According to a mid-year report by the Prague Research Forum, the office vacancy rate dropped from 15.1 percent at the end of 2004 to the current 13.6 percent. Office takeup was 90,390 square meters in the first half of 2005, according to the report. This is a strong recovery from last year when, at 130,000 square meters for all four quarters combined, office takeup was the lowest since 1996.

Most experts agree that the reasons for the office market recovery aren't purely economic. "I think that the main reason is cyclical," says Richard Curran, head of agency and corporate services at the Prague office of CB Richard Ellis (CBRE). "In Prague, lease lengths are about five years, and a lot of the leases came up for renewal. Since 2000 was a very good year in terms of office takeup, we're experiencing another strong year."

In recent months, there has been much talk about surplus office space in Prague. But according to Curran, the vacancy rate for offices is somewhat misleading. A lot of office space that came on the market during the 1990s was refurbished residential space. Landlords were eager to turn residential space into offices because the rents they could charge were substantially higher. Often, though, the resulting space wasn't very suitable for offices. Some of the companies occupying those spaces have moved into higher-quality offices, and the old buildings remain vacant. Many landlords simply aren't willing to invest in refurbishing these spaces.

"These buildings will probably revert to being residential," says Curran. In spite of this, the demand and supply, he says, are now quite even. "The supply is slightly outstripping the demand," says Curran. "At the current level, the vacancy rate is just a little bit above ideal."

According to Cory Hrnčiřík, CBRE head of Central and Eastern European research, this slightly higher vacancy rate means that the Prague office market continues to be a tenant's market. That means it's an ideal time for companies to lease space — the vacancy rate is higher than average, rents have fallen somewhat, and developers are willing to offer incentives to attract tenants.

In a tenant's market, says Hrnčiřík, pre-leases are very uncommon. "Tenants prefer to see the space with their own eyes before signing a contract," he notes. As a result, an increasing amount of space is being built speculatively, without leases already signed. Hrnčiřík says that with speculative building, it's common to see a building completed with quite a bit of vacant space, which can significantly impact the overall vacancy rate in the quarter in which it is completed. "Once tenants can see the space, most modern, class-A space is leased very quickly — usually within a year of completion," he adds.

Other factors

Not everyone agrees that the market in Prague continues to favor tenants. Andrew Thompson, head of the office agency at Cushman & Wakefield Healey & Baker, says, "I don't think it's a tenant's market any longer. That was the case a year ago, but not any more. I woud say that now the market is relatively in balance."

According to Thompson, there is limited new supply when it comes to office space. Next year, he says, there won't be any new major office projects coming on the market. "I think that this trend will remain for a while," he says. "They won't overbuild."

Thompson notes that current demand is mostly for new office space. "Over the last few years, 60 to 70 percent of the deals have happened in new buildings or in major refurbishments." According to Curran of CBRE, the quality of the buildings intended for office use has improved a great deal over the last five years. Thompson points out, however, that in his experience, the quality of the space isn't the only factor that tenants consider when looking for a new location. "Choosing offices works a bit on an emotional level as well. In some ways it's like choosing a flat," says Thompson. "Your building has to feel right. It also has to be flexible."

Another factor in the mix: The way buildings are marketed is becoming increasingly important. A growing trend is for buildings to have some philosophy behind them, or to be promoted as having their own specific character. Thompson cites the example of the recently constructed Danube House and the Nile House (scheduled to open this year), whose bold design and energy efficiency set them apart from other office developments.

Thompson also notes that in Central Europe, there are higher GDP (gross domestic product) growth rates predicted than in Western Europe. "The economy will expand in different areas, and it's difficult to predict the level of growth," he says. As a result, flexibility in new developments is very important. "You build the unpredictibility into your choice of office space," explains Thomson. "Flexible buildings are the flavor of the day, and I think that this will remain the case."

Curran agrees. "Multi-functional centers allow the investors to spread their risk," he says. "You can't focus on just one sector of the market and then watch your investment go down the toilet."

Retail stays strong

Despite the market's unpredictability, Martin Žížala, head of the retail team at Cushman & Wakefield Healey & Baker, is optimistic when it comes to demand for retail space. "It's one of those markets where you never know, but I think that [the strong demand] will probably last for a while," he says, adding that some markets are beginning to see some saturation.

According to Žížala, the demand is already moving to regional cities. In Brno, for instance, the retail market is starting to become saturated. But Žížala stresses that the demand for retail remains strong. When the Czech market first opened up following the Velvet Revolution, people were very receptive to new brands that were coming in, according to Žížala. This was mainly because under the communist regime, Czechs didn't have many brands to choose from and didn't have the opportunity to develop brand loyalty.

These days, Czechs are probably not as open to new brands as they were in the early 1990s. But foreign investors continue to flock to the Czech Republic, seeking a slice of the retail market. According to Hrnčiřík, this is largely because investors here continue to realize higher yields than in Western Europe, and also because many of these investors have a mandate to expand their portfolio into the Central and Eastern European region.

"Higher yields are still one of the main drivers of the Czech Republic retail market's attractiveness," says Hrnčiřík. Prime yields for retail in the Czech Republic are approximately 7.5 percent compared to 4.75 percent in the UK and 5.5 percent in France and Germany, Hrnčiřík notes.