Building pressure

High development activity is making owners of existing assets rethink their strategies By Adam Zdrodowski The significant amount of new office space which is now under construction in Poland is continuing to provoke concerns from property experts about the market already being overheated and unable to absorb all of the upcoming schemes. The intense development activity in the office sector in recent years has translated into fierce competition for occupants, with the owners of existing buildings having to think of new ways of keeping tenants, as more and more new projects are delivered. Developers have been optimistic, claiming that the decent condition of the leasing market continues to justify the launch of new schemes. Arkadiusz Rudzki, leasing and asset director at Skanska Property Poland, pointed out that this year we are going to see record take-up levels. However, Rudzki admitted that the market situation is more challenging for owners of older office buildings as the highest demand for office space in Poland is generated by tenants already present in the country, and those tend to move from older to newer facilities. [caption id="attachment_85303" align="alignleft" width="300"] Savills[/caption] “A total of more than 1.3 million sqm of modern office space is now under construction in Poland, of which 612,000 sqm is being developed in Warsaw,” said Michał Lis, director of the office space leasing department of JLL. As more and more new office projects are delivered to the market the share of older buildings in the total existing office supply in Poland will gradually decrease. “We will witness more and more thorough modernizations and demolitions,” Lis said. According to Karol Bartos, executive director, portfolio and asset manage ment at Tristan Capital Partners, “landlords cannot afford to rest easy, especially when faced with the stream of new developments that will open in the coming years.” The owners of existing buildings still have many trump cards to play, but effective property management is critical and depends on a constant hunt for improvements to make a building stand out so that it can meet the needs and expectations of tenants, Bartos added. Tenants keep moving Property market experts agree that new office projects are becoming major competition for existing properties, some of which have aged quickly. “Tenants generally prefer new buildings,” said Paweł Skałba, partner and office department director at Colliers International. There are several reasons for the trend – some occupants may simply need a change, whereas others may be interested in securing better leasing conditions and in optimizing costs, Skałba said. In Skałba’s opinion, global trends are now exerting significant influence on the companies which lease office space in Poland. The approach to the workplace is changing, and so are tenant expectations regarding the standard and arrangement of the occupied area. Meanwhile, a tenant who wants to completely re-arrange their office, more often than not, chooses to move to a new location simply because staying in a building that is being renovated is a major logistical challenge. According to a recent report by Colliers International, relocations accounted for almost 50 percent of the combined volume of lease transactions that were brokered by the company in the third quarter of this year. The implementation by tenants of the “workplace solutions” concept is one of the main reasons for relocating to another building. Many tenants are also currently moving to new premises as a result of their office consolidation processes, the Colliers International study found. When it comes to those tenants who are looking to lease large areas, going for a new office development is usually the only option because finding more than 10,000 sqm of vacant space in an existing building can be a daunting task. Skałba also pointed to another important factor that influences tenant decisions – the fact that developers, for the most part, are more flexible and have a better understanding of the needs of occupants than the investment funds which own older office buildings. Holding their own Which office buildings can be described as “old”? According to Lis, generally speaking, the term refers to buildings which were completed approximately ten to twelve years ago, but this is not a hard-and-fast rule. [caption id="attachment_85300" align="alignright" width="300"] Image: JLL[/caption] He pointed out that there are even older buildings on the market which, despite their age, meet the requirements of tenants and remain popular with companies looking for office space. On the other hand, there are relatively new office buildings in Poland that are not fully leased. Real estate market experts point to the Warsaw Financial Center office skyscraper in the Polish capital, which was completed in 1998 and is owned by Allianz Real Estate and Tristan Capital Partners, as a good example of an older building that has aged very well. “Our experience at the Warsaw Financial Center shows that landlords with a proactive approach to property management can hold their own against new office developments,” said Bartos. According to JLL data, for the third quarter of this year, in Warsaw the vacancy rate in office buildings that are less than five years old amounts to 14.3 percent. The vacancy rates in facilities between five and ten years old, and over ten years stand at 14.2 percent and 11.4 percent respectively. However, one has to remember that the relatively high vacancy rate in newer buildings results from the fact that the complete commercialization of a building takes some time after the building has been commissioned for use. “We believe that both new office projects and existing buildings will find tenants,” said Dariusz Karwański, an associate at the office agency of Savills. He added that it all depends on the situation on the leasing market, tenant needs and the location of a given building. Katarzyna Gajewska, a consultant at the consulting and research department of CBRE, argued that due to their central location, many older office buildings remain attractive. Nevertheless, their standard needs to be improved as tenants’ expectations grow. The modernization imperative Indeed, some investment funds have already realized that their office buildings can only be successful after the in troduction of adequate negotiation policies, supported by actions aimed at the improvement of the standards of those buildings, Skałba said. “In some cases, an older office building needs to be re-introduced onto the market,” Skałba added. This basically means that the building needs to be renovated, its standard needs to be upgraded and the brand of the building needs to be created anew, he said. Lis pointed to a number of older office buildings in Warsaw – including Sienna Center, Spektrum Tower, Moniuszki 1a and Koszykowa 54 – where successful modernization schemes have resulted in securing new tenants. Karwański mentioned the Warsaw Trade Tower office skyscraper in the Polish capital as an example of an older asset which has boosted its attractiveness by the addition of new functions. A conference center was implemented on the 35th floor of the building earlier this year. However, Lis argued that the decision to launch a modernization process always needs to be preceded by proper cost calculations because each office building is different and requires the application of a specific strategy, depending on the location and the tenant mix. The owner has to be convinced that the planned modernization will result in the reduction of vacancies and will positively impact the rental levels at the building. If an older office building is occupied by good tenants, slight renovation will probably be sufficient, Lis added. [caption id="attachment_85302" align="alignleft" width="300"] Image: UBS[/caption] In some of the cases when the property owner is convinced of the need to upgrade an aging asset, the question arises whether the demolition of the existing building and its replacement with a new structure would not be a more favorable option. This option is mostly taken into consideration by owners of office buildings which were developed before the political and economic transformation of 1989 or in the early 1990s. It is also a solution to the problem of the low availability of vacant office sites, Lis said. According to Skałba, the demolition of an existing office building is only justifiable in the situation when the property owner will be able to develop a considerably larger amount of leasable space in the same location. A well thought-out modernization process can often be more profitable and more efficient than a new investment, said Skałba. Gajewska also pointed out that demolition makes sense when the new project is going to be taller than the existing building. In downtown Warsaw, there are now at least two planned skyscraper office schemes that will be developed on the sites of older existing office buildings. PHN is planning to build its City Tower investment on the site of a communist-era building located close to the Rondo 1 tower. Additionally, UBS wants to demolish the 103-meter tall Ilmet building, completed in 1997, and replace it with a taller skyscraper called Warsaw One. At the moment, it is not yet known exactly when construction on either of these two developments will be launched