Richard Curran (Knight Frank): €29 rents in central Prague are a myth

central Prague

Robert McLean

#cee, #proptech, #development a #architecture

Are rents in central offices going to go up to €27 – 29 as advertised?
No. Certainly not in the short to medium term. People are taking this number off of one building, which is Masaryčka. Penta appear to be very successful in renting it, however, it’s not reflective in the least of the wider market. It’s an outlier.

Why is it doing well, if it’s not the market?
It’s only once every couple of years that a headline building becomes available and there will be a small group of cash-rich companies that will buy into a project like that. Because they want the visibility. Palladium did that, Quadrio came up. But there’s only a handful of companies willing to pay that kind of headline rent, and the figure doesn’t take into account incentive packages. Masaryčka isn’t reflective of what’s happening elsewhere. If you want to take a comparable building, there’s Via Uno which is across the road, similar location and they’ve managed to lease one or two floors. But it’s completed and still largely vacant.

So you think Masaryčka is the exception that proves the rule?
It’s the exception. So, we really know what’s going on with the occupiers. What’s panning out now is what we all expected from Covid…now that the pandemic is over, companies are looking around their offices. And in certain sectors like IT, they’re just seeing swathes of empty desks. Their business has fundamentally changed, and their people are not coming back to the market. They have 30 or 35% occupancy and it’s not going to improve (again, I’m talking about the IT sector).

What’s happening is that as those companies come to the end of their leases, they’re downsizing. These are big players and they’re going from 3,000 to 1,500 sqm. Those who still have years on their lease are looking to sublease. That’s going to free up a lot of space on the market, and this will impact prices.

For most of the last decade, the IT sector was responsible for a big share of new take-up on Prague’s office market. So, any downsizing has to have an effect.
Exactly. And if it weren’t for Covid, that growth may have continued. But it’s not just limited to the IT sector. We’re speaking with a number of banks at the moment, and the big ones are running at occupancies of 50 or 55%. What we’re seeing is that companies who move to out-of-town locations, or locations that are badly serviced in terms of amenities, their staff don’t want to come back to work. If you’re downtown or Karlin, you’re okay. But if you’ve moved out of town, those staff aren’t keen to come back to work.

But isn’t that precisely the argument used to explain why rents in the center will rise to €29? Keeping employees and getting them back into the office requires something that’s a bit special. And the center is special.

In order to do that, you can’t increase your costs massively. If you’re already in a city center building and your landlord wants to keep you, your headline rent may be €17 or €18 but your net effective is €14 or €15. Especially as we head into a recession, it’s very difficult to go back to your head office and say, “I’m in a building where I can stay for €14 or I can move to a €28 building across the street.”

If companies are reducing the amount of space they need, won’t that make them more open to spending more per square meter?
We’re just not seeing that. People are very cost conscious at the moment. And don’t forget, moving means paying for fitout costs. Today, with construction costs being where they are, fitouts are a huge thing. It used to be that if you got a fitout contribution of €200 or €250 per square meter, that would cover most it. Now it only covers maybe a third of your fitout. And if you’re looking at 1,000 square meters, that’s serious money.

How can rents have been stuck at €19 for so long if rent indexation is always in leases? Is my math really that bad?
Indexation isn’t something that anyone’s paid much attention to for the past ten years because it was always 1 or 2%. So, who cared? What generally happened was that at the end of the lease term, it was negotiated back down again. Prague’s been extremely unusual like that.

So, what happens now? The math has changed.
The math has changed now, and in the short-term the value of properties will fall. Everyone knows that yields are going to move out. Everyone is factoring rental growth because of indexation, especially for this year. What we’re seeing in most negotiations on new leases is tenants looking for caps on indexation. Landlords aren’t terribly thrilled about that, since the whole idea of a lease is that it’s an inflation hedge. But we’re seeing many landlords coming around to the idea of caps being set at somewhere up above 5%.

We see it being very much a tenant’s market for the next 6-12 months with incentive packages increasing, especially with regards to fit-out contributions.

 

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