Ukraine: The Office of Disappointed Hopes or Some Practical Aspects of Office Space Classification

Considering various commercial office space lease offers in Ukraine, tenants often have to figure out the difference between business centers of Class A, office centers of Class B and, say, an office block of Class C multipurpose center. The need to study office space classification issue does not arise merely from idle interest in the recently applied Western European approach, but has quite a pragmatic purpose to obtain unbiased information and to make the smartest choice while selecting the best rent (rental rate and related payments) vs quality ratio in regards to the leased space and services rendered by the owner of the business center or its management company.

So what lies behind such a seemingly marketing trick as office space classification? Who and on what basis assigns such classification? Is it always unbiased and does it meet the declared parameters? What is its practical purpose? How to prevent the consequences of unfair office positioning? How can one protect oneself after discovering that office space does not conform to the declared parameters? Let us try to sort out these issues.

General Description of Office Space Classification

There are several classifications of office real estate. The most popular is the one where office space is grouped into three classes: Class A, Class B, and Class C (in a descending order: from the most prestigious Class A to the least prestigious Class C).

This classification is based on the standards of the British Council for Offices, an influential body representing commercial property operators that brings together over 1,300 individuals representing 646 organizations. In addition, the above classification relies upon international standards of BOMA, Building Owners and Managers Association. Both sets of the standards underlying the classification applied in Western European countries are accepted and used by most of the commercial real estate operators. Taking into account integration trends, the abovementioned peculiarity positively characterizes the office space market that makes clear the understanding of its development level and determines its needs and possible future prospects.

Eastern Europe countries and CIS states do not have a unified approach to office space classification and there is not one approach considered to be most widely used either. Ukraine is no exception in this case. Nowadays, a unified approach to office space classification is neither enshrined in Ukrainian law nor applied in business practice.

The lack of regulatory classification is generally explained by the lack of objective necessity: office centers are usually built in accordance with various construction, sanitary, epidemiological, technical, fire safety and other standards without any reference to the expected class of office space or to the criteria usually underlying such classification. Another factor, such as a utilization value of office space (rental rate and related payments), is a purely market category, which depends on the assigned (declared) class of an office centre and is not regulated by administrative methods. Thus, there is hardly any sense in a statutory office space classification.

Meanwhile the lack of unified approach to office space classification in practice is obviously somewhat related to the lack of an influential organization in Ukraine – an analogue of the British Council for Offices, which would unite all major commercial property operators, including developers, management companies, office and business center owners, and commercial property advisors. The lack of such organization from a practical viewpoint explains the lack of a collective entity, which would generate a unified and generally accepted by major office property operators approach to the office space classification.

Ukrainian "National" Peculiarity of Classification

Due to the abovementioned lack of a standardized approach office space classification in Ukraine is rather a reflection of general trends in the office real property market than a unified approach. In this case, we can talk about a certain set of peculiarities that distinguish the classification applied in Ukraine from the Western European one that originally served as its prototype.

Such peculiarities consist in the interpretation of the requirements of the British Council for Offices that modifies the existing criteria by adding new approaches based on the peculiarities of Ukrainian commercial property market.

Such "domestic" approach cannot be characterized negatively but rather the other way round because the classification is objectively based on the existing market situation, in particular, available market supply, its quality and cost components.

Office buildings and premises should obviously be measured using available criteria in the office real property market. The classification approaches often differ already at the level of buildings constructed in various regions of the country: the same property, say, in Kyiv and, say, in Poltava, Kharkiv, Odesa or Lviv, not to mention the European office property market, would be classified quite differently. It is reasonably obvious that a Class A business center in the Ukrainian market will hardly correspond to a Class A business center in the British market, which is one of the most expensive and highest-quality office real property markets.

Three or Five, Plus or Minus?

Ukraine continues to apply a basic approach to classification: office real estate is rated as Class A, Class B, and Class C. As it is with Western European classification, these three classes are used to classify professional office real estate such as business centers, office centers, business parks, etc.

The three-level classification of office premises in Ukraine, however, often includes the forth class – Class D and sometimes even the fifth one – Class E. The forth and fifth classes are used to classify semiprofessional real properties. These are outdated buildings of non-residential stock, which are usually referred to as so called administrative buildings, management buildings and non-residential premises on the first, ground and basement floors in residential buildings.

In view of their semiprofessional character, the last two classes of premises are theoretical rather than practical in nature because their landlords generally do not need to actively position their premises on the commercial real estate market. Such premises are not very commercially attractive and are mainly intended for small-sized start-up tenants or tenants with limited resources for office maintenance.

Commercial real estate advisors frequently, at their own discretion, add a plus or minus sign to certain classes of office premises. This sign is sometimes replaced and extended by adding several subcategories which are denoted by 1 to 3, e.g., A1, A2, B2, B3, etc. Such detailed description of applied class rating is aimed to advantageously and most objectively position those office spaces which, by certain parameters, rank above or, vice versa, below a certain class.

Thus, there is currently no universal approach to office space classification even in any given separate geographic or economic region of Ukraine. In most cases, the boundaries between classes are quite blurred, which is particularly manifested in a five-class classification and in subclassification or subcategorization that uses a plus or minus sign.

Classification Purpose and Prospects

The classification of office space is a quite successful marketing instrument, which, however, contains a rather practical component.

The objective classification based on the transparent and clear criteria enables potential tenants to learn about leased properties concerned and to look into types and peculiarities of office and business centers, business parks, administrative buildings, multipurpose complexes and other office premises currently available in the commercial real estate market.

It is often the case in Ukraine that office real estate is unfairly positioned, which is accompanied by an actual non-conformance of premises offered for lease to a set of requirements of the declared property class.

More often than not, tenants face serious problems when trying to find a suitable space with an optimal price/quality ratio. Although financial and economic difficulties of several past years have corrected this situation to a certain degree, the issue of a unified approach to classification and the establishment of standard assessment criteria for assigning one class or the other is still pressing, as it plays an important role in mitigating the adverse effects of unfair competition.

Besides, objective classification is necessary for commercial purposes: serving as the basis for applying rental rates, it guarantees the balance of financial interests. A standardized approach to office space classification would allow tenants to defend their interests with more substantiated arguments when discussing amount of rent with the landlord or with its management company. When justifying the assigned property class and respective rental rate, the property owner, in turn, would strive to increase the quality of its services, which would facilitate healthy market competition all together.

The standardization issue becomes particularly important in view of the current market practice of independent class assignment directly by companies that implement respective office property projects.

Classification Criteria

Considering the lack of a unified approach, the three-level classification criteria may somewhat differ from a more detailed five-level classification and a classification using a multilevel approach within one property class. However, basic criteria used in any classification are generally similar and can be defined as follows.

As a general rule, the following classification criteria are applied:

• Location (in this case, takes into account the remoteness from the historical and business center of a respective city, availability of transport links, high-quality and convenient driveways, absence of any image spoiling facilities – plants, dumps, cemeteries, etc.);
• Constructional features of buildings (in this case, takes into account the general condition of buildings, repairs, used materials, tailor-made space planning option, floor height and other technical features of the building, in which a potential lease property is located, floor area, window size, frontal location of façade, etc.);
• Parking options (higher class offices usually have an underground parking garage or a multi-storey covered parking facility and a visitor parking area nearby; some experts also compute the so-called "parking ratio", i.e. the ratio of parking spaces to total area of the office space);
• Engineering systems (in this case, takes into account the availability of quality heating, air conditioning and ventilation systems with the option of individual temperature control, a continuous fresh air supply, sufficient power supply facilities, digital fiber-optic phone lines, Internet services, possibility of connecting communication systems at any point, etc.);
• Professional management (in this case, takes into account the availability of professional building management arranged by the owner or a management company with a transparent accounting procedure based on the "open book" principle, optimal accounting treatment of total operating costs, etc.);
• Services for tenants (effective organization of the office building's daily life: from simple cleaning, catering and engineering systems maintenance to reception area, conference rooms, delivery services, administrative office, expert equipment maintenance services, security services, dry-cleaning services, beauty salons, sports and recreation centers, and other infrastructural facilities).

The assignment of a certain class to an office property requires a thorough analysis of all the parameters and characteristics of such property. The assigned class depends, in its turn, on the quality of the indicators characterizing the appraised property: the more it complies with respective appraisal criteria, the higher is the rating and the class of such property.

For example, the classification procedure for capital city office properties, as developed by the Kyiv Forum of Property Market Operators and the American Chamber of Commerce in Ukraine, involves the assessment of office properties in terms of their compliance with 20 requirements, which include 10 mandatory and 10 optional requirements. These requirements are based on the abovementioned criteria. Under the suggested classification, a Class A office must meet a total of 16 requirements (10 mandatory and 6 optional requirements), a Class B office must meet a total of 13 requirements (7 mandatory and 6 optional requirements), and a Class C office must meet a total of 7 requirements (5 mandatory and 2 optional requirements).

Class A business centers are usually located in the city center and have the most state-of-the-art technical and engineering equipment maintained by a professional management company. This class implies expensive decorations, individual planning options, guarded underground or multi-level surface parking facilities, a local security guard system, catering and recreational facilities, etc. Class B offices, which are usually located not far from the city center, possess nearly the same characteristics, but offer a much narrower range of services. C Class offices offer a very limited range of services and are located in remote districts, but they have the advantage of convenient transport access routes. These are usually repaired administrative buildings inherited from Soviet times.

Office Classes F and E are a rare phenomenon, but even if they are singled out into a separate class, they usually cover half-professional premises located in small detached buildings with outdated utilities and non-residential premises located in residential buildings.

It should be also stressed that the established boundaries between the classes are conditional and relative. The ongoing development of the office real property market, the emergence of new trends, the commissioning of better-quality buildings, the introduction of modern technologies, and the increasing requirements of tenants mandate both a review of the classification criteria and a more demanding property assessment procedure. Office premises are often moved from one class to another, and this is but a logical result of the market development and the growing quality of the commercial property supply.

Lease Agreements as Important and Necessary Tools for Protection of Interests

Considering the relativity of the applicable criteria, as pointed out above, and the somewhat subjective application of these criteria in the assessment of office real properties, tenants occasionally find themselves in a rather unpleasant situation where the premises they lease in a business center do not meet all their expectations both in terms of the condition of such premises and in terms of the services provided by the owner (or the owner's management company).

In these circumstances, it is particularly important to have a quality, well-balanced and properly drawn-up office lease agreement in effect. This agreement may become an effective legal tool for protecting the tenant's rights and interests. Tenants should not rely solely on landlords' assurances and their promotional booklets advertising the high class rating of the offices they offer for lease.

It is also difficult to underestimate the importance of lease agreements for landlords, as these agreements protect the landlords against their tenants' unreasonable claims.

In addition to the general requirements set for real property lease agreements, such as mandatory inclusion of all the material terms and conditions listed in Article 184 of Commercial Code of Ukraine No. 436-IV, dated January 16, 2003, (the "Commercial Code"), and the written-form, notarization and state registration requirements set out in Articles 793 and 794 of Civil Code of Ukraine No. 435-IV, dated January 16, 2003, (the "Civil Code") for three years and more lease, lease agreements signed should contain provisions registering the general technical condition of the premises, the condition of their structural elements and utilities, and the level of professional management services provided by the owner or the owner's management company, which serve to justify the declared class of the premises and the respective rental rate and which must be maintained by the landlord throughout the entire lease term.

It is also important to include provisions to govern situations where the quality of the provided services or the leased premises fails to match its declared level by prescribing a particular course of action for each party. Separate attention should be given to the grounds for changes in the rental rate or for early termination of the lease agreement, subject to the business continuity principle laid down in commercial laws.

A clearly and carefully drafted lease agreement setting out the level of the services to be provided and the condition of the leased premises is of major importance both from a commercial and legal standpoint, as it serves as documentary evidence of the tenant's right to use the office property of a certain specific class and rating. A valid lease agreement is also a mandatory requirement for the ability to resort to legal or contractual remedies available for infringement of tenant rights.

Inadequate Class Rating: Options for Protecting Tenant Rights

If there is any material discrepancy between the actual condition of the leased premises and/or the actual level of the provided services and those initially declared by the landlord, tenants can use relevant remedies to protect their rights. It is important to stress in this context that for a tenant to be able to resort to any such remedies, the technical conditions of the leased premises and the level of the provided services must be expressly stated in the respective lease agreement. The remedies most frequently used to protect tenant rights include:

1) A claim for the elimination of defects found in the leased premises or the provided services, accompanied by a claim for the provision of premises and services of the proper class in line with the statutory principle of the obligation of contract;

2) A claim for a reduction of rent, under a contract or through court, in line with part 2 of Article 286 of the Commercial Code and part 4 of Article 762 of the Civil Code, - if the defects cannot be removed or if the premises and services of the proper class cannot be provided;

In addition, in this context, one should bear in mind that until the parties sign an additional agreement to fix the new rent or until a respective judgment enters into effect to amend the terms of the lease agreement, the tenant must pay the rent stated in the original lease agreement; otherwise, the tenant will accumulate debts, which may serve as grounds for the landlord to terminate the agreement and demand that the tenant vacate the premises in line with Article 782 of the Civil Code, and, although such right of the landlord is restricted by the effective prohibition of the unilateral termination of contract, the landlord still has good chances to recover the debts and terminate the agreement through court proceedings;

Moreover, one should also bear in mind that under Ukrainian laws, if any such discrepancies are revealed, tenants can only claim a reduction in the rent, and only if the respective leased property is altogether unfit for use the tenant can be exempt from having to pay the rent;

3) A claim for early termination of the lease agreement; the best scenario is when the agreement is terminated by mutual agreement of the parties, otherwise it may be difficult to avoid litigation; the tenant can use the right conferred by part 3 of Article 291 of the Commercial Code and demand that the agreement be terminated under clause 1 of part 1 of Article 784 of the Civil Code on the grounds of "the transfer by the landlord of the premises failing to comply with the terms and conditions of the agreement".

Here one should also bear in mind that the termination of the lease agreement, especially in the current economic conditions, will cause losses to both parties: the tenant will need to find and move to a new office, while the landlord will lose the opportunity to receive rent payments in the period before the vacated premises are transferred to a new tenant; therefore, it is better if the parties come to a mutual agreement, including when they want to terminate their lease relations, and carefully set out their mutual arrangements in a respective agreement.

Whether the tenant will be able to use the chosen remedy depends on how accurately and thoroughly the condition and the class of the leased office premises are described in a properly drawn-up lease agreement.

Summary

The lack of a unified approach to the standardization and classification of office premises causes conflicting assessments of some office properties and misleads potential office tenants.

The standardization and the unified classification approach are important components of a well-organized competitive office real property market. At the same time, they should not be forced upon the market: the market must develop to the point where it is ready for the application of uniform standards recognized by all market players.

In view of the above, more attention should be given to lease agreements as legal components serving to balance the interests of both parties.

It is important not to rely solely on the declared class rating of an office property, but also to expressly indicate the technical condition of the premises and the level of the services to be provided by the owner or the owner's management company in the respective lease agreement, as these factors justify the declared class of the premises and, therefore, the applicable rental rate. The lease agreement must also be in place if either the tenant or the landlord wants to use any of the legal or contractual remedies available for infringement of their rights.

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