Can Municipal Property Become a Profitable Asset Portfolio for the Recovery of Ukrainian Territorial Communities?

Upon the generally successful completion of administrative reorganization, other elements of the decentralization reform still require refinement. First and foremost, it is necessary to ensure a solid financial foundation for developing territorial communities. Among the tools for achieving this goal, communal property rights become extremely important. Transparent and effective management and accounting of municipal property are key aspects of trust to the authorities by local citizens and businesses, a factor of investment attractiveness, formation of credit ratings, and the potential for municipal borrowing.

The global expert community’s perspective on managing municipal (communal) property has evolved in recent decades. Today, this type of property is viewed not only as a public good but also as a productive asset, which provides a combination of measurable and hard-to-measure (including social benefits) revenues. Thus, we suggest employing asset portfolio management approaches and methods that are widely used by private corporations.

In the private sector, corporate real estate management is the decision-making process on acquiring, holding, and disposing of assets, which can be used for the company’s operations or as an investment. When a company owns and uses real estate for its business, it aims to maximize corporate value (or profit). When real estate is used as an investment, the goal is to optimize investment returns by considering various combinations of risk, profit, and liquidity. The same philosophy underlies advanced practices in managing municipal real estate. Essentially, there is a key similarity between asset portfolios of private corporations and municipal entities. In the broadest sense, they include two components: real estate for “core business” use and the so-called excess property.  

The problems of managing municipal real estate

For local self-government bodies (LSGBs), the “core business” involves performing management functions and providing public services. Thus, asset management aims to determine the optimal parameters of real estate (quantity, location, etc.) required for LSGBs to fulfill their duties with minimal costs compared to all possible alternatives. Excess property is typically defined as assets currently unnecessary for LSGBs’ core functions and social programs. Managing these assets aims to maximize financial returns (see Table 1). This objective can be achieved by various means: leasing at market rates to generate current income, leasing to businesses at minimal rates to stimulate local development and increase tax revenues, or privatizing real estate for lump sum income and subsequent property taxes. All of these measures help reduce budget expenditures on property maintenance.

Currently the majority of local self-government bodies in Ukraine primarily engage, with varying levels of experience, in the day-to-day operational management of communal property. Often, they do not consider their entire real estate holding as a “portfolio”, composition and structure of which can be altered, taking into account the alternative value of different properties through various usage scenarios. Existing municipal property management programs typically lack financial evaluations of different usage scenarios (options) and fail to justify the best approach in terms of long-term strategic development goals for the territorial community. In practice, it is common for communal property within a community to be divided into several “portfolios” managed independently by different agencies and institutions. Even if some of these entities manage their properties effectively, the overall outcome tends to be suboptimal.

Publications outline a number of issues that limit the implementation of advanced practices in municipal real estate management: 

• Lack of political will;
• Lack of reliable information about existing community assets;
• Ineffective organizational structure and distribution of responsibilities among local self-government bodies regarding asset management;
• Shortage of qualified personnel with relevant skills;
• Absence of internal rules and regulations;
• Limited opportunities to monitor the use of communal property, etc.

In 2023-2024, the Centre for Economic Strategy, in cooperation with ProZorro.Sale and supported by the U-LEAD with Europe program, implemented a pilot project “Improving Municipal Asset Management for Community Recovery” in the territorial communities of Ivano-Frankivsk, Novovolynsk, and Chernivtsi. Project results confirmed significant opportunities and a wide range of challenges that require resolution. Below we discuss the most important and typical ones in more detail.

Low-quality information about existing municipal assets, associated with imperfect procedures of inventory and asset accounting

Asset pools of territorial communities were formed as a result of lengthy processes of voluntary amalgamation of village, town, and city communities since 2015, merging of individual communities into already formed united territorial communities in 2020, and reorganization of governance at the rayon level. The law “On Amendments to Certain Laws of Ukraine on Organizing and Operating Local Self-Government Bodies and Rayon State Administrations” stipulates that by July 1, 2021, the legal successor of the rayon council of a liquidated rayon must transfer all assets jointly owned by territorial communities into communal ownership, in accordance with the expenditure division between budgets established by the Budget Code of Ukraine. Most district councils reached agreements with territorial communities on this complex issue, and as of July 1, 2021, almost 100% of such objects were transferred to the communities. However, the actual results of the property transfer are not as optimistic. Some objects did not undergo proper evaluation, inventory accounting in custodian institutions, or state registration of property.

As a result, local authorities often do not have complete and reliable data on their communal property and its condition. Available sources show that most territorial communities have struggled to establish and populate databases or registries of immovable property owned by the community. Not all property objects have been entered into the appropriate databases, and the information about them is often uncertain, with outdated details on their technical condition. Additionally, there is limited or no public access to this information, or it is presented in a format that does not attract potential tenants or buyers. This issue is particularly acute for objects located within rural communities that have merged with towns or cities.

The lack of quality, reliable, and up-to-date information for comprehensive accounting of community asset management causes a number of serious risks and threats: incorrect and distorted budget forecasting and planning; failure to implement planned programs, events, and projects; inability to collect planned revenues and underperformance of local budgets; loss of some community assets, inefficient and non-transparent sale and use of assets, etc. 

Implementing a comprehensive inventory of municipal property and organizing its accounting by creating a public electronic registry of community-owned property rights is one of the fundamental tasks in establishing an effective property management system. This initiative will expand opportunities by developing appropriate strategies and action programs, making informed management decisions, and forming plans for property use (leasing, concessions, privatization, etc.); increasing investment attractiveness, thereby attracting additional resources to local budgets; and by enhancing transparency of government actions and increasing community trust.

On May 15, 2024, the Law “On Amendments to the Law of Ukraine ‘On Local Self-Government in Ukraine’ on Ensuring Transparency of Local Self-Government” entered into force. It states that public information in the form of open data about the property rights of territorial communities, including inventory results, must be published and regularly updated on the single government open data portal (data.gov.ua) and official websites of local authorities.

These positive changes aim to speed up inventory and accounting processes, enhancing their transparency and openness. However, this legislative norm does not clearly regulate several vital issues, including the minimum list of information to be disclosed, obligations to conduct a comprehensive inventory of communal property and its timing.  

Today, a number of local governments publish information about their municipal property, but the content and functionality vary significantly. For instance, the official portal of Chernivtsi City Council lists real estate, leased properties, objects intended for privatization, etc., including basic characteristics of these objects. However, this is rather an exception than a common practice. In most cases, information on the websites of local governments is limited to lists of objects and their addresses, lacking details that could be of interest to potential investors or tenants.

Notably, the draft law (No. 6401), submitted to the Verkhovna Rada for the first reading, included the following provisions:

• Obligation to conduct a comprehensive inventory of all the communal property of a territorial community every five years;
• Obligation to create and maintain a Registry of communal property objects of a territorial community;
• Requirements to the mandatory minimum list of registry data, etc.

The respective parliamentary committee, in its conclusion for this draft law, highlighted certain provisions that require clarification and improvement, namely on the mechanisms for comprehensive inventory, the status of the Registry for communal property objects in a territorial community, an opportunity to integrate it with state registers and official databases, etc. However, lawmakers removed these provisions from the text of the draft law. As a result, the final version of the law (No. 3950-IX) does not fully address problematic issues related to inventory and accounting of communal property.

Therefore, a separate regulatory act on the registry of communal property rights of territorial communities, clearly defining legal and organizational principles for establishing and operating such registries, must be developed and adopted.

Experience of European countries (especially of Sweden, Finland, Norway, and Estonia) demonstrates effectiveness of establishing information systems based on registries to address managerial tasks. Without organizing registries, improving quality of registry data, and establishing information exchange between registries, Ukraine would find it challenging to address issues important for local governments, such as creating a municipal statistical system, implementing an information-analytical system for monitoring the development of territorial communities, assessing impact of tax changes on local budgets, and others.

The frequency of inventory remains a topic of discussion since it can be a costly and labor-intensive process. Researchers often link the periodicity of inventory to the classification of municipal property objects. For objects that serve government functions and provide social services, experts from the Civil Society Institute recommend conducting an inventory once every few years (typically about every five years). For instance, at the start of a new local council’s term, property can be transferred from one administrator to another. Inventory should be much more frequent for so-called excess property to accurately estimate its current market value and help make informed decisions regarding its ownership or disposal.

Inefficient delegation of responsibilities, staffing shortages, and insufficient professional knowledge limiting the application of modern practices in municipal property management

According to the Law “On Local Self-Government in Ukraine,” a local council and its head approve the structure of executive local government bodies and the total number of council staff. The head of the respective council submits proposals on these matters, which the council approves at a plenary session. Thus, local self-government bodies have the right to approve executive bodies’ staffing based on their vision and available resources. Consequently, the distribution of powers between executive bodies varies across different territorial communities. In some, it is effective and functional, while in others, it is quite irrational, which in practice leads to:

• Some functions and responsibilities implemented by more than one department.
• Some functions and responsibilities are not implemented by any department.
• Shortage of labor and material resources in some departments and a surplus in others.
• Delegation of non-typical responsibilities to municipal enterprises, to name a few.

The full-scale war has exacerbated existing problems in local self-government, including the lack of human capital. The National Agency on Civil Service (NACS) has reported a catastrophic shortage of personnel in both central and local government agencies. The majority of employees are occupied with current issues and responding to various requests. Yet, there is a shortage of competent professionals with skills in strategic planning and implementing modern management approaches.

Currently, it is difficult to discuss overcoming labour shortages  by increasing salaries to competitive market levels. From a budgetary standpoint, administrative expenditures of local governments are reported as a share of total budget of a territorial community. According to the “Budgets of Municipalities of Ukraine” dashboard, in the first quarter of 2024, in nearly half of the communities expenditures on administrative apparatus (salaries, IT, and material-technical support) accounted for over 30% of general budget fund revenues (excluding transfers), and only in o% of communities this number was below 10%. For most local government bodies, especially rural ones, the potential for increasing salaries is extremely limited.

Under current conditions, key directions for improving the situation could include: 

• Optimization of the local government back office, particularly through redistributing staff among different structural units.
• Digitalization of services using widely accessible (mostly free) software tools to reduce the workload on existing personnel. Recently, the Ministry of Digital Transformation presented the Diia.Engine Platform—a digital tool for automation, creation of digital services, and managing registries, which local self-government bodies can use.
• Introduction of performance-based bonuses linked to KPIs. For instance, officials could have bonuses for successful privatization or leasing of municipal property, with criteria for successful property realization set by the local council.
• Facilitation of community engagement, specifically attracting volunteer real estate experts to managing municipal property.
• Development of professional knowledge and competencies, integrating modules on municipal property management into training and qualification programs for local government officials. The U-LEAD with Europe program has successfully implemented the “STEPS for Specialists. Municipal Property Management” training program.

Lack of effective control over the processes of municipal property management

The problem can be addressed systematically by establishing an effective State Internal Financial Control (SIFC) in Ukraine – a system of rules and measures implemented in budgetary institutions to ensure compliance and efficiency of  budget funds use. 

In European countries, municipal asset management is under the scrutiny of SIFC, which, according to EU requirements, should be applied across the entire public sector and include Internal Control (IC) and functionally independent Internal Audit (IA). The key goal of implementing SIFC regarding IC and IA is to promote operations and processes in the public sector that adhere to principles of sound financial management, transparency, efficiency, productivity, and cost-effectiveness in the use of public funds, ensuring compliance with legislation and established rules.  

Ukraine has some achievements in implementing SIFC. The adopted legislative acts in this area generally conform to international standards and best practices. However, the Budget Code of Ukraine (Article 26) mandates the implementation of Internal Control (IC) and Internal Audit (IA) in budgetary institutions, while a Cabinet of Ministers resolution from September 28, 2011, only provides recommendations for implementing IA on activities funded by local budgets. The non-binding nature of IA at the local level resulted in a lack of effective mechanisms to control management of communal property in most local self-government bodies.

Therefore, the priority task is legislative regulation to implement IC and IA locally. Looking for relevant organizational models suitable for Ukraine in local self-government bodies is also crucial. The practice of implementing SIFC systems in EU countries and Eastern Partnership countries shows the impossibility of using a single universal model, given the specific characteristics of each country, national legislation, administrative-territorial structure, and so on. The most typical scenarios include: 

• Establishing a separate IA department within an institution (administration / city council), subordinate to the executive body, by a local council decision;
• Creating a single department for several local authorities by decisions of respective local councils;
• Contracting private companies/auditors certified to perform such activities for local authorities.

Ukraine may find interesting Romania’s experience of issuing subsidies for rural communities, which often struggle to independently establish IA departments. Romania’s regulatory framework allows for cooperation among several local authorities. The IA organizer can be one of these authorities or a joint structure created by them. Thus, IA cooperation implies jointly creating and using IA functions and pooling necessary financial resources to ensure appropriate operations. The key is to ensure that IA provision costs are lower than establishing a separate department.

Loss-making municipal enterprises

In recent years, there has been an increase in the number of municipal enterprises (ME) in Ukraine. As of early 2024, there were 14,012 registered municipal enterprises, compared to 13,883 in 2020 and 13,778 in 2015. According to Article 78 of the Economic Code of Ukraine, a community owns the property of a municipal unitary enterprise. This property is entrusted to such an enterprise either for economic management (municipal commercial enterprise) or operational management (municipal non-commercial enterprise). The ideology behind municipal enterprises is that they are not “evil for the community.” The question is, how effective is asset management of such enterprises and what are the opportunities and mechanisms of a community to control the activities of such entities.

Research indicates that the activity of a large number of MEs is unprofitable. According to estimates by the Centre for Economic Strategy, the average return on assets (ROA) for MEs in oblast centers between 2010 and 2019 was 0.03%, and the return on equity (ROE) was 0.05%. Taxes paid by municipal enterprises to local budgets do not even compensate for the amounts used to replenish their statutory capital, apart from value of land and property taxes on assets managed by municipal enterprises that the community could have received. According to our estimates, there are situations when municipal commercial enterprises, those not specializing in the provision of services of general economic interest, declare profits several times lower than revenues which the community could have received if the ME property were leased out.

Solutions to this problem should be considered together with a comprehensive strategy for management of territorial community assets: 

• Conducting audits and “triage” of MEs based on their importance and operational efficiency.
• Privatization or liquidation of MEs operating in competitive markets with low profitability compared to potential alternatives (e.g., leasing out property).
• Ensuring transparency in the operation of municipal enterprises.

Within the framework of the lasting SOE (state-owned enterprises) corporate governance reform, it is necessary to introduce the best international corporate governance practices for municipal enterprises. This will improve financial oversight of their activities, avoid unnecessary budget expenditures, and protect management from undue interference by local politicians.

Conclusion 

Municipal property is one of the most underutilized resources in many communities. Losses from lack of strategic management of municipal real estate are significant, negatively impacting local budgets and the quality of public services (overspending on property maintenance, foregone revenues due to inefficient use of excess property, etc.). Despite the wide range of approaches to managing local government assets, most best practices view it as a holistic “portfolio,” the composition and structure of which can be altered based on different property valuations depending on utilization methods. Developing such an approach in Ukraine at the state level requires the following:

• Addressing problematic issues related to the systematic conduct of inventory and accounting of municipal property and creating a register of municipal property rights of the territorial community;
• Promoting affordable software for managing and disclosing information about municipal property among territorial communities;
• Enhancing the system of control over processes of municipal property management, including legislative regulation for implementing internal control and internal audit at the local level;
• Promoting best practices of corporate governance in municipal enterprises;
• Improving qualifications of personnel responsible for managing municipal property.