is participation in projects that have been initiated by Ukrainian investors and developers, where the matter of the land allotment has already been resolved. However, foreign investors are highly recommended to make diligence a priority when selecting the local Ukrainian partners in whose building projects they will participate. Due care and caution should be demonstrated towards schemes of investment participation that are not fully transparent and lucid in terms of asset allocation, return on investment and ownership rights.

While there are, in practice, few noticeable inconveniences regarding investment by foreign investors in residential building projects where the investment is being carried out with own capital, other forms of financing have been more problematic. Schemes whereby a developer collects advance payment from private individuals and legal entities for apartments in a residential development have been subject to widespread fraud and corruption. In this context, recent changes in the investment legislation in principle rule out the possibility of financing a residential building project through capital collected from a group of private individuals or legal entities.

With the aim of protecting investors contributing financial means for the realization of a residential building project, the financing and investment into residential building projects should be undertaken through:

  • Finance funds, which are capital funds established by financial institutions and managed by a bank or another financial institution with the aim of financing a residential building project, followed by the allocation to investors, that is, contributors to the fund, of apartments in the building upon its completion.
  • Real estate operation funds, which are created by financial institutions and managed by an issuer of certificates of the fund (or by other financial institutions to which the issuer entrusts its functions). The issuer invests the capital collected from the sale of the fund certificates, which confirm the right of their owner to a certain portion of the profits from investments in real estate operations.
  • Joint-venture funds.
  • Private pension funds.
  • Mortgage-backed securities.

Buying an entity that owns real estate

Another option for the acquisition of real estate is the acquisition of 100% of the shares in a Ukrainian company that owns real estate. Further details regarding the acquisition of a company in Ukraine are outlined in the chapter on mergers and acquisitions in this guide (see "Triumph against adversity", page 21).

Risky business

Foreign investment in real estate in Ukraine is increasing steadily, but this investment remains risky. Whether undertaken through the direct acquisition of existing real estate or through the realization of a real estate project at the initiative of the foreign investor, and whether or not jointly with other investors, the remaining obstacle in Ukraine is the accessibility to and availability of (correct) information regarding real estate. The ever-present bureaucracy, favouritism and corruption with respect to the permits and documents required to realize development and construction projects impedes the transparency, and potentially the potency, of the real estate market in Ukraine.

But the real estate market in Ukraine is booming at a greater rate than ever. Real estate, especially commercial and residential real estate in urbanized areas, is becoming a favourite investment target for foreign investors, and the capitalization of real estate transactions is increasing exponentially year after year. The high demand for western-style real estate in Ukraine's major cities against low availability is swelling real estate prices, augmenting a return on investment at rates greater than anywhere else in Europe.