Budapest Office Market Study 2012

Budapest Office Market Study – 2012 November Roland Låposi

Heriot-Watt University School of Built Environment Real Estate And Planning programme Real Estate Economy course 2012.10.26.

The paper looks into the features and turning points of the economy and office market between 2007 and 2012, with regards to the back-log in delivery and the resulted office oversupply, and the reluctance of international developers to invest and the new phenomenon of place sensitive small scale developments in the more characteristic historic inner districts. This paper highlights that office market could reach supply-demand equilibrium on long run depending on the market capability to take-up the available office spaces. New investments scale and form needs to reflect to the specific demands of newly appeared small and medium enterprises (mostly creative, IT, or media businesses) by offering cost effective co-working options and seeking location in impulsive and vibrant urban environment and using the local character as a branding asset.

Budapest Office Market Introduction This paper is aimed to examine and analyse the current situation of the office market in Budapest the Hungarian capital city in order to determine which key economic factors, trends and policies are affecting the rental values, the spatial distribution of the sector, the relations between demand and supply, the changing forms and scales of developments reflecting to changing company structures and preferences and their possible impacts on possible investment decisions and opportunities in the sector.

The key method of evaluation is the recognition of connections and changes in the different patterns of various economic factors, events and trends and revealing the reason or motives behind them (Ratcliffe and Stubbs, 1996 pp. 406-409.). The paper based on primary sources in the term of the author own research, experience and interview with local experts as well as on secondary sources to explain the main economic determinants (National Bank of Hungary, OECD etc) and Budapest’s economic environment by using office market studies and surveys of the field leading agencies, and professional bodies (RICS, DTZ, Jones Lang LaSalle, Colliers). To have a background insight to local brownfield development and world heritage policies and to get an understanding how zoning regulations altered the market conditions strategic development documents have also been analysed.

The paper looks into the features and turning points of the economy and office market between 2007 and 2012, with regards to the back-log in delivery and the resulted office oversupply, and the reluctance of international developers to invest and the new phenomenon of place sensitive small scale developments in the more characteristic historic inner districts. Budapest’s situation is unique in a way, that the recent global recession is the first one experienced since the political system changed to democracy and the birth of the private property and free market in 1989. Therefore similarity between the impacts of previous crisises in the 1980’s on other globally connected cities such as Tokyo’s, New York’s and London’s property market and spatial restructuring – then facing the same challenges - can also be drawn to explore possible outcomes of recent events. The market performance of the competitor capital cities in the Central Eastern European (CEE) makes it possible to give a context and reference point to the trends in Budapest and in the region (Appendix B).

This paper highlights that office market could reach supply-demand equilibrium on long run depending on the market capability to take-up the available office spaces. Also states that under this re-balancing period new developments on major scale are unlikely because of the current oversupply and high vacancy level of 21.3%. The current levels of yields are expected to remain on the current level around 7.5% and rental fees between 8 (secondary) – 20 (prime) euro/m2 respectively. More tightening credit conditions and decrease of construction productivity combined with the dramatic rise of building industry companies went into administration also significantly restrain capability to deliver any new developments and threaten completions of many other stalled projects. Supply has to wait till vacancy rates are going down to anticipate effective demand for new developments. New investments scale and form needs to reflect to the specific demands of newly appeared small and medium enterprises (mostly creative, IT, or media businesses) by offering cost effective co-working options and seeking location in impulsive and vibrant urban environment and using the local character as a branding asset.

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Key economic factors, trends and government policies The year 2012 hasn’t started well for Hungary’s economy. After the rise of the crisis in 2008 the national economy turned into recession and the commercial real estate market stalled (RICS 2012). As a result of impacts of the global credit crunch and the economic performance the country has been downgraded to non-investment - ‘junk’ category by all the three major credit ranking agencies.

The amplitude of GDP fluctuation gives a good picture of the difficulties of the economy in the Fiscal Stability Report of the National Bank of Hungary (2012). It has been reached its lowest point in 2009 at -8% when the government asked for IMF bailout then climbed back and stabilised for a short period on 1.6% in 2011 after which it turned downward again into recession and was -1.4% in the second quarter of 2012. Expectations of the OECD and National Bank of Hungary (NBH) show that there might be a slow increase in 2013 at the level of 0.2% which practically a stalled state of economy not a growth proper (OECD 2012, NBH 2012).

Households’ average annual income rates were 2.2%, -4.0% in the last two years respectively and anticipated to be around -1.3%. Considering that inflation also went up and down but remained relatively high by touching 6% annually it can be indicated that average purchasing power is decreasing steadily. People are becoming poorer in real terms which lower the households’ consumptions as well as mass of financial savings in banks. Unemployment rates since 2009 are over 10% and rising.

The national budget balance is of 4.3% but expected to be around at -2.4% in the next year. It has to be mentioned that Hungarian government de facto nationalised the personal private pension funds to balance the ‘leakage’ to compensate the negative effects of the newly introduced flat income tax (16%), without which deficit would have been -3.7% in the reality.

The world’s investment market hasn’t welcomed it well which can be clearly indicated by the volatility of the yields-curve of the 10Years Hungarian Bond meaning that borrowing from the market to lower budget deficit become more and more expensive when government policies couldn’t prove that effective counteracts are planned. The interest paid by the country was over 12% in 2009 (IMF bailout corrected it) and remained around a 7 %, when it has become unsustainable to finance because of the eroding trust of recovery and reached almost 11% at the beginning of 2012 (Trading Economics, 2012).

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Government debt despite all measures taken – like committing pension’s previously owned funds to lower it – was 81.4% was reported by Napi Gazdaság (2012) Changes in the currency exchange market were following the similar pattern the Hungarian Forint (HUF) fell down and rose up to the Euro and Swiss Franc, both currencies are the most frequent foreign currency denominated credit, hence resulting huge surge in the amount of monthly payback in households and literally dried up the credit pool available for companies as well. Credit conditions are tightened up similarly than in the Eurozone accompanied with higher interest rates and risk avoiding lending behaviour of banks.

As Hungarian economy experienced it increasingly difficult access to bank loans also could be joined by the lack of foreign and national private investment as the same risk and uncertainty factors are being at work. Survey made by the national statistical institute the shows that investment levels declined slowly year by year in comparison to the investments in the previous one. That again indicates that venture capital, foreign direct investment and national investment are not keen on investing without clear, secure perspective (Kozponti Statisztikai Hivatal 2012).

To solve this liquidity problem and improve trust and credibility as well as expand financial opportunities to finance growth the government started negotiating for a new IMF – EU bailout in the end of 2011, markets expected to close the deal by September which did not happen yet and can be postponed for longer period. Not surprising than that the 2012 country report OECD (2012, pp.1.) summed it up that ‘Hungary’s economy faces severe headwinds’.

Eddy Kester in his article in the Financial Times (2012) summarises the policy responses, controversial and sometimes quite popularist government measures in 2012 included the mentioned private pensions funds nationalisation, the introducing of flat income tax rate, austerity packages, onepaid off tax on banks, utility and telecommunication companies – has been extended for another year, taxation on bank transfers, fixed currency pay back opportunity for housing mortgage payers indebted in Swiss Franc (and causing significant loss to banks). The government’s expansionist economic strategy and its reluctance to impose structural reforms and austerity measures to its spending led to unorthodox measures that have put its laws at odds with the EU’s directives on lowering the country’s fiscal deficit, which in turn threatens its access to ERDF finances in the period of 2014-2020.

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Another way to explain the current economic situation is comparing economic performance in different years which exactly what the Economist (2012) did in its Daily Chart ‘Putting the clocks back’ displaying very well the backdrop of the Hungarian economy to the level of 2003-2004. Karacsony (2012 pp. 6.) cited the IMF World Economic Outlook from 2009 when previous global crisises in the history has been analysed to examine the length of recovery needed after each. The time needed lasted from 6 quarters (1.5 year) almost up to 16 quarters (4 years). He suggests that around 2015 recovery might start up, provided that long term macroeconomic balance can be secured.

Implications of a recent agreement announced by mainstream economists that property tax introduction should be considered mean that cost of running any new property developments office sector included would add new element of tax burdens smothering the already ‘frozen’ demand (Gerőcs, 2012). Apart from new taxes building costs have already risen in the last 4 years already as VAT increased from 20% to 27%.

Having said this paper thinks that ongoing negotiations with the IMF and the EU eventually will enforce structural reforms and helps finding a more sensitive and strategic approach to deal with social, and economic uncertainty. But on short term the country’s economic development doesn’t support sustainable growth, therefore companies and firms are not able to expand, therefore no additional demand will be generated.

Office market responses to economic changes In the ‘Need to expand – Hungarian developers abroad’ Csűrös and Ditróy (2012) reported that major Hungarian developers are looking for new locations in the BRICS countries where profit higher, economy still grows and policies are in favour of foreign investments. Partly it is caused by the current economic situation of Hungary, on the other hand the built up back log in taking up new office buildings make makes market oversupplied and tenant driven. It is interesting to understand why it did happen in the context of the demand and supply relations of Budapest’s office market.

According the last Budapest City Report of Jones Lang LaSalle (2012) Budapest has class A (prime) and class B (secondary) around 3.1 million m2 office space located into different districts of the city.

The country’s public administration and business life is concentrated in Budapest therefore modern speculative office market has almost exclusively here Before 1990 Hungary was a communist country where office place for administrative uses were located by central planning decisions and only served owner occupied (industrial sector and the state and Party) needs, the property market as free market didn’t exist. Private developers for customers with different expectations and requirements only started at the end of the 1990’s. Real estate developers with international and local backgrounds enjoyed a golden age period lasted till 2008 when increasing demand met with new supply. Office 5

market reached its peak in 2009 when the completion of office space in m2 was the highest meanwhile vacancy rates started climbing up from 2007 and peaked in 2010. Since then expansion of supply has fallen back dramatically from a level between 300.000 – 350.000 m2 to a mere 2350 m2 but vacancy still remained relatively high on 21.3% in the second quarter of 2012 (Appendix A).

The situation shows similarities with other globally connected cities such as Tokyo’s, New York’s and London’s property market and spatial restructuring in the 1980’s (Sassen, 2001 pp. 125). Sassen noted that office users highly benefited from brownfield regulations and regeneration policies (2001 pp. 8-31) when accessible and well located ‘rust belt’ areas close to CBD and other central have been taken over by financial, insurance, real estate – FIRE companies - legal, IT, accounting and management services. This trend parallels with the evolution of Budapest’s office market since beginning of the 2000’s resulting the main office locational pattern where firms benefit from proximity and access to supplies, clients, local intelligence and innovative milieu.

Regulations also helped agglomeration economics of new developments pushing them out of the UNESCO World Heritage area of the wider city centre along the main roads and the Danube river (Budapest Városfejlesztési Koncepciója, 2011, pp. maps). 10 years later another Jones Lang LaSalle report (2011) still listed Budapest as good location for business process outsourcing saying that it has been well provided with prime office spaces with shared service centre infrastructure and a central location in the wider Central Eastern European (CEE) region. The lesson to be learnt from the three cities that after the crisises in 1982 and 1987 they experienced spatial re-structuring and decrease of large scale, area sized and big office developments and the emergence of more surgically operating smaller developments.

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A survey conducted by the Colliers International has similar implications. The smaller (under 500 m2) offices are more likely to move into new developments meanwhile bigger market players (over 2000 m2) incline to renew their leases. This will have implications in the future of the market.

Usually property agents when analysing available property and sectorial data are satisfied to produce a graph or illustration in which they can show basic information such as stock and vacancy rates, completion and take-up in time. However in the professional community there is another approach aiming to explain connections between different events. Karacsony pointed out that Commercial development is time-consuming and entails high transaction costs. This means that there are no quick supply responses to a change in demand.

The typical property cycle of supply driven development of backlog conditions in the office sector and land banking enterprises are caused by perceived lack or excess in supply compared to vacancy rate. In Budapest between 2000 and 2003 vacancy rates were around constantly 23%, as market experienced the oversupply a steady decline started in building new offices.

Later as the economic growth were relatively high and GDP above 3% sometimes 4 % new entrees into the market slowly started taking –up existing offices spaces and almost halving vacancy rates down to 11-12%. It has a knock on effect on developers who reacted with deploying new developments increasing the supply side up till 2009 by almost three times to 2004.

Now as the main users, tenants, occupiers belonged to the FIRE and legal, IT, accounting and management services were hit by global financial crises and produced a backlog of underutilized commercial properties and development pipeline of approximately 20 planned investments (Colliers International 2012) which now exert a negative influence for future price developments possible well into the next economic upturn.

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Location choices by companies aren’t influenced only by rental prices as Florida (2003 and 2010) summed up in his books, re-use of old buildings with new ideas, street level vibrancy, street side cafes, closeness to cultural institutions and third places (Oldenburgh, 1997 pp. 20-65) and places supporting various lifestyle opportunities also are important to keep workers on board. Especially true this in the strata of highly skilled employees working many times under pressure for companies occupying office spaces. Although no research has been done on this segment of the market this paper recognises that a new phenomenon occurred in last 5 years, on the field. While major national and international developers are look for more profiting development opportunities abroad, underutilised buildings are being converted to mixed use consisting office spaces – 1-2 storeys per building by small scale developers. In fact community accept them much better in European cities because those small scale developers are more sensitive to the social construction of the market.

Adams and Tiesdell (2010 pp. 194.) cited Guy et al. emphasising the importance of having market insight into ‘routines, procedures, distinctive relations, social culture, and other institutions’ talking about the ‘local maverick developers’ producing a very different form built form than the institutional developers. The author of this paper identified such developments in conservation areas and walkable neighbourhoods surrounding the CBD close to characteristic places (such as the old Jewish Quarter, and the theatre district the so called ‘Pester Broadway’ the area of many ‘ruin-pubs’ – where hundred years old derelict houses are converted to sidestreet or garden cafes, pubs and terraces attracting and stimulating office workers.

These developments are made by local entrepreneurs who are more sensitive to local specifics.

Sustainable buildings with low energy reduction and use of green friendly solutions often common in this segment, as users coming from creative, IT, or media businesses are more environmental conscious. Shared service centre and co-working option also part of the package. Even the Hungarian headquarter of the CBRE is located in a similar building.

Conclusions

In the current economic climate – uncertainty, risk avoidance – demand for office space in Budapest will remain limited to renegotiations of existing leases on large space-user tenant and relocation of smaller existing market participants (EHL, 2012). There is flexibility in the supply system with a possible buffer of 7-10 % considering that on this level had new developments sparked previously.

The office market can reach supply-demand equilibrium on long run although the speed depends on the capability to take-up the available office spaces. Under this re-balancing period new developments on major scale are unlikely because of the current oversupply and existing high vacancy level of 21.3%. The current levels of yields are expected to remain around 7.5% and rental fees between 8 (secondary) – 20 (prime) euro/m2 respectively. Tightened credit conditions combined with the dramatic rise of building industry companies went into administration also significantly restrain capability to deliver new developments and threaten completions of many other stalled projects. New sub-segment market opened up for small scale projects reflecting to the unique demands of small and medium enterprises (mostly creative, IT, or media businesses) by offering cost effective co-working and locations in impulsive and vibrant urban environment by using the local character as a branding asset.

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