Staking it all on speculation

Four developers set to break ground this year on office projects in core Prague markets will do so speculatively, without pre-leases from future tenants - something experts say was unthinkable only a few months ago.

Rohan Office Centre and River Garden Office West, both slated for Karlín, will bring 8,500 sqm and 19,000 sqm respectively to the Prague 8 office market by the first half of 2012, and developers of both projects are going ahead without any pre-leases (and hence without any bank financing). Other projects like City Green Court, Lyra Office building in Prague 5 and Budějovická 3 in Pankrác, are funded largely by the developers' own capital, as market conditions continue to prevent the 40 percent to 50 percent pre-leases most banks demand before lending.

The developers say they are willing to take the risk of building without customers if they have to, since most market forecasts predict a shortage of space in the next few years, and companies want to be first in line when demand starts to outpace supply.

"There will only be 55,000 sqm of new office space delivered this year and around 65,000 next year, which means there will be an undersupply of space by 2011 to 2012, when these projects are set to be delivered," said Eduard Forejt, national director and head of office agency with property adviser Jones Lang LaSalle. "Developers know buildings delivered in 2011 and 2012 should have no competition."

"We have some potential clients, but none of them are signed yet," said Vít Ulmann, marketing director with Pankrác, the developer of Budějovická 3. He says they would like to try to secure some amount of bank financing, but it's anybody's guess how much they'll be able to get. He admits that building based on market forecasts is risky but says that since the project has been in the works for eight years, it's time to build. "Construction costs are also much lower now, so that was obviously part of the decision as well," he said.

Other developers scoff at handwringing about risk, pointing out all of the added advantages of speculative building.

"With the exception of built-to-suit for owner-occupiers, speculative development is the only reasonable way to satisfy client requirements in terms of guaranteeing the completion and move-in date," said Martin Prokeš, spokesman for Karimpol, developer of Rohan Office Centre. He also stresses that you can't underestimate the impact on potential tenants of actually seeing the physical space, which can only happen if the building is built on speculation.

Karimpol is also currently in negotiations with three different banks about a construction loan they'd like to acquire in order to free up cash for other ventures, and Prokeš is confident they'll solidify a loan with no pre-lease requirement in the next few weeks, but he is critical of the banks and their continued hesitance to lend.

"Banks caused the trouble in the first place, and they cause even more problems as they are extremely restrictive in providing financing, not only in the real estate sector but across all sectors," he said.

When asked why banks are still clinging to strict lending conditions for office developments when the Prague market is expected to experience an undersupply of office stock in the coming years, Bert Hesselink, director of office and industrial agency at property adviser DTZ, said it was a good question with a difficult answer.

"I guess the banks are simply more careful and have learned their lesson from the financial crisis, but at the same time, lending is their business, so eventually they will be interested again," he said.

DTZ's research also shows that in addition to having a common taste for speculative building, developers of the impending office projects also share the common goal of obtaining green building certificates like LEED and BREEAM, which they say will make their projects more attractive to future tenants and will mitigate the risk of developing without pre-leases.

"People usually focus on resource efficiency when they talk about green buildings, and that is definitely an advantage, but what sometimes gets overlooked is that green buildings offer a better internal environment, which increases the productivity of the occupiers' employees, and companies can also use it as a way to express their social responsibility," Hesselink said. "If you add everything up, the occupiers should be willing to pay more rent per square meter per month."

Despite the optimistic outlook, developers and analysts alike agree that the return of speculative development is a paradigm shift most likely isolated to Prague's core markets.

"The developers see a potential undersupply of their specific type of office space at a specific location," Hesselink said. "If you look at the Prague office market as a whole, in order for vacancy rates to come down, the economy has to pick back up. It is, but I'm not 100 percent sure the overall vacancy in the city will go down in the next few years."

Emily Thompson can be reached at
ethompson@praguepost.com