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Retail Property Market of Ukraine: Crisis Tendencies

The year of 2008 appeared to be critical for the retail property market as well as for other real estate market segments in terms of changing development tendencies. The forecasts of the beginning of 2008 and the actual market situation at the end of the year and the beginning of 2009 differ significantly. The 2008 results moved Ukraine down to position 17 in the A.T.Kearny Trade Development Rating from position 5 in 2007. This reflects to a considerable extent the changes on the retail trade and retail property  markets and can be considered as an important indicator of Ukraine loosing its attractiveness for international players. Previously, the demand for trading space used to exceed the supply in the capital city and on most regional markets, but today the situation turned to be different -  the supply available is not completely consumed by the market. The change of the demand-to-supply ratio increased the share of vacant spaces in trade centres. For example, vacant spaces in some trade centres in Kyiv make today a third or even more of some floor areas. 

What caused the current market situation? How did the economic crisis influence the retail property market?

The retail property market is characteristic for the crisis aspects common for all market segments as well as for its specific crisis reasons. One of specific features of the retail property  market is that besides the lessee and the lessor there is another important player on the market - the buyer who comes to spend his/her money to the shops located on the rented areas. UAH devaluation followed by higher prices for imported goods, reduction of people’s income, mass unemployment, almost completely curtailed crediting of consumers and future uncertainty resulted in reduction of consumers’ disbursements for buying different types of commodities. This became especially painful for the trade agents selling durable goods and non-first-priority goods (domestic appliances, footwear, expensive souvenirs, cosmetics, jewellery, clothes, etc.). The food stuff trade operators, as well as operators working in the entertainment and fast-food industries encountered a smaller commodity turnover reduction. Cinemas many of which declared increasing incomes during the crisis period make a separate group. In general, the population tends to spend less with their disbursements being re-directed towards cheaper goods and first-priority goods. 

In the situation of reduced commodity turnover and increased costs of business supporting, many retailers who rent their trade space found themselves unable to pay the pre-crisis rent rates. Moreover, in many cases the rent was set in hard foreign currencies which should have increased significantly its UAH equivalent. But most of retailers receive their incomes in UAH and not in hard currencies. A considerable number of trade operators have also to deal with their high debt burden, serious difficulties in re-financing of current debts and actually complete inaccessibility of financing via previously engaged channels (credits, foreign loans, corporate bonds). This has already resulted in technical defaults of a number of network operators on their public obligations, failures to return credits and initiated bankruptcy procedures of some networks, as well as activated merging and overtaking processes among the market players especially in food stuff retail.

The above mentioned problems have considerably curtailed development programmes for trade and entertainment operators who had to move their accents from quantitative presence on the market towards selective quality projects. Before the crisis most operators  used to have their own large-scale development programmes  funded to a considerable extent by credits and implemented according to the principle “to occupy a market vacancy as soon as possible”, but now only some operators, mostly foreign ones (e.g. Metro, IKEA) declare they keep supporting their network quantitative development programmes. The others intend either to cut their presence especially in the regions, or to open separate shops and close at same time unprofitable objects.

The mentioned reasons have resulted in serious recession in demand  for retail space and accordingly in changing the current market balance.  All this could not leave the rent rates unaffected. Since the beginning of 2008 the rent rate upturn had been observed for some period. For example, rent rates in prestigious capital city trade centres increased by one third by autumn 2008 and reached $US 150-200  per one square metre (for shopping mall operators). 

After the active phase of the economy crisis phenomena began, the rent rates rallied. The above described problems, and the UAH devaluation in particular, have resulted in the process of re-considering agreement conditions by the lessors and the lessees concerning at least a reduction of the rent rate value. Today it’s possible to speak of  the rent rate decrease. The rate value depends on a number of factors -  success and professional level of the trade centre, particular region and city, specific location in the city, operator, availability of agreements, lessor’s readiness to make concessions, etc. However, a more substantial rent rate reduction (often twice lower than the pre-crisis level) is observed in the regions than in the capital city. A more substantial rent rate reduction and growth of retail space vacancies is also typical for non-professional retail objects the lessees of which have experienced a more critical decrease of purchasing force in the crisis conditions. Cases have been observed on the market when the lessors were ready to prolong the rent for anchor lessees only for paying operational costs and staying further in the same retail location.

Besides the rent rate level, basic agreement provisions have also changed. UAH devaluation resulted in the fact that a considerable part of agreements turned to be concluded in UAH instead of hard foreign currency as previously, or if in hard currency – with a fixed exchange rate for a specific period of time. Calculating of the rent rate as a per cent of the turnover has been actively discussed recently and is already applied as a way to distribute the turnover reduction burden between the lessee and the lessor which is widely used on European markets. In other words, lessor’s dictation on the market is being replaced by a situation when the lessor has to try all possible ways to build a partnership with the lessee in order to survive hard times or just to accept lessee's conditions in order not to find himself or herself  abandoned with empty retail rooms.

Investment deals on the retail property market in 2008 are worth mentioning in a short way. They were not that numerous but it looks comforting, however, that such deals were concluded not only on the capital city market. It’s understandable that the deals had been concluded before the industry faced the crisis. Thus, the Davento company bought the Alta-Centre  retail centre in Kyiv (GLA – 17 thousand m2) for about $US 50 million, the British investment fund Meyer Bergman Europian Retail Partners bought the Kyiv trade and entertainment centre Alladin (GLA – 10.2 thousand m2) for about $US 60 million. The City Centre trade centre was sold in Mykolaiv and the AVE PLAZA trade centre that is still being constructed was sold in Kharkiv. As the result of the crisis phenomena, the capitalization rates on the market have considerably increased to attract the potential investor to buy the objects, however, the lack of realized high quality projects is still observed as previously.

The situation on the new objects development market also looks quite complicated. The total area of the retail centres in the capital city reaches 450 thousand m2.   According to Colliers International, the index of retail area availability in Kyiv is 170 m2 of rented area per 1000 inhabitants. To compare,  in Budapest – about 1000 m2, in Madrid – 820 m2, in Warsaw - 770 m2, in Berlin -  340 m2. In 2008 only few retail centres with total trade area of  80 thousand m2 were opened in Kyiv which is less than planned for 2008. Launching the first Auchan Network hypermarket in Ukraine is worth mentioning in this connection. There are about 300 retail centres in Ukraine so far with total rented area of 2.7 million m2,  the retail area having increased by 647 thousand m2  or by 32% in 2008.

For developers the retail and retail property market crisis has manifested itself in recession of the demand for new objects and accordingly in difficulties to fill up the new retail centres. However, the credit challenges had even more serious impact on development of new objects. For the recent years many developers and investors were keen-set on large-scale projects often financed by external sources, in particular by  bank credits. In the circumstances when it became impossible to attract such funds, construction of many objects appeared to be frozen especially of those that had just been started.  The developers started focusing on the objects that needed less funds to be completed. The others try to address the challenge by dividing their projects into separate smaller portions and finishing them one by one.  Projects financed by foreign investors, especially by major international distribution network companies are to be discussed separately. The crisis has less affected a considerable part of such projects and their construction in most cases is going on.

Many national developers have to re-consider their portfolios offering a part of their projects for sale. For example, the XXI Century real estate development company had to sell the Quadrat Trade Centre project in  Balzac Street in Kyiv. Many projects of building retail centre networks all over Ukraine have been suspended until better times or, probably, even cancelled forever (e.g. projects of retail distribution networks Caravan, Dafi, Miriada were previously announced and implemented). In other words, besides settling their debts, the developers have to focus on finalizing their almost-completed projects, selling a part of their assets and curtailing their large-scale plans for some time.  

Further development of the retail property market will depend to a considerable extent on the situation in economy in general an on the situation in retail in particular. Should people’s incomes keep falling and UAH devaluating, the number of distribution networks might be contracted and some separate retail centres might be closed, first of all those selling non-first-priority goods and particularly those importing their commodities. It might be forecast that accents would move towards the operators dealing with cheaper goods and that the product choice set in the national retail would reduce. In this respect, the regions will suffer more. Many companies will have to return several years back when they operated mostly in the biggest cities. Only few of them will open new shops in small towns though several years ago many operators used to point out their intentions to develop the hinterland. Commitment to well-reasoned presence will make many companies close inefficient shops and implement only well-judged projects. For most retail objects this will act as a catalytic agent for building up their professional profiles. In fact, non-professional objects used to be also successful in terms of occupancy rate and rent rate in conditions of market disproportion. These will suffer most from the crisis. The professional objects will be able to preserve more buyers and accordingly will have to reduce the rates by smaller values. The most inefficient retail objects might face shutdowns especially those abandoned by anchor lessees.

Due to reduction of people’s incomes the interest of many international retailers in the Ukrainian market might fade away.

The rent rates will keep falling in the medium term and will differentiate depending on each particular operator status as well as on the flow of buyers in each particular retail centre. It could be expected that the method of calculating rent rates as  a per cent of retailer’s turnover will spread.

On the retail property development market one can expect that developers will try to finalize the almost-completed objects (in case the relevant financial resources are available). Most of the objects that find themselves far from being completed by the midst of the crisis will remain frozen due to the lack of funds and their occupation uncertainty in the medium term.  Launching new projects in the medium term can occur sporadically. There is also a low probability of implementation of large-scale projects in the short term.  Developers will try to divide the large-scale projects that have already been started into smaller phases. Implementation of minor projects being in demand in one or another particular region is much more probable. Developers and investors will pay much more attention to working out the project in general and the object concept in particular. After all, the crisis will prove that objects created professionally suffer less than those implemented carelessly.

Many international players will lose interest in implementation retail projects in Ukraine due to reduction of the rent rates with the previous risk level remaining the same. However, completed objects will enjoy a high level of interest but they will be in short supply on the market as previously. The market might be abandoned by some companies who practised retail property development as only one of many fields of activities, in particular subsidiaries of some national financial and industrial groups who planned to develop distribution network retail centres. In this respect, foreign players who have already come to the market and implemented or are implementing some retail projects, and who know the specificity of the national market and are not going to leave it, but vice versa intend to further develop their project portfolios will have significant advantages. In the longer term, when in the course of its economic development the Ukrainian economy enters a growth phase, the companies who are launching their projects now will enjoy additional advantages as they will be able to supply the market with their objects in conditions of demand-to-supply misbalance that might occur in future due to the lack of supply of new objects. Most of the players planning new objects will first of all focus on the capital city and other biggest cities.

On the reverse side of the crisis strong players might find a possibility to occupy/increase their market shares against weakening of their rivals. Strategic investors who understand cyclicality of the real estate market development will find profitable possibilities in the medium term by buying land and projects for implementation due to serious drop in prices on the real estate market. The players with the necessary liquidity will take an advantage of such possibilities.

Due to the crisis, the real estate market of Ukraine is and will be in future a catalytic agent for professional construction and operation of retail objects, will correct the incredibly overstated rent rates, will clear the market of occasional players, will provide the strategic players with good chances to enter new high quality projects and will allow to preserve its attractiveness for investments.