Building risky, rents low, government unpredictable
Top Manager in Discussion:Kay-Uwe Blandow, CEO of IVG Hungary Kft
While things are quiet on the construction front at property development company IVG Hungary too, CEO Kay-Uwe Blandow is focusing his attention primarily on letting and the property and asset management of the firm’s existing properties, as well as the acquisition of long-term property investments for the institutional property funds of IVG Hungary’s parent company.
When was your company last engaged in construction work?
Our last major building project was the E building of the Infopark, which is also the key building of that complex. It was completed in summer 2009. Since then we have only developed a new project on Hungária körút to a ready-for-construction stage. We could begin construction there at any time, if we have a pre-letting agreement. Building speculatively under the current circumstances is too risky, not least with respect to financing. Since then we have only carried out building work on a smaller scale. We have built tenant-specific extensions to the E building, for example.
Are you also holding back when it comes to the search for possible new properties?
Of course we always have our eyes open for new properties but we are looking with the handbrake on, so to speak. Instead we are looking intensively for investment possibilities for the institutional funds of our parent company. We are interested solely in completed properties in an optimal location with high construction quality and a high occupancy level. In Germany the IVG institutional funds are the market leader in the field of institutional investors. Recently, for example, they acquired the Silver Tower, the former head office of Dresdner Bank, in Frankfurt for EUR 200 million.
What are the prices of such properties like in Budapest?
They are now very attractive again. Comparable properties with similar international tenants cost around a third less in Budapest per square metre than in Prague or Warsaw. I assume that that difference will not remain for very long. Accordingly, we are making intensive efforts to find something suitable. Unlike my colleagues in Warsaw or Prague I have not been able to find any suitable properties for a long time in Budapest.
Why is that?
Because one of the three main parameters is always off. Generally long-term letting is the problem. The typical rental contract in Hungary is currently just for three to four years, and increasingly rarely for five years or more. If you look today at properties that are two or three years old, the weighted residual terms of the rental agreements are sometimes just another two or three years. There is a correspondingly high risk of the property being sufficiently let beyond that period too. That is why our investors are primarily interested in projects with a residual term of at least five years.
The search for such properties is likely to be difficult given the real residual terms for Hungarian office buildings
Yes but there are exceptions. Of the five buildings currently belonging to the IVG fund portfolio three buildings were not built by us including Art’otel and the building at Andrássy út 93, where the Budapest Stock Exchange has its seat. That is a relatively small but very elegant property in a premium location with a long-term rental agreement. Earlier institutional investors were somewhat less risk-averse than today. The area also plays a role. In Warsaw they would be more willing to accept a building with an average residual term of three years than in Budapest.
What size of building are you looking for?
An ideal property has an investment volume of between EUR 15 million and 50 million. Smaller investments are not really worthwhile for our funds. The time and effort involved is comparable to that required for larger investments but the revenues are considerably lower. On the other hand, larger properties with a volume of over EUR 50 million are too risky for us in Hungary too, because too much risk is tied up in one property. Another interesting option is sale and lease back constructions. Companies sell to us the properties used by them, either because they need their liquidity for something else or would like to focus more strongly on their core business, and then lease them back from us with a long-term agreement.
Your company is engaged in property and asset management as well as development and investments. How many properties does IVG Hungary manage currently?
A total of 15, only four of which we built ourselves. The properties are partly owned by our funds and partly by the Hamburg-based fund HGA Capital, which has contracted us to carry out property and asset management of its buildings. That includes the search for tenants. It is helpful that we now have a wide spectrum of attractive office spaces thanks to 15 properties of different kinds. That means we can satisfy almost every demand in Budapest in the upper range, from the prestigious, renovated listed building Krausz Palace, on Andrássy út on the Pest side, our Riverpark project by the Danube, which includes loft offices with wonderful roof terraces, to our Infopark buildings in south Buda. In addition, our customers have excellent opportunities to change to a building of a different size within our group. We were recently able to sign a rental contract with National Instruments for 1,500 sqm. Currently 19 per cent of our office space is seeking tenants. However, it should be borne in mind that we have several properties that are still in the first letting phase after completion of the project. Even so that figure is not bad when you consider that the general vacancy rate in Budapest is currently around 21 per cent. Our aim is to reduce our vacancy rate within one to two years to our Europe-wide IVG level of around ten per cent.
How are prices at the moment?
There was a phase a few years ago when one supplier caused some disquiet on the market by offering aggressively marketed knock-down prices. That is over now, however. Of course there are always suppliers that use special incentives to attract tenants. My impression is that overall rental prices have been stagnating for some time. Of course there are still price wars. For us there is a certain limit that we will not go below. That is why the letting of the E building is not going as fast as it could do if we gave more price discounts.
What is your view of the general price level?
It’s too low from the perspective of letting companies and developers. Of course we would like it to be higher. We have some existing properties in our portfolio that were calculated with higher rent prices. On the other hand the low rents lead to absorption of the available supply, without it being revitalised by new properties. With the current rents it is barely worth building any more. Meanwhile there are tenants that are already thinking now about where they will move to in two to three years. That was fairly rare before the crisis. Then every company could rely on being able to find something suitable if required. Especially in the case of larger office space from 2,000 to 3,000 sqm. it is now advisable not to leave it to chance, especially if companies have high demands of their future office in terms of sustainability and energy efficiency.
Are customers interested in such considerations?
Yes, if only for reasons of economy. Precisely in these times it is far from irrelevant whether you are paying as much as EUR 5 in utility costs or just EUR 2.77 as with us at the E building of the Infopark. With good insulation and efficient building technology, a lot can be done to make offices more economical. Happily, awareness of sustainability and environmental issues is increasing, especially among international companies. After all, the building stock contributes greatly to worldwide CO2 emissions, which rose by six per cent again last year.
What role do utility costs play when it comes to choosing an office?
Unfortunately they are not given as much attention as deserved. There is still too much focus solely on square-metre rent prices. A far more important parameter, however, is the total cost per work station, which includes the utility costs. The square-metre rent price is not sufficiently informative when it comes to the total costs. A comparison of different office options should always be made on the basis of the total costs per work station, not least because not all square metres are equal. There is no uniform standard. In the case of deep buildings, for example, there may be large spaces that have to be artificially lit. They are not suitable for work stations and can be used at most for kitchens, storage space and photocopying rooms. Or there is too much circulation space. If I were to move somewhere I would look at the utility cost bills from the previous year and have a layout plan drawn up. We always offer our potential tenants that service free of charge. I find it short-sighted to make rental decisions primarily dependent on the square-metre rent price.
As a supplier of high-quality offices IVG certainly has its work cut out for it in raising potential customers’ awareness.
We always try to explain those considerations to companies. If they get in touch with us we have the opportunity to do so. However, often the way it works is that the office leader is told to “look around” on the market when a company’s rental agreement is coming to an end. Here, looking around generally means going through the relevant internet sites with corresponding offers. The main excluding criteria are the location and the square-metre price. As a result offices that may seem too expensive can fall through the net, despite possibly being more efficient and cheaper per work station. If the square-metre price of an office does not fit the search criteria, then it doesn’t stand a chance in that particular search.
Could more transparency on the part of suppliers help?
Not really. Ultimately layout plans are very individual. The space requirements and therefore the cost per work station of a company depend not least on whether they are planning an open-plan office or a cellular office, where the need for space is naturally higher. Future tenants need to look more closely themselves and do some additional calculations.
Although many customers already capitulate when making such calculations, you now also offer offices in buildings with LEED “green building” certification.
LEED, which stands for Leadership in Energy and Environmental Design, is an American company that certifies sustainable, energy-conscious buildings. The main problem which led to the establishment of LEED and similar systems is that it is very difficult to compare completed buildings with one another with regard to certain sustainability criteria such as energy or water consumption. LEED certificates are a good reference point for users. They don’t need to pore over the details of the building technology, and can rely on the fact that LEED-certified buildings are certainly above average when it comes to sustainability and energy consumption. That is why the certificate is an advantage when it comes to selling and letting.
What does the certification involve?
LEED examines buildings according to those criteria based on clear, uniform measures, and at the end of the process can award a bronze, silver, gold or platinum certificate. We were awarded silver for the E building. Interestingly some LEED criteria that help to obtain a higher point score can detract from the tenant’s comfort. In case of doubt we always decided in favour of the tenant’s comfort. For example, for environmental reasons a large number of car parking spaces is judged as disadvantageous because the intention is to promote public transport and bicycle use. We decided on the LEED certification system because it is most widespread internationally on the office market and is the most sought-after by investors, as well as being the most widespread in Germany. Across Europe IVG owns 18 LEED-certified buildings. In Munich IVG even developed the first newly developed office building in Germany with a LEED platinum certificate. At Frankfurt Airport, incidentally, we own the largest European LEED-certified office complex, the 140,000 sqm “Square”.
How many LEED-certified buildings are there in Hungary at present?
Our building is the first and so far the only one, so we are the trendsetter in this respect. We’re proud of that. There are a number of buildings that are “registered” with LEED. In reality that is little more than an application for certification. Often the certificate is not obtained because the criteria are not fulfilled. Any property can be registered. It is only after completed registration that the actual auditing process begins, whose outcome is uncertain. There is no guarantee of successful certification at the end. Currently we are investigating whether we can obtain LEED “in use” certification for two more of our existing buildings. Ideally, however, the decision about certification is made at the start of construction. For our new building which is still to be constructed we are aiming for LEED gold.
Are customers willing in such times to pay more for a LEED-certified property?
They don’t have to pay more! They don’t pay a single forint more. That is not the purpose of our efforts concerning LEED. Our primary aim with the certification is to make ourselves stand out more from the competitors. With the LEED certificate we are giving potential tenants one more reason to decide in favour of our offer. It helps us to find tenants more quickly. Customers benefit tangibly through lower utility costs, rather than simply because the LEED certification gives them a better conscience for doing something for the environment. Moreover, an LEED certificate, which shows that the company effectively has a “green office”, is also good for marketing and the external image of the company. That is part of the reason why an increasing number of international companies are instructing their subsidiaries to choose certified offices where possible.
When do you expect office construction to get going again in your sector?
I fear that we will have to wait at least two years. Currently economic growth is simply too sluggish and the market environment is relatively uncertain. The high degree of unpredictability when it comes to Hungarian economic policy is also a hindering factor. Ideas that make one’s hair stand on end keep being put forward, where one has the impression that not enough thought has been given to the likely effects. It does not make the situation any better that many of these ideas are then retracted. When you launch a property development project, you invest many millions of euros in order to get an appropriate return after around three years at the earliest. If, however, the economic environment changes for the worse to a significant degree, for example in terms of tax legislation or construction legislation along the way, then there is a problem. That is why a stable environment is extremely important for our sector in particular. The ban on building new shopping centres that has just been announced doesn’t affect us directly but such an intervention in the free economy creates great insecurity. Companies that acquired land with the intention of building a shopping centre now have to wave goodbye to a lot of money just like that. Leaving aside the fact that the battle has already been lost when it comes to shopping centres because of the entirely liberal approach of the past 20 years, there is nothing wrong with that market being regulated to some extent. However, the current construction ban is simply too blunt an instrument.
The fact that virtually no more offices are being built at the moment is surely also related to there still being sufficient vacant office space.
Yes, apart from all the difficulties mentioned, there is currently no pressing reason to create new office space because supply is still too great with regard to demand. As long as no new office space is created there will simply be a movement from worse to better office buildings. Suppliers with a portfolio of above-average quality like us will benefit from that shift. We are finding tenants even now although it is more difficult than before the crisis. That is also reflected in the numbers: while we manage just three per cent of office space in Budapest, we accounted for five per cent of office rentals and conclude a rental agreement almost every five working days on average. I am confident that we will benefit from such a shift to a greater than average extent.
