Cleveland, Ohio-based Developers Diversified Realty Corp. became the first U.S. REIT to announce a major development initiative targeting the Russian Federation and Ukraine this week. It might have some company soon, though, as Indianapolis-based Simon Property Group disclosed during its first quarter earnings call in late April that it is in the early stages of working out a deal to enter Europe's largest country. Russia, along with other former Soviet bloc nations, appears to be ripe for more foreign investment.

In Developers Diversified’s case, the REIT is forming a $300 million joint venture with Hamburg-based ECE Projektmanagement G.m.b.H. & Co.KG, a German real estate development and management firm. The joint venture plans to leverage the fund by up to 75 percent, giving the partnership investment potential of up to $1.2 billion that it will invest over the next five years developing shopping centers in urban markets west of the Ural Mountains in Russia and in Kiev and other major cities of Ukraine.

Developers Diversified will contribute 75 percent of the equity--$225 million—to the venture, with ECE Projektmanagement supplying the balance.

A spokesperson for Developers Diversified said the company is not yet at a point to discuss specific sites or projects, but it plans to concentrate on multi-level enclosed malls in infill locations anchored by hypermarkets or general discount merchandise stores.

After Developers Diversified announced the venture on May 14, its stock price showed a slight decrease, from $64.89 per share on Monday morning to $62.22 per share on Wednesday afternoon, a difference of 4.1 percent.

Meanwhile, in late April, Simon Property Group CEO David Simon said the firm was close to one deal in Russia and considering another, but would not elaborate on the specifics. Head of Simon’s global division Hans Mautner was on the road this week, and could not be reached for comment. But local real estate professionals are aware that Simon is in talks with a Russian-owned firm to form a joint venture for the development of a large regional shopping center in Moscow, says Peter Hensby, who works in the Moscow capital markets department of the real estate services firm Jones Lang LaSalle.

Simon has invested in central Europe previously. On Apr. 17, the company signed a definitive agreement to sell five non-core retail assets it owns in Poland in a joint venture with Ivanhoe Cambridge for approximately $248 million. Simon also has interests in shopping centers in Italy and France.

Investing overseas is one way for REITs to generate higher returns than those available in the fiercely competitive domestic market. “They will be going not only to Eastern Europe, but to South America and China and lots of other places,” says Rich Moore, a REIT analyst with RBC Capital Markets. “Anywhere where returns might be good.”

Specifically, Russia and Ukraine are good markets for development because of projected GDP growth and a burgeoning demand for higher-quality retail properties. In 2007, Russian GDP is projected to grow by 6.2 percent, according to a recent report from brokerage firm Colliers International, compared to growth of 2.4 percent to 3 percent in the United States. Last year, foreign direct investment in Russia’s economy reached $31 billion, a 137 percent increase over 2005, and as of year-end 2006, prime yields for retail properties in Moscow were among the highest in Europe at 12 percent, according to research from GVA Worldwide. Yields for retail properties in Central and Western European capitals ranged from 2.75 percent to 6.7 percent.

At $185 billion in retail sales, Russia is also the 12th largest retail market in the world, according to Jones Lang LaSalle, but Moscow has only 1.604 square feet of shopping center space per capita, compared to 20.3 square feet per capita for the United States.

Ukraine’s property market is “booming” as well, according to real estate services firm NAI Pickard. The country is expected to post GDP growth of 5.9 percent in 2007, estimates Kiev-based Institute for Economic Research and Policy Consulting, with private consumption growth set to reach 8.9 percent. Meanwhile, Developers Diversified’s figures show that there are only 1.076 square feet of shopping center space per capita in Kiev – a number that is even lower than Moscow’s. NOI yields for new retail developments in Ukraine range from 18 percent to 28 percent, according to Deol Partners, a Kiev-based real estate services firm.

Still, Developers Diversified and ECE might face a challenge in getting the necessary permits and approvals in place if they don’t get a local partner, says Hensby. There have been cases where foreign companies have been able to build by themselves – Swedish furniture seller Ikea and international real estate firm Hines are two examples, – but both firms spent from three to five years just on developing relationships with Russian officials. “Having a local partner provides you with a contact within the government, so it’s a lot easier to get the required permissions,” Hensby says.

(For more on the potential for foreign investment in Eastern Europe, check our January cover story, Touching Down.)

This will be Developers Diversified Realty’s first entry into Europe (the firm currently has properties in the United States, Puerto Rico and Brazil), but ECE Projektmanagement has already established offices in Moscow and Kiev. The firm spent the last three years studying the local markets and will contribute two existing retail projects to the joint venture: a 645,800-square-foot Western-style shopping center in downtown Yaroslavl, a city of 603,700 people on the Volga river that serves as a popular tourist destination and a 645,800-square-foot shopping center which it developed in partnership with Prague-based ECM Group in Ryazan, a city of 533,100 people 121 miles away from Moscow.

ECE Projektmanagement also has a track record of teaming up with U.S. REITs. It has a partnership with General Growth Properties, another American REIT, with which it previously developed six shopping centers in Turkey.

--Elaine Misonzhnik