Market Talk: Questions Around Supply and Demand but ESG Grows in Significance

The office market faces challenges around demand and take-up, changing specifications from tenants and staff, and the need for well-being provision in the workplace. There are also concerns over investment liquidity and the availability of suitable development plots at transport hubs reasonably near residential areas.

In all stages of the office development cycle, designers, consultants, architects, lenders, tenants, FM and PM providers, developers and investors must adhere to a combination of market forces and increasingly stringent ESG regulations.

These elements, in addition to rising utility costs and the necessity of making the provision of services more sustainable, could increase office operating costs. However, sustainability consultants and PM and FM firms argue that it will be cheaper in the longer term while also adhering to developing ESG regulations.

Despite these challenges, there is a relatively healthy development pipeline, though it is an active question whether there is enough to meet demand. Market and ESG pressures are producing higher quality, more efficient, and better-located office developments that help improve the city’s overall infrastructure.

In our experience, office demand is ever-increasing for several reasons, such as the ambition to decrease operational expenses by upgrading to an environmentally conscious building or simply because companies are just finding the right way to work in the office after facing the challenges of creating home office policies and adjusting to hybrid forms of working. I firmly believe that the time has finally come to make up for the rash decisions some occupiers, unfortunately, were forced to take during the most intense period of the pandemic. Lease renewals signed in 2020 are now being reviewed and remedied to suit the companies’ needs better and support them with a more mature real estate approach.

Unlike in the 2008 financial crisis and despite all the hardships that the commercial real estate sector had to overcome in the past few years on a global and local scale, there is available capital to deploy; therefore, we anticipate some office investment transactions in the second half of the year. There is a constant demand for value-add investment products amongst the more opportunistic buyers. However, core grade “A” sustainable offices are still likely to be considered due to the spread of EU taxonomy norms and the ever-increasing demand for ESG compliance among occupiers, developers, investors, and generally across the business world.

Máté Galambos

Leasing manager

Atenor Hungary

 

The first quarter in the investment market in Hungary was very quiet, with less than EUR 100 million transacted and only one small office transaction taking place. The period before summer is expected to remain subdued with high inflation and, with rising interest rates, the availability of finance is tight. The market perception gap between vendors and buyers remains, and the majority of European markets are quiet, with the exception of Poland and Ireland, which are probably the most liquid investment markets currently. Nobody has a definite idea of how long this quiet period will continue.

Although there is little transactional evidence, prime Budapest office yields can be estimated at 5.75-6%. When you think the cash flow burden on the debt would stand at 6-7.5% (including amortization) in case of gearing on a prime asset, you realize we are definitely in a cash buyer market.

So far, the Budapest office fundamentals remain solid with take-up activity holding (similar to Prague). We see particularly strong activity in the tech sector. This is reassuring. Due to the ownership structure of the logistics market (with a few strong developer/manager platforms not trading out), and the concerns over the retail sector (with the exception of strip malls), the office segment remains the backbone of investment activity on the Hungarian markets. If offices are not trading, volumes will be significantly down.

Benjamin Perez-Ellischewitz

Principal

Avison Young Hungary

 

CPI Hungary predicts a challenging market situation in the Budapest office segment in the upcoming 18-24 months. We see that occupiers are reluctant to secure long-term leases or expand their businesses in the current economic situation.

There is increasing demand for environmentally conscious buildings and office space (and landlords) as the tenants themselves will soon require an ESG rating to access green financing vehicles. The ratio of those tenants who include ESG solutions as part of the office selection criteria is around 15% today, but this ratio will grow very fast in the near future.

New and renovated space needs to provide access and amenities for disabled people, spaces enhancing work-life balance (gym, massage room, etc.), and an increased volume of common social areas where informal collaboration can occur. Refurbishing existing buildings is undoubtedly an attractive development option. From an economic and sustainability point of view, redevelopment is a viable investment for landlords. A well-located renovated office building can be worth nearly as much as a new one.

I suspect moderate demand from international investors in the next 24 months. Domestic money will still be available below the EUR 20 mln ticket size. Other regions in CEE will recover faster.

Mátyás Gereben

Country manager

CPI Hungary

 

In the name of the FM market, I would say both ESG and Well certification viewpoints have already opened new perspectives, and in the coming years, they will emerge even more. In the provision of the basic work environment, this means reaching the most optimal energy consumption and saving requires core FM competencies. FM experts and service providers have become at least tactical partners and, in many cases, strategic partners for landlords and large building users.

I believe in the future of technology. Our FM industry is labor-intensive, so the robotization potential is extremely high. Autonomous industrial cleaning robots are already on duty, but many more applications are already in the early adaptation phase. In our business flow, the number of documents is also very intense. There are already high-scale automation solutions available that can reduce human interaction needs.

There is a saying: “What you can measure can be controlled.” The management and control of the building operation and facility management become more crucial to reaching the lowest energy consumption and the highest employee satisfaction.

Gábor Décsi

CEO

Dome Facility Services Group

 

During the past few years, the well-being and loyalty of co-workers have become a key focus area. Many companies and office building owners are concentrating on providing a wide range of services, flexible space, reasonable operating costs, and environmental aspects simultaneously. At Frame Group, a professional FM provider, we help our partners find the best and most cost-effective way to achieve this goal. It is never too late to adapt and optimize, but we encourage investors and architects to consult with us before planning to maximize the benefit potential.

Owners and investors are under higher pressure to gain certificates to prove how their buildings are prepared and equipped and that related processes are correctly aligned. We expect a rapidly increasing demand for renewable energy solutions; therefore, we are prepared to design and deliver complex solar systems for our clients. On the other hand, we are extending our fit-out and construction teams because we trust these trends will soon cascade down, reaching class “B” premises too.

László Orbán

Group CEO

Frame Group

 

ESG standard offices will not be more expensive, as these spaces are simply better managed, and hopefully, they have a lower impact on sustainability (through well-managed systems, energy consumption, and so on). This alone will not increase costs. The implementation of ESG-related features and systems will decrease costs. Further, these spaces will also be core attractions for investors, tenants, and other stakeholders.

ESG benchmarking is currently coming to the Budapest office stock. There are already a few buildings that were assessed against ESG standards, but I would expect that a more significant ESG boom will arrive in the Hungarian market during 2023 and 2024. It is clear that investors, financing institutes, and tenants require ever more ESG compliance; therefore, this requirement will push the whole market firmly towards ESG benchmarking.

It is expected that ESG benchmarking will be harmonized and standardized for the commercial building sector. Currently, there are many ESG standards and methodologies available on the market.

Zsombor Barta

President of the Hungarian Green Building Council (HuGBC)

Founding partner at Greenbors Consulting

 

At Icon, facility and property management services are in one hand, which is not common in the real estate market; however, the feedback from our clients shows that this is an effective way of managing a property. The synergies of the two areas (property and facility management) at Icon can be effectively used and taken advantage of in the case of ESG strategies. The Corvin 5 Well-certified office building is an excellent example of this, where Icon provides both property and facility management.

How an office is built and what technological solutions are applied have a smaller part in how efficient and environmentally friendly it is. What is more important from this perspective is how the building is operated daily: for example, what settings are applied on the machinery, quick reaction to changes and problems, as well as the education of tenants.

For landlords, the main priority is the return on investment, which can only be achieved if the office building is well-utilized and long-term lease contracts ensure its occupancy for years in advance.

As for tenants, the top priority is efficient operation, market-level rents, and energy costs. Given the low unemployment rate, how ESG standards are met at the office of the given company is often an important aspect in acquiring and retaining employees, especially for the young.

Róbert Flück

FM director

Icon Real Estate Management

 

The Budapest office market reacted to the total removal of COVID restrictions, and leasing activity reached 400,000 sqm of office space in 2022, a slight increase compared to 2021 and a more significant one compared to 2020. This increased demand might decline slightly in 2023, but we expect demand for “A+” category sustainable offices to remain stable. 

The market has a couple of principal driving factors due to the last few years’ COVID-home-office effect that will remain. First, some tenants will reduce their office space requirements, as employees will continue working in hybrid mode, resulting in fewer workstations. Another factor is the increased utility prices, resulting in multiplied service charges in inefficient buildings. Eventually, companies will relocate to new “A” or “A+” category buildings to control their operational costs and provide an attractive working environment for their employees. 

In the short-term, moving to an ESG office is a higher financial investment for firms than staying in their original “B” category offices, but in the long-term, moving to an ESG-compliant office will always pay off; every firm will face much lower energy bills, and avoid the need to meet renovation costs or the expense of replacing outdated technologies.

Dömötör Károly Makk

Head of leasing

TriGranit

This article was first published in the Budapest Business Journal print issue of May 5, 2023.