The office market in Sofia shows first signs of recovery. Market players as well as the majority of the businesses in the country seem to have understood that the new economic environment is going to last for some time and easing up will come gradually. Both sides of the market are trying to get more flexible in order to absorb the shocks from the economic crisis, a report by Forton International shows. Falling demand and deteriorating business confidence have been the main issues for many companies in the financial and services sectors.
Tenants are optimizing their office costs by improving utilization of rented space or by leaving all office space in excess. Landlords and developers are offering a variety of incentives to attract sustainable tenants. Rent-free periods, step rents and free fit-outs are common for the market. The significant compression of rents in 2009 has greatly increased competition. Prime quality buildings emerge above the remaining office stock in clients' preferences. Lower rents in newly finished buildings have made many businesses to consider relocation. This rise in tenants' activity supposes that rents should reach their support levels in the next twelve months. Vacancy rate continues to rise mostly driven by the newly finished office stock coming to the market. Expected supply from the pipe-line remains high.
The demand side started to utilize the rents decrease in the last months. Demand is still mainly driven by relocation with the idea of financial optimization as many companies realized that they can get an advantage of the favorable market situation. More and more tenants realize that the current market creates good conditions to sign favorable lease agreements. In addition some companies, especially international ones, feel more positive about their future after the first signs of overcoming the global crisis and these positive expectations also provoke activity.
Approximately 38 200 sq.m. new office space was delivered to the market in Q4 2009 compared to 65 900 sq.m. of new office stock a year ago. Most of the newly-delivered offices are located in the suburban areas of the city and along Tsarigradsko Shosse Blvd and Bulgaria Blvd. Still some of the largest office projects are expected to be completed in 2010. If all of the announced completion dates are met approximately 360 000 sq.m. (TBA) should be delivered to the market in 2010. However a more conservative forecast shows 240 000 sq.m. (TBA) of new office space expected in 2010, which is still outpacing by large the current market demand and absorption rate.
The total office stock in Sofia passed the million mark and has reached at the end of Q4 2009 approximately 1 026 000 sq.m. This figure includes both speculative and owner-occupied buildings. Almost 80% of the modern office stock in Sofia is equally distributed between main roads and suburbs areas. These are also the areas where most of the projects in the pipe-line are located. Modern office space in the CBD accounts for only 16% of the total stock. The notable disproportion in favor of the suburban areas is due to the lack of spacious vacant land plots in the city center.
The absorption of new office space in Q4 2009 amounts to approximately 11 200 sq.m., compared to 22 000 sq.m. a year ago. A notable drop in the absorption rate is observed since Q2 2009 as a result of the economic crisis. We expect that the absorption rate will slightly recover, but it will be significantly outpaced by the expected supply of new space coming to the market in 2010.
Absorption figure for Q1 2009 also includes the National Army Complex (TBA of 33 800 sq.m.), which presently is regarded as an owner occupied building.
Office vacancy rate continues to increase for sixth consecutive quarter. It has started from the record low 3% in Q2 2008 and has reached 16,8% at the end of Q4 2009. Almost all of the companies from the financial and services sectors are affected by the economic downturn. Job-cuts and fixed costs cuts have lead to drop in office space demand. Some companies optimized their office costs by leaving their excess or unutilized office space. The drop in demand coincided with the increase of supply, which lead to the rise of vacancy levels in all office buildings. Office buildings Class B and Class C at the suburban areas of the city are the most suffering groups. Such buildings struggle to attract tenants. We expect that office vacancy level will continue to rise in Q1 2010 with the completion of the large-scale office project under construction.
Prime office rents has decreased further to 13,50 euro per sq.m. monthly, compared to 17,00 euro per sq.m. a year ago. Asking rents for Class B office space has dropped to 8 euro per sq.m., while Class C and residential units converted to offices are leased at 4 euro per sq.m. Furthermore scarce demand has motivated landlords to offer incentives to prospective tenants, such as rent free periods extending up to 12 months, step rents as well as fit out and moving costs covered by the landlord. We expect that current prime rents have now adjusted to the new market conditions and will stabilize in 2010 around their current level.
As of Q4 2009, approximately 743 000 sq.m. office space is under construction. However most of the projects are progressing at a slower pace compared to their initially announced completion dates. We expect some of the projects to extend their completion dates, while others may be put temporary off the active pipe-line due to lack of prospective tenants - mostly Class C buildings and smaller mixed-use buildings at secondary locations. Almost 460,000 sq.m. were frozen or cancelled in 2009. Most of the progressing projects are announced to be completed in 2010 and early 2011.
Two investment deals were closed in Q4 2009 on Sofia office market. The Cyprus investment management firm Bluehouse Capital acquired Auto Union Center (GLA 19 200 sq.m.), which comprises an office building with car show-room space on the ground level. The transaction is a sale and leaseback type with a long term tenant the previous owner of the building, Eurohold. The other notable investment transaction involved the sale of the building of the former Hotel Serdika (TBA 11 000 sq.m.) located at the heart of Sofia CBD. The building needs a full reconstruction and was regarded by the former owner Equest Balkan Properties as a development site. The new owner of the property is the Bulgarian Terra Tour Services, which is specialized in investments in tourism properties.
The Bulgarian telecom Vivacom has been among the most active sellers on the property market. Although the company has not officially announced details regarding the closed deals our estimates show that some 130 000 sq.m. GLA have been sold in 2009 comprising mostly administrative buildings and former analogue exchange premises in Sofia and secondary towns. The company is trying to extract value from its excessive real estate assets and to finance its core business. Most of the concluded deals include lease-back agreements for parts of the properties, mostly retail space on ground floor as well as technical premises where key telecommunication equipment is located. Among the most notable buildings sold in the end of 2009 were the company's main administrative buildings in Sofia, Varna and Veliko Tarnovo.
Prime office yields in Sofia remained at 11%. The significant increase in yields reflects the higher risk premium that investors require to compensate for the deteriorating market conditions as well as to preserve the yield spread between the Bulgarian market and more mature markets. Most of the investment interest is concentrated on prime fully-occupied buildings and sale & leaseback schemes. The latter are still uncommon for the Bulgarian market due to its early stage of development, but could be the vital resource of funds for many local companies, who were traditionally buying or building tailor-made properties in the past. Investors are carefully selecting office buildings with prime location, which correspond to the international quality standards.