Nicholas Watson in Prague -

Western investors have an opportunity to gain exposure to the roaring Ukrainian property market when the largest Ukrainian IPO to date, the real estate fund Dragon-Ukrainian Properties & Development, begins trading Friday on London's Alternative Investment Market.

Dragon-Ukrainian Properties, the real estate arm of Kyiv-based investment bank Dragon Capital, sold on May 16 around 95% of the shares in the real estate fund to a variety of hedge funds and propriety trading desks of major investment banks. These shares, priced at $2 per share, will start trading on AIM, the London Stock Exchange's market for smaller growing companies.

Dragon-Ukrainian Properties says it plans to invest the money raised in new commercial properties as well as in the redevelopment of existing properties in Ukraine. The company's initial investment and development activities will focus on Kyiv and Kyiv oblast (region), as well as other major regional centres in the country where the population exceeds 700,000.

The board says it's targeting a dividend yield of 7-10% per annum at the placing price. If the Ukrainian property market continues its meteoric rise, that won’t be hard to achieve.

Office space

Like property markets throughout Central and Eastern Europe, Ukraine's is booming; and Ukraine's is probably booming more than most. According to recent surveys, residential prices in the capital Kyiv have risen an astounding five times in value over the past three years, while those of commercial property grew about four times.

Unsurprisingly, this kind of growth is attracting the attention of more and more foreign investors. Just in the past month, US shopping centre developer Developers Diversified announced it's entering the Russian and Ukrainian markets through a $1.2bn joint venture with Hamburg-based developer ECE Projektmanagement. And Austria's Immoeast raised €2.8bn via a capital increase to fund its existing expansion programme in its core markets of Russia and Ukraine. Another big Austrian developer, Meinl European Land, made its first big investment at the beginning of this year, putting €150m into a new shopping centre in Odessa.

On the drawing board

The reason behind the massive price increases are several-fold. First and foremost, there's simply a dearth of decent office space in Kyiv and other major cities. The vacancy rate of Class-A offices is just 1.7% in Ukraine, compared with a European average of about 10%. Ukrainian News reported that in April alone the average price for class-A premises on the Kyiv office realty market rose by 2.2%, or $82.20, from the month before to $3,835 per square metre.

"The penetration in any segment of commercial real estate - retail, office, warehouse, hotel - as a percentage of GDP or per capita is 3-5 times below that of Central Europe," says Tomas Fiala, the managing director and founder of Dragon Capital, whose private equity division will act as investment manager to the real estate arm, responsible for identifying, structuring and executing investment opportunities for the fund.

Then there's shopping. Like their Russian cousins, Ukrainians have taken shopping to their hearts and shopping malls have been springing up to cater for the consumerism that's rising along with incomes and credit availability. This is opening up a huge, relatively undeveloped market for retail developers.

And there are good reasons to think this property boom will continue.

"Yield compression, from approximately 20% four years ago to 9-10% currently, will continue due to declining sovereign risks, convergence with Central Europe and increased interest from international property investors," says Fiala. "We expect the rents to continue moving upwards in the next three to five years due to supply continuing to lag the demand and the yield compression continuing."

Room for football

One new driver of prices on the horizon is the Euro2012 football championships, which Ukraine will host with its neighbour Poland. Euro2012 will bring a flood of investment to fund the massive infrastructure projects that Ukraine has undertaken to complete in the next five years. According to Ukrainian government estimates, construction of new highways, hotels, soccer-related facilities and other infrastructure will require at least $5bn.

Hotels will be a focus for developers and Dragon-Ukrainian Properties says it will consider hotel investments. Just as in office space, Ukraine lacks top-notch hotels to cater for the flood of teams, officials and tourists who will visit during the month-long football competition.

The European football governing body UEFA stipulates that host countries must provide visiting fans with European-standard accommodation within a 50-kilometre radius of sporting venues. Yet even the capital Kyiv only has 13 four- and five-star hotels, and 30 three-star hotels; the situation is even worse in the other host cities of of Dnipropetrovsk, Donetsk, Lviv and Odessa. As such, reports say Ukraine may need to spend at least $200m to build the necessary hotels over the next five years.

Dragon Capital also reckons Euro2012 could be a good cause for the country’s perennially bickering politicians to unite over. The political crises that have wracked Ukraine since the Orange Revolution helped propel President Viktor Yushchenko into the presidency in January 2005 are a continuing cause concern for foreign investors, though judging from the thriving economy and stock market not perhaps as much a worry as it once was.

"Political noise has a much lower influence than it used to on investment decisions," says Fiala.

Another worry for real estate investors is what happens after the Euro2012 championships. There will be lots of hotels, but will there be the tourists to what is still a country off the European beaten track? Admittedly, tourist numbers have picked up since the country abandoned its ludicrously priced visas since hosting the Eurovision song contest in 2005, but there will be a lot more rooms to fill.

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