Risky Business

Economic News

22 Jul 2010
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A real estate scandal dominating headlines in recent weeks has served as a fresh reminder that investment in Ukrainian bricks and mortar is not an entirely risk-free affair - even if returns can sometimes be impressive.

Now, however, Kiev city authorities and some 1500 customers of the now infamous Elite Centre construction project are engaging in some damage limitation. Some $100m was likely stolen by fraudsters, who had persuaded many to put money upfront into this residential housing project. Each investor has now lost an estimated $45,000-60,000.

The local media are asking what can be done to prevent similar scams in the future.

Advance payment plans are very common in a lucrative residential property market, with many buyers enticed by considerable discounts offered by real estate developers for 100% down payments.

The Elite Centre scandal has, however, exposed legal loopholes and a poor level of scrutiny of industry participants. The fraud started to unravel in early February, when regulators apparently wanted to check the activities of what has turned out to be a fake company.

The principal suspected organisers of the Elite Centre financial scheme, Oleksandr Volkonskyi and Oleh Shestak, have since fled the country with some $100m, which they had managed to collect by often selling the same property several times.

The two of them, allegedly, invented a scheme whereby owners were sold special construction bonds in exchange for property rights to an apartment. The Elite Centre promised to build four exclusive, residential, multi-storey buildings in desirable Kiev locations.

The project was backed by reputable banks and investors, who had apparently received all the usual guarantees and assurances. But the company, it transpired, did not invest anything into construction and instead resold the rights to apartments to several owners.

Both President Viktor Yushchenko and the mayor of Kiev, Oleksandr Omelchenko, have initiated investigations into the affair and are seeking to repair the damage.

At Yushchenko's behest, the Ministry of Construction, Architecture and Housing and Utility Economy is now launching a state register of investment agreements to avoid the double sale of apartments.

The authorities are also investigating all of the construction companies related to the Elite Centre and have managed to arrest some people involved in the management of the company.

Meanwhile, critics have accused the city authorities of complicity with the Elite Investments scam. Vitaly Klichko, former world heavy weight boxing champion now turned politician, has criticised the city authorities for their negligence.

"Advertisements about the Elite Centre company group's activity could be found all over the place," Klichko was cited as saying on the web site of the political party, Pora. "The construction documents concerning the land parcels allotted to the Elite Centre had been signed off by Kiev officials. That was the reason why the authorities of the capital couldn't have failed to know about [the Elite Centre]."

In a recent interview with OBG, Klichko, who is running both for parliament and the mayor of Kiev post at the end of March, said the biggest problem in Kiev today is corruption. Most real estate industry participants admit that graft is rife, largely because of the 400 or so signatures that need to be collected to get a real estate project up and running.

The overly burdensome bureaucratic process, they say, needs to be simplified, with an introduction of a one-window system.

Meanwhile, as the police investigation intensifies, with an international arrest warrant being issued for the two suspected fraudsters, real estate market participants are wondering if the affair will have any knock on effect on the somewhat heated residential property market.

Some real estate market brokers believe that the top end of the residential estate market is about to peak. Most buyers in this exclusive segment are primarily investors who hope to make gains on the appreciation of their assets.

However, if the feverish growth stops and demand falls off due to any political or economic shock, these people may find it difficult to secure the level of return they had initially hoped for. That could result in a market correction.

The prices of residential properties, however, keep rising and are now approaching the same level as Prague and Warsaw, testimony to the market's tight supply.

According to the Ukrainian real estate portal, Nerukhimost, the average price of one square meter in a primary market of a one-bedroom apartment in downtown Kiev this week reached $3205 - some 15.2% higher than the previous week. A lull however has been detected in the overall average price, with prices per square metre of a one-bedroom apartment sliding by 0.5% in January.

The Association of Realty Experts of Ukraine, however, believes that the prices of residential real estate will not be affected by the Elite Centre scandal.

Real estate market bulls point out that although the affair may well damage investment confidence and raise the level of scrutiny in the future, there is still a lot of heat left in the market and with a new wave in mortgage finance, demand will continue to exceed supply.

The National Mortgage Association recently published a report showing that the total volume of mortgage credit has doubled in the last year, reaching $2bn, or 2% of the country's GDP.

While an increase in mortgage finance will help to offset the fall in demand from more cautious investors, the main victim, market-watchers say, is trust. This may translate into a slowdown in construction and thus an even tighter supply of new properties. By this logic, prices will indeed stay up, but at the cost of a slower development of an otherwise very promising real estate market in Kiev.

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