Slice and dice

interview by Beata Socha Alan Colquhoun is the head of DTZ for the CEE region. Only a few years ago, real estate investors were willing to buy prime schemes in Poland’s major cities “on the block.” Now, they are far more selective and careful. Warsaw is no longer seen as the CBD plus outer districts. Meanwhile, regional cities are still largely viewed as homogenous markets. What is on the investors’ radar and where do the opportunities lie? We’ve seen some fairly significant office deals in the first half of the year. The volume of office transactions has thus far outstripped that of the retail segment. Will the trend continue? In retail, one huge deal can skew the statistics. I would normally rank office and retail somewhat equally, but in the first half of this year, there were three large retail transactions in Warsaw and eight more in provincial cities. Office usually has a larger number of deals, while deals in the retail segment are far bigger in volume. So all it takes is one or two major transactions to outstrip the office segment. Four industrial and logistics deals saw volumes in that sector almost reach those in retail. These are the three main sectors that we involve ourselves in. We do sometimes encroach on development land, hotels or even residential, if it’s part of a mixed-use scheme. Warsaw’s office market continues to see further rent pressure, and in turn lower yields. Are we going to see a rent crunch in all major cities in Poland or is it just the capital that is overheating? In general, as advisers we look at the market from different perspectives. From the perspective of the tenant, you could argue the market is good at the moment. Further downward rental pressure in Warsaw is possible due to the higher supply levels; tenant incentives will probably increase to maintain headline rents. Provincial city rents will likely remain where they are; I would expect demand from the outsourcing sector to shore them up. Core investors are now much more discerning than they were a few years ago. They are very specific about what they want to buy: generally only the very best in terms of quality and location in the Central Business District. Whenever one of the prime CBD schemes is up for sale, for instance Skylight Tower, Lumen, Rondo 1, Warsaw Financial Center or the Metropolitan, a certain group of investors will look at any one of these but probably not consider much else. There is also a more recent trend. As the economy and the financial market have recovered, more investors are looking at provincial cities, seeking higher yield. For instance, they are looking at buildings with a long-term blue-chip BPO tenant with a lease for 7-10 years. That might be more attractive for certain investors because the yield might be a bit higher than taking a risk in Warsaw, where we will see a lot of supply in the future. Including the Arka portfolio, eight provincial city office buildings have been sold in the first half of this year in Kraków, Wrocław, Gdynia, Poznań and Łódź. Let’s focus on Warsaw. Hines recently started building its next project – the Proximo building, a 30,000-sqm office scheme in Warsaw’s western Wola district. The 100,000-sqm Warsaw Spire continues to rise less than 200 meters away. Wola will soon see a slew of prime office space come online. What will be the investors’ response to that? Between 2000 and 2010, investors were far less discerning when it comes to buying properties than they are now. They considered Warsaw to be divided into two submarkets: in-town and suburban. Now, they are very specific, almost on a building-by-building or street-by-street basis. To give one example, we’ve dealt with an investor who, because of the oversupply issue, would only look at a couple of more prestigious locations where there is less competition. Investors are now interested in some micro-locations, such as in the eastern end of Warsaw’s city center, from Aleje Ujazdowskie and Krakowskie Przedmieście towards the east. It’s perhaps not an established office location, but architecturally, it’s arguably the “nicest” part of Warsaw. There are a lot of ministries, embassies and the Warsaw Stock Exchange is in this area. And you don’t see five new office towers being built on your doorstep. Because of the planning regime and historic nature of that part of the city, there will always be a natural block on supply. I’m not saying that investors will flock there, but at least one big fund in particular is focused on that area. Other areas of interest are Powiśle and around Dworzec Gdański, each with large developments that reportedly have pre-lets to auditing firms in place. As the market matures, it becomes much more specific, “sliced and diced” by investors. So you’re saying we’re going to see more interest in the eastern part of Warsaw now? Yes, I think so. For example, investor interest in Mokotów, a well-established office location in Warsaw, has been cooling off. The success of the district as an office location has even begun to work against it, because of the heavy traffic in the area. I’m not saying that the issue will put tenants off entirely, but it will make them consider other locations, such as around Dworzec Gdański, which is an up-and-coming office area on the north side of Warsaw. One area I’m going watch with interest is Praga, particularly the central part around Wileńska, near the metro line. It will take some time and people will have to get used to commuting across the river. There are a lot of middle-class housing projects being built around in the north-east, on the eastern side of the river. This will influence where companies locate their offices. After Dworzec Gdański and little pockets in Powiśle, I think the next thing will be Praga, particularly the metro-connected parts. [negative]“As the economy and the financial market have recovered, more investors are looking at provincial cities, seeking higher yield.[/negative] Outside of Warsaw, how would you rank Poland’s provincial cities in terms of attractiveness for investors? The most developed provincial cities in terms of the office market are Kraków and Wrocław. They have clearly developed better than the other provincial cities, Wrocław perhaps even a little better than Kraków. The Tri-City comes next. Poznań has also developed, but in terms of demand it didn’t achieve the same initial success as Wrocław did. Wrocław has a higher vacancy rate than most other regional cities. Isn’t that a bit alarming? The city initially did very well because of the BPO boom and because of the efforts of the city authorities. In consequence, Wrocław saw more speculative supply than Kraków did. But looking at them from a helicopter view, these cities are all much of a muchness and outsourcing/BPO sector demand is expected to remain strong. What about smaller, third-tier cities, like Rzeszów, Olsztyn and Kielce? Are they prospective markets for developers and investors? Any city with a university has significant attraction, particularly for the BPO operators, because there is a ready supply of a multilingual and qualified workforce. The first entrants into such a market avoid competition. In some of the larger cities, like Wrocław, the employment market has become tighter. It not only raises cost, but also makes it more difficult for some companies to get all the people they need. If you’re setting up a BPO and you need a couple hundred people in phase one, it’s difficult to get them in one hit as the labor supply gets tighter. Having a university is one thing. The other one is the supply. When we did a BPO lease acquisition on behalf of Hewlett Packard in Wrocław in 2004/2005, a big issue we faced was the lack of office space. It was an issue that could have jeopardized the whole deal. It so happened that we put them in the Renoma building, which at the time was considered strictly as a retail location by its owner. But it had a lot of empty and flexible office space upstairs, which we convinced them to refurbish. Then as the landlord refurbished the space, HP grew into it very nicely. Could these smaller second and third-tier cities repeat Wrocław’s success? Some of the obvious places for me would be Lublin, with over 300,000 people and universities. They already have had some successes, as has Olsztyn with Citi Bank. I think that all of these tertiary cities have possibilities, but I wouldn’t say it’s going to be a huge boom. Why not? One thing to bear in mind, is that in order make it a success, almost all developers need to have an exit route. Once they’ve built, they need to sell it. It’s not easy to get one of the institutional funds, thus far only focused on Warsaw and maybe a few first-tier provincial cities, to buy these properties. What would help these smaller cities, apart from a proactive local authority supporting the planning process, would be loosening of the investment legal framework allowing Polish pension funds to invest directly in real estate. If we could create more of a local institutional investment market, the smaller cities would have better prospects. Local funds would be much more likely to buy an 8,000-sqm or a 15,000-sqm office building in Kielce or Osrów Wielkopolski. When you're in your own home environment then your investment risk will be perceived to be lower than for foreign investors.