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Retail evelopment is “just starting to bubble” in post-communist Ukraine

By Curt Hazlett

Misery has hounded Ukraine through much of its modern history. Josef Stalin forced the dissident Soviet republic to its knees in 1933 by engineering a famine that killed over 6 million Ukrainians, and a decade later an additional 7 million died in battles between the German and Soviet armies on Ukraine’s soil.

Years later, when the collapse of the Soviet Union brought the promise of prosperity to former Soviet bloc nations, Ukraine continued to suffer. Flourishing corruption and economic instability made life hard, especially when the country’s inflation rate exceeded 10,000 percent in 1993.

Now Ukrainians are hoping the hard days are past. Tighter fiscal policies have brought inflation down to a relatively low 11 percent, a reformist government is in power, and officials hope to create a closer relationship with the European Union and eventually gain membership. Among the signs that life is getting easier is this: A Kiev newspaper now runs an annual competition to select the city’s best supermarket — remarkable in a nation where privation was once the standard.

Helped by ample mineral and agricultural resources, Ukraine’s economy is coming on strong these days. Real incomes rose 19 percent in 2006, while unemployment fell to 3.2 percent. Preliminary estimates put gross domestic product growth for the year at 7 percent. All of this is making Ukraine a prime location for retail development. “The word I use to describe Ukraine is ‘velocity,’ ” said Peter O’Brien, country representative in the Ukraine for German developer ECE Projektmanagement, which has 89 shopping centers across Europe, with 19 more in the planning or construction phase. “In terms of retail, it’s just starting to bubble right now.”

So far it has been a relatively quiet revolution. “There are a lot of people who underestimate Ukraine,” O’Brien said. “They look at where it is today and think it’s five years behind Poland or several years behind Moscow, but they miss how quickly it is developing. In five years I think it will be one of the vanguard countries in terms of retail development in Europe.”

Unheralded or not, the retail market has been upwardly mobile. In a 2006 report on Ukraine’s prospects, Danish retail consulting firm KOBA notes that retail sales through June rose 27 percent year on year. Dragon Capital, the leading investment banking firm in Ukraine, says in a 2006 market overview that Ukraine is the fastest-growing retail market in Central and Eastern Europe. The KOBA report says that outside Kiev “all cities with more than 1 million inhabitants are becoming more and more interesting for retailers and developers due to low competition in the market and also due to increasing income of the residents.” There are five such cities in Ukraine, a country of 48 million people that is geographically slightly smaller than Texas.

Foreign investors, seeing a still-untapped opportunity, have been eager to put their money behind Ukrainian projects. Through September foreign direct investment totaled over $3 billion, three times the level of a year earlier, and the government reported in mid-November that foreign banks had invested $385 million in real estate of all types for the year thus far.

Along with the money come international managers like ECE’s O’Brien, who moved to Ukraine in 1998 because he wanted to gain international experience. The native Californian and former real estate manager for the San Francisco-based Una Mas Mexican Grill restaurant chain spent the next few years as an independent contractor working on Ukrainian real estate projects. Then he earned an MBA from the prestigious INSEAD business school in Fountainebleu, France. He joined ECE at its new Kiev office last year and is working to identify development opportunities.“We’re hoping to do as many quality transactions as we can,” said O’Brien, who is 37. “We’re looking to be a major player in this market, and we’re working as fast we can to close deals.”

ECE isn’t the only one to see value there. In December Ireland’s Quinn Group bought 93 percent of the Ukraina department store, a nearly 400,000-square-foot center in downtown Kiev. The seller was New York City hedge fund NCH Advisors. Others said to be looking at development opportunities include Poland’s Echo Investment, the U.K.’s London & Regional Properties, the Netherlands’ Multi Development and Hungary’s Trigranit Development. “My sense is that anybody who has been a major player in Central and Eastern Europe is looking seriously at this market,” said O’Brien. Along with development interest has come an influx of foreign brands to Kiev and the other large cities. Marks & Spencer recently announced the opening of a franchise store, and such brands as Burberry, LVMH and Roberto Cavalli are well entrenched. Most of Ukraine’s recent developments have been supermarket-anchored neighborhood centers. The largest builder of supermarkets and hypermarkets is Ukraine’s Fozzy Group, followed by another Ukrainian chain, ATB-Market. Two leading German retailers, Rewe and Metro, have just entered the market.

As development gains momentum, the projects are gaining size and sophistication. “There are a lot of second-generation centers that are much closer to a modern international standard, and there is a growing number of third-generation centers,” O’Brien said. First-generation centers are generally smaller than 100,000 square feet, he says, while second-generation ones are often double that size, and the third-generation centers are even larger.

In the western city of Lviv, for instance, the Ukrainian Intermarket supermarket and discount chain is building a 1 million-square-foot, hypermarket-anchored center that will house about 130 retailers, some restaurants, a cinema and a bowling alley. In Kiev Lithuania’s Hanner Development is aiming for a first-quarter opening of its Olympic Plaza, an enclosed, 114,000-square-foot retail center downtown. Many of Ukraine’s older shopping centers date from the Soviet era and suffer from the gray, institutional feel common to that time. There are exceptions, sometimes grand ones. In Odessa, the Passage — a combination shopping center and hotel built near the end of the 19th century in the city’s old downtown — still draws shoppers and tourists with its elegant architecture.

Another vestige of the Soviet era is bureaucracy. Swedish retailer Ikea’s plan for a $400 million Mega mall in a Kiev suburb has been delayed by a dispute with local government officials over the location. And Lybid Plaza, another large downtown project, conceived six years ago as Kiev’s first mall, has failed to get beyond the pouring of its foundations because of property disputes and cost overruns. The majority owner, Hungary’s Transelektro Group, sold its interest in December to an unidentified Ukrainian buyer.

Whatever the obstacles, though, the demand for modern space is fueling a hot market. O’Brien says the owners of prime real estate that could be of interest to developers are holding out for top prices. “If you’re a developer, the issue is acquisition of land,” he said. “At this point you are competing against some very capable and well-financed Ukrainian developers, and if you can beat those guys, there is a full plate of international completion. If you are buying completed assets, the issue is lack of supply.” Yet there seem to be good reasons to deal with the shortages and tough negotiations. According to Dragon Capital, modern retail accounts for less than 5 percent of nationwide retail trade, indicating a strong upside for those firms building international-standard projects.