Leasing market conditions generally deteriorated over the first quarter of 2009, as sharply weaker economic activity and negative sentiment about future prospects led to a reduction in office take-up and general downward pressure on rents. The CB Richard Ellis office rent index for the EU-27 fell by 3.6% in the first quarter, with rents down by around 6.5% from their peak of last year. The quarter's decline reflects rental falls in most markets, although some key cities, such as Frankfurt and Milan, remained stable.

Vacancy levels are rising across Europe, driven upwards by a combination of weaker demand, new developments entering the market and, increasingly, occupiers looking to dispose of surplus space. Vacancy rates across the EU-27 group have risen by over a percentage point over the past year. As a result, further rental falls are expected in most major markets. However, new construction starts have virtually ceased in the region, which will constrain stock additions in the medium term. Although of little benefit in the short term, this will help rents to stabilise more quickly once some level of occupier demand returns to the market.

“Landlords are finding it increasingly difficult to lease vacant space, given the understandable caution being expressed by most occupiers at present,” commented Richard Holberton, Director, EMEA Research at CB Richard Ellis. “With those occupiers requiring space driving a hard bargain, and increasing choice available in the market, it is inevitable that we will see further weakening in rents and an increase in leasing incentives in most markets over the coming months,” Holberton added.

At the same time, changing market conditions are offering new real estate opportunities for occupiers as they too seek to cope with difficult conditions in their own markets. Companies across a broad range of sectors and geographies are experiencing weakening demand for their products and services, in many cases coupled with price deflation. Occupier behaviour is therefore largely characterised by caution, cost reduction and space rationalisation.

Driven to cut costs, occupiers are pursuing a range of new strategies to take advantage of the market. Even when they are not seeking additional space, tenants are increasingly able to negotiate with their landlords. Those who have impending lease expiries or break clauses are in a particularly strong position, as few landlords would welcome the prospect of a vacant building in the current market. Investors are focused on two factors at present: the quality and the length of their income stream. These factors determine the value of an asset, so a good tenant who offers to renew a lease is well placed to secure a rent reduction or other benefits.

However, the same pressures mean that even those who have no formal option to vacate are currently in a strong position, provided they are a good quality tenant. Occupiers are initiating discussions seeking rent reductions or rent-free allowances in exchange for lease extensions, or seeking to alter specific lease terms (such as dilapidations or reinstatement clauses) in their favour, thereby reducing liabilities they have to carry on their balance sheet.

Matthew Pullen, Head of Global Corporate Services EMEA, CB Richard Ellis, commented: “With corporate expansions scarce and asset values and investment returns falling, some office landlords are under huge pressure and the negotiating power is often in tenants’ hands in many European markets. Occupiers who have an opportunity to vacate and are actively prepared to do so are particularly well-positioned. The cost and quality of alternative accommodation available, as a greater choice of quality space enters the market, makes the threat of relocation credible to the landlord and therefore places tenants in an even stronger position.

“The ability to secure rent reductions or reduce space will depend on a wide range of factors including local market conditions, lease structures and the position and attitude of individual landlords. Yet the current market does present opportunities for occupiers who can combine awareness of real estate market conditions with an ability to influence further changes in their business cultures. Timing, market intelligence and high-quality advice are vital at this time.”

Source: FD