Vacant, but still pretty?

The current vacancy levels in the capital cities in our region lie between 13.4 pct and 18 pct. This might seem like a lot, particularly considering the figures of 3–5 pct in the recent past. “The maximum vacancy level sustainable for the market is about 10 pct and it is best if it stays at a level of around 5–7 pct,” insists Jos Tromp, the head of research and consultancy for the CEE region at CBRE.

Cranes to stay in Warsaw yet

These levels were exceeded in Warsaw, the largest office market of our region, some time ago. According to the calculations of the Warsaw Research Forum (WRF), at the end of Q2 the average vacancy rate amounted to 13.4 pct. This is some way above half a million square metres and more or less as much as what is currently under construction. The forecasts for the next two years are also hardly encouraging. “Despite the fact that tenant activity on the capital city’s market is strong, vacancy will grow due to the considerable development of new office facilities,” believes Konrad Heidinger, a senior consultant in the consultancy and research department at CBRE. The agency’s calculations point to a level as high as 18–20 pct at the end of 2016. Elżbieta Czerpak, the director of the market research at Knight Frank, agrees. However, she also points to diminishing demand as another factor. “The indexes reflecting the situation on the Warsaw office market after Q2 2014 are giving us no cause for optimism. The supply of office space has been growing at a rapid pace, but we have been observing weaker demand at the same time, which will result in a significant increase in the vacancy rate,” she argues. However, there is not much evidence that developers are suddenly about to stop building. “Around 579,000 sqm of offices are currently under construction and another 62,000 sqm is undergoing renovation,” reveals Mateusz Polkowski, the director of the market research and consultancy department at JLL. “A total area of 350,000 sqm of new offices could be delivered to the Warsaw market this year, which includes space in modernised facilities. The capital city’s market will also maintain its vigorous rate of development in 2015 and 2016, when the supply will grow by app. 300,000 sqm per year. We estimate that in 2016 the total office stock in Warsaw will reach 5 mln sqm,” he adds. Compared with the region as a whole, the level of supply of new offices in Warsaw is particularly impressive. According to CBRE, the planned 2015 supply in Warsaw (350,000 sqm) will equal the total amount of offices that are to be built over the same period in Prague, Budapest, Bucharest and Bratislava. Even with a gross demand of around 600,000 sqm, that is a lot, especially given that the absorption level hovers at around app. 200,000 sqm per year. “At the moment Poland has become a victim of its own success. The vacancy rate will certainly grow, but may not go as high as 20 pct. The spread of rents is huge, from EUR 20+ per sqm in the city centre to less than EUR 10 per sqm in Mokotów. But the office market will diversify. The centre is a traditional location for law offices, consultancy and real estate developers. On the other hand, tech companies or those from the creative sector could choose to exit the strictly business districts. All the shiny new buildings will attract tenants, but they will also lay down the gauntlet for older projects, forcing them to focus on revitalisation,” claims Jos Tromp of CBRE.

Growth potential

Is it the case that the main market players simply cannot see any problems arising? It could be that they are aware of such possibilities, but they are hoping that their projects will not be among those struggling with leasing issues. “Warsaw still generates a great deal of demand for modern office space and is continuing to attract developers,” explains Tomasz Lewandowski, the managing director for real estate assets at MS Towarzystwo Funduszy Inwestycyjnych. “Half of the office projects currently being carried out in Poland are being developed in Warsaw. On the other hand, such a large and growing supply of new space is having an impact on the vacancy level, which has increased considerably compared to the same period of last year. This is proof that the market is becoming more and more difficult and the fight to secure tenants is getting tougher. And naturally this is leading to a decline in rent rates and lower margins for developers. Of course, we take this data into account when planning our activities,” he adds. The position of Warsaw in the region has changed over the last few years. After Budapest in the 1980s, Prague in the 1990s, it is now Warsaw’s moment to be the main city for locating businesses in the region. “Warsaw has grown to become the office hub of Central and Eastern Europe in the last few years. The dynamic development of the Polish economy and the size of our market has helped this process a great deal. Warsaw is a very stable market and nothing should happen over the next dozen or so years to undermine its position in the region,” believes Arkadiusz Rudzki, the leasing and building value management director at Skanska Property Poland. “When we look at the high level of vacancy, we have to recognise that this results from the supply being accumulated in just a few projects. It is also natural that large projects commercialise slowly” he adds. The future supply in Warsaw will be subject to the availability of bank financing. The lack of this during the crisis years led to a stagnation in office building construction – only those who could afford it were able to build. “The banks’ policies have recently changed – they are now much more flexible in terms of real estate financing. This is where the high supply is coming from,” explains Arkadiusz Rudzki.

Prague atmosphere

The mood on the Prague office market is somewhat calmer. Despite the fact that the Budapest market is bigger (3.2 mln sqm), there are more projects under construction in the Czech capital at this time. “280,000 sqm is currently under construction, the majority of which is to come online in H2 2014 and in 2015, with some projects due for completion in 2016,” says Kevin Turpin, the director of the CEE research and consultancy department at JLL. “Due to the large number of speculative projects, the vacancy rate, currently 14.6 pct, will increase substantially in H2 – and the trend will continue in H1 2015. A reversal of the trend will only be possible starting from H2 2015,” he adds. It is estimated that at least another 200,000 sqm of office space will be finished in Prague next year and all this will take place in an environment of declining demand. According to the Prague Research Forum’s calculations for Q2 2014, the gross demand (including renegotiations) in Prague amounted to 61,100 sqm – 9 pct less than in Q1 and 16 pct less than in the same period in 2013. “As far as the demand side is concerned, the situation in Prague is not very healthy. There is some demand, but the vast majority of it is being generated by companies that are merely switching from one building to another. The situation has lasted for some time and such transactions do not have a significant influence on the vacancy index on the market,” claims Jos Tromp of CBRE. However, developers do not seem to have lost any of their self-confidence and are preparing for more projects in the capital city. “Prague is a very mature market with a large number of international tenants. Investors regard the market highly. Rent rates and the vacancy indexes are stable and tenants are satisfied with the high quality of office space. The City Green Court project, which is mostly leased to PwC, was a big success for us. There are other pipeline projects, such as the small River View development, that are almost fully leased, while for Corso Court 60 pct of the area has already been filled. This is encouraging us to buy more plots, despite the fact that we now have a land bank for a number of projects. Next year we are planning to launch two office projects in Prague, each with an area of app. 15,000–20,000 sqm,” adds Arkadiusz Rudzki.

The three CEE Bs

In spite of the fact that the market analyses are not yet pointing to this, experts are anticipating a marked improvement on the office markets of Budapest (17.56 pct vacancy) and Bucharest (14.68 pct). Budapest, which is the second largest office market in the region after Warsaw (3.2 mln sqm), is now moving into a higher gear after a few years of limited interest in the Hungarian market. According to the Budapest Research Forum, in H1 2014 a total area of almost 250,000 sqm was leased in the city (21 pct of which was in new contracts). This is 71 pct up on the same period of 2013. Unsurprisingly, vacancy has decreased – by almost 1 pct. “Around 110,000 sqm of new office space is under construction in Budapest. We have also registered a satisfactory level of leasing. I believe that the trend should continue until 2016 as long as the volume of new leasing contracts continues to increase,” believes Kevin Turpin of JLL. Arkadiusz Rudzki of Skanska Property Poland agrees that Budapest is on the way up: “We have leased and sold our Green House development – this was the first investment transaction on the office market in many years. We are currently working on our next project, Nordic Light, which will be a speculative one. We have built up a land bank and are still looking for new locations – for plots in places where vacancy is at a moderate level,” he reveals. The situation is somewhat similar in Bucharest, which as a result of the healthy Romanian economic growth is seeing dynamic office development. “Over 100,000 sqm of offices are currently under construction in the Romanian capital, and these are planned to enter the market in the next 18–24 months. We also expect that the vacancy level will decrease from the current 14.7 pct to 13 pct before 2016, due to the stable demand and greater confidence on the Romanian market,” forecasts Kevin Turpin. Such projections are unsurprising, since in H1 an area of 132,000 sqm was leased – 27 pct more than a year earlier. “When investing our own money we are much more cautious in terms of choosing the locations. It took a long time before we decided to invest in Romania, but we are now satisfied with this decision. The first building in the Green Court Bucharest complex in Bucharest is now almost fully leased before its completion. We have also launched the construction of the second phase of the project, which is enjoying a great deal of interest. We are even signing lease contracts and letters of intent at this early stage. A third stage of the project is also to be built, but we are also actively looking for new plots for subsequent projects in Bucharest,” says the leasing and building value management director at Skanska Property Poland. However, the biggest growth can be seen on one of the smallest office markets of the region: Bratislava. According to the data of the Bratislava Research Forum, the growth on this market has been astronomical. In Q2 2014, 75,000 sqm of office space was leased in the Slovakian capital. This is 270 pct more than in the previous quarter and as much as 290 pct more than in the same period in 2013. On top of this, 93 pct of the contracts are new and pre-leases (20,000 sqm by ČSOB bank, 19,400 sqm by Johnson Controls and 17,000 sqm by IBM). Due to this large demand for office space, the vacancy rate in Bratislava has fallen by 1 pct – from 14.55 pct to 13.55 pct, partly the result of the lack of finished construction projects in Q2. An office area of 40,000 sqm should be completed by the end of the year. Meanwhile, the capital city of Bulgaria seems to be unable to shake off its recent stagnation. “Sofia is a totally different story. The market collapsed completely after the financial crisis, but it is currently rebuilding itself,” explains Jos Tromp. According to JLL’s latest figures, even after a slight fall the vacancy rate still comes to 25 pct. However, this is mostly due to the weaker locations included in the calculations. In the best locations the level falls below 10 pct. The Sofia office market is being dragged down by the levels of debt borne by projects in the city and the gap between buyers’ and sellers’ expectations.

Investors will buy anyway?

Despite the diverse situation on individual markets, increasing investor interest in office properties in our region is still apparent. According to the latest data from Cushman & Wakefield, the total value of investment transactions on the markets in Central Europe (i.e. in Poland, the Czech Republic, Romania, Slovakia and Hungary) in Q2 2014 amounted to EUR 754 mln – 14 pct higher than in the same period last year. Since the beginning of the year, app. EUR 2 bln has been invested in the region, constituting a growth of 12 pct compared to H1 2013. The office sector continues to enjoy the most interest, with 42 pct of the total value of investment transactions concluded in Q2. “Considering the large number of transactions under preparation, the investment volume this year could exceed last year’s,” according to C&W’s experts. But they seem to be the only ones who are thinking this way. “There is a lot of equity on the investment market and the banks are increasingly willing to lend money for real estate. Therefore I think that investor interest in office properties will remain high. Partly because of the lack of alternatives, real estate remains one of the best forms of investment as the gap between the return on bonds and real estate remains wide. The money has to find an outlet and there are not too many alternatives to real estate,” believes Jos Tromp. Developers are also looking to the future optimistically. “Assuming that the positive economic climate and the stable political situation in the region are maintained, we are not in any danger of any stagnation in terms of office development,” believes Stanislav Frnka, the managing director of HB Reavis. “However, only those developers who analyse the market properly and are flexible enough to adjust their offers to tenants’ increasingly complex requirements will survive on the market,” he adds. ν