The road to recovery

Judging by the christmas cards and the new year’s wishes ‘Eurobuild CEE’ received in december, there is a lot of hope on the market. After a remarkable – unfortunately mainly in a negative way – 2009, market players are hungry for some good news. Is there any? We posed this question to the people who are closest to the market – the top managers of the leading real estate consultancies. The first of these was Bert Hesselink, head of the office and industrial agency at dtz in the Czech Republic. and his reply? Yes, there are some green shoots, but just to be on the safe side, don’t get too carried away. Yet

Mladen Petrov

Take-up was 30-50 pct lower, accompanied by decreasing supply and falling rents – this is, in a  nutshell, how 2009 looked for the CEE office market. The market has demonstrated that ‘prime’ price sensitivity is much lower in hard times than it is for ‘sub-prime’ properties, which do not meet all the criteria being sought after today. Prime properties are generally valued and trading at app. 100-150 bps below their peak values, whereas properties which are not so attractive to investors are valued at a discount of 200 bps plus. We might not be back to square one, but certainly the market has taken a major step backwards. The example for Poland is clear enough – in 2008 the take-up of office space in Warsaw amounted to 500,000 sqm, but at this year’s close we were looking at take-up of only 145,000 sqm. One can only expect that 2010 will be better.

But will it? Mature office markets such as Warsaw, Prague and Budapest appeared strong in 2009, of course, despite the conditions. Obviously, the vacancy rate increased everywhere, but the crisis is not the only factor to blame for that. In the case of Prague (vacancy rate of 10 pct) and Budapest (20 pct), the record supply of new office space in 2008 in Prague and 2009 in Budapest was another very important, if not the most important, reason for the increasing vacancy rate.

Across the region we are now observing increasing demand, but it is too early at this point to identify any new, positive trends. At the beginning of 2009 most tenants were unable to take any important decisions due to uncertainty about the near future, but now they know that the worst is behind them. And yet they remain very cautious. There are, however, lots of opportunities on the market right now. The office space available for sub-letting is top of the list. The amount of space available for sub-letting and which is known to agents in Prague comes to around 40,000 sqm – 1.5 pct of the total stock – while in Warsaw the figure is about 60,000 sqm. The real number is actually very likely to be higher and marketed through different channels than through the agencies. Our forecast is that in 2010 we are going to see the amount increasing.

Another major current trend is for the re-negotiation of rents. As long as there is space available for sub-letting on the market being by offered by tenants looking to save costs (rather than to make a profit), landlords will be under pressure to remain competitive. Rents will not recover so fast in these conditions and in 2010 tenants will be able to take advantage of higher vacancy rates. Sub-leasing will only really start disappearing once tenants start increasing (and recruiting) again. Achievable terms and conditions for tenants depend on local demand and supply situations. It takes only two aggressive landlords for rents to start falling.

Summing up, 2010 will not be a year of major office market growth. However, deals will continue to happen – especially in markets which had strong take-up in 2005/2006 – because the leases signed then are in many cases coming up for renewal, or because relocation will occur. The growth of the office markets will recover slowly as economies pick up. Some markets, however, have more challenges facing them than the others. Take Budapest, for example: the economy is still in recession, with a massive new supply of office space (230,000 sqm in Q1-Q3 2009). For this market, 2012 seems to be the year when things will finally start to look better. Until then it will remain a tenants’ market. Kyiv also has a long way to go. The situation there is entirely incomparable to the rest, with rents tumbling from USD 70-85 per sqm to USD 30-35 per sqm. In Central Europe, Budapest has the lowest rents, but does that mean tenants will start flocking to the capital all of a sudden? Not really. For large international tenants rents are not the most important factor when choosing a location.

What will 2010 bring? The major trends will be reasonable take-up, absorption, the disappearance of subleased space, and a limited new supply of office space throughout the whole region, which combined with positive absorption rates once the economy starts picking up again will eventually lead to falling vacancy and rising rents.

On the investment side, in 2008 there was a general shift towards core markets by investors starting from the onset of the global downturn. This is a simple ‘stick to what you know’ approach that that can be expected in times of uncertainty. The core markets of the CEE region have always been Prague, Warsaw and Budapest. The current interest of international investors is specifically oriented towards prime assets, which must satisfy a number of criteria to qualify as potential acquisitions. As Central and Eastern Europe is considered an ‘emerging’ market, investors will only invest where they perceive absolutely minimum risk, and due to the critical volumes of the capital cities of their respective countries it logically follows that they will buy properties in the capitals. Anything outside the capital is therefore regarded as not prime. In 2010, international funds will still only be looking at the core CEE capitals, but this leaves the door open for domestic funds, private equity groups, consortiums and high net worth individuals to fill the vacuum left behind and acquire excellent investment product at discounted yields.