Scaling the heights of Warsaw

With rents once again on the rise, Warsaw is witnessing a flood of foreign direct investment in the office sector. Private equity real estate firms are looking to the capital city and beyond. By Robin Marriott.

Taking the elevator in the Rondo 1 office building is a slightly hair-raising experience. The glass-enclosed elevator, located on the outside of the shimmering glass tower, not only offers an unobstructed view of central Warsaw, it also ascends rather quickly to the top of the 40-floor building. Vertigo sufferers beware.

But once at the top, visitors can begin to relax. The elevator doors open onto a vast open space reserved for a future office tenant. And the building, which has the largest floor plates in Warsaw, gives one plenty of room to roam around. Last year, the office tower also became the subject of the largest single asset deal in Central Europe when London and Regional Properties purchased the office tower for €260 million ($338 million). Several months later, Macquarie Global Property Advisors acquired a 50 percent stake in the property.

From the top floor of Rondo 1, visitors can also indulge in a panoramic view of the capital city's impressive skyline, which has been transformed over the past two decades into a thoroughly modern city. There is the InterContinental, the tallest five-star hotel in Europe, with a striking “cut-out” design which allows sunlight to hit the low-rise, Soviet-style residential blocks below. Not every building, it seems, has moved into the modern age, but the city's office buildings are clearly not stuck in the past. The tallest of them, the Warsaw Trade Tower, was completed in 1999 and rises 208 meters above ground; in 2002, it was reportedly purchased by an affiliate of Apollo Real Estate Advisors for approximately $100 million. And then there is the Warsaw Financial Center, which stands at 144 meters; more importantly, it represented one of the first and most significant private equity real estate investments in the Polish office sector.

In 1996, the Chicago-based property investment firm Heitman, along with its development partners, broke ground on the 32-story building. Today, the tower is located in the heart of the city's financial center, but according to one person who worked on the transaction, construction began at a time when no central business district even existed. As the markets of the region developed and more institutional capital entered Poland, Heitman and its operating partners were able to sell their stake in the building. In 2005, an 80 percent stake in the property was sold to Austrian real estate group CA Immobilien Anlagen and German real estate fund TMW Pramerica for approximately $120 million.

Turning the corner
With the benefit of hindsight, the timing of that sale may have been good, but it certainly was not perfect. The office market in Warsaw suffered horribly during the early part of the decade as the country slid towards recession. In 2000, GDP grew by 4 percent, but over the next two years, growth dipped to just 1 percent and 1.3 percent, respectively. According to Guy Speir, leasing and marketing director of Quinlan Private Golub, a joint venture between the investment vehicle run by former Irish tax inspector Derek Quinlan and the Chicago-based developer Golub, vacancy rates in the central business district of Warsaw hit 15 to 16 percent.

However, around 2005, the country's office market turned a corner. Along with an improving economy—GDP grew by almost 6 percent in 2006—more multinational companies set up shop in Poland while many others expanded their operations. At the same time, there was little new office supply in Warsaw's central business district, which has led to a rapid rise in rents. According to Cushman & Wakefield, prime rents in Warsaw's central business district increased by 10 to 20 percent in 2006.

“The Warsaw market has performed a dramatic U-turn in the last 24 months,” says Speir. “Foreign direct investment has picked up mirroring its confidence as the country came out of recession. The office market has really blossomed.”

Strong fundamentals in the office market are leading to renewed activity among private equity real estate firms, who hunkered down during the recession that lasted between 2001 and 2004. Macquarie's acquisition of a stake in Rondo 1 was one of the largest signs of confidence in the Warsaw office market. The building, which is widely regarded as one of the best office developments in the capital city, was completed last year and has attracted tenants such as Ernst & Young. The accounting firm is one of a number of occupiers whose office space boasts its own atrium.

Daniel Harris, who heads up investment in Central and Eastern Europe for MGPA, admits that he is often asked why an opportunity fund would invest in a prime office property in the heart of Warsaw. “The answer to why we bought it is simple,” he says. “Rents are rising here.”

“We saw the Polish economy booming,” he adds. “There is not that much competition here in terms of prime offices in the central business district. Rondo 1 is a prime asset leasing up quickly, and rents are rising quickly and significantly.”

When Rondo 1 opened last February, the offices were 48 percent occupied, but the building has been filling up steadily. According to Harris, rents in the office tower have risen 15 percent in the past year.

“In the last six to nine months, the city has soaked up space,” he says.

Polish suburbia
On the fringe of Warsaw's central business district, the picture is the same. Quinlan Private Golub, for example, is currently developing the second phase of the International Business Center, which measures 200,000 square feet. The entire complex encompasses almost three times as much space. PricewaterhouseCoopers, the accounting firm which is already a major tenant in Phase I, is leasing more space in the new development. And according to market rumors, tenant demand at Phase II is buzzing.

“The phase is 70 percent leased, and we still haven't received the occupancy permit yet,” says Speir. “The interest level has been so strong we have been able to pick and choose who we want in the latter part of the project.”

But it is not just in the center of the city that demand for offices is encouraging development. In the Mokotow suburb, a new business district is being created. Assuming all the projects on the drawing board are completed—and there are many—the area will one day become the largest office district in Warsaw. Today, visitors to Mokotow can easily spot the old manufacturing premises interspersed with modern office blocks. The industrial sites, one day soon, will probably make way for the likes of IBM and packaging company Tetra Pak.

Hines, the US developer that built one of downtown Warsaw's most well-known office schemes, the Metropolitan, is currently trying to tie up a site in Mokotow for a 17,000-square-meter project. Mietek Godzisz, a director with Hines, says one particular area of Mokotow is heavily populated by old warehouse space and is risky given the amount of new office supply coming on line. But he adds that sites closer to the Galeria Mokotow shopping center are safer, given that the area is more defined and the number of sites is limited.

Although he agrees that there is the potential for overdevelopment, he notes that there is significant demand as well. “A lot of companies, especially Polish companies, need good quality office space and this is the first time they have been able to afford it,” Godzisz says, adding that top rents are at €15 per square meter per month in Mokotow. “Four years ago, even half this would not have been affordable.”

Quinlan Private Golub is also busy constructing a development in the suburbs. Building F at Wisniowy Business Park, located near the Warsaw airport, is being jointly financed by Heitman and GE Real Estate. Some 88 percent of the 16,000-square-meter project has been pre-leased. Brewing giant Carlsberg, building materials company Lafarge SA and power supplier Schneider Electric are to be tenants. And healthcare giant Johnson & Johnson has selected the development as its Polish headquarters.

The cost of doing business
The certainty that more office buildings will spring up in Mokotow is giving some private equity real estate firms pause. However, according to market participants, there is a more daunting worry that may have a far greater impact on office development in Warsaw: construction costs.

It is a much discussed topic for real estate practitioners in the capital. What began a few years ago as a mild annoyance has rapidly become a deciding factor in whether or not a project gets built.

Over the past couple of years, construction costs have increased at the rate of 10 to 15 percent due primarily to shortages of qualified workers. Many locals have used their new EU citizenship to go work in England and other parts of Western Europe, leaving behind a dwindling labor pool.

The effect has been dramatic. “You have to make a calculated gamble on where rents are going to go versus construction costs,” says Speir. “We are walking away from sites in Warsaw at the moment because we don't feel comfortable with the construction risk. There is a lack of depth of skilled workers as a lot of people have gone on to work in other countries. Also, salaries as a whole in Central Europe are rising.”

Beyond Warsaw
In what has become a familiar story in other sectors of the Polish property markets, office investors are now looking well beyond the capital, where it is not only less competitive to acquire land, but also less costly to build. According to Hines' Godzisz, there are other factors that make Poland's secondary cities more attractive, including less bureaucracy. He is confident that Hines will have projects outside Warsaw within the next 12 to 18 months.

Poland's second- and third-tier cities are already attracting larger corporations, which are being drawn by both cheaper labor pools and, in certain cases, more skilled workers. For example, firms such as IBM, Hewlett Packard, Philips and Gillette want to be close to big technical universities. For companies looking to support their European operations with shared service centers, EU grants are also available in some secondary cities, making investment viable.

US alternative investment firm Harbert Management, which manages a European real estate fund, is targeting the Polish office sector. And the firm believes that there is still development potential in the country's secondary and tertiary markets. Yet Harbert also notes that some secondary cities are already at risk of becoming saturated in the next year and a half; they are working hard to identify smaller markets between 400,000 to 500,000 people where there are no Class-A or even nice Class-B offices.

Ireland's largest bank, AIB, is another firm eager to capitalize on the opportunities in Poland's secondary markets. In April, the bank announced that it was raising up to €150 million for the Polish property sector; its first real estate fund, Polonia I, invested in the Poznan Financial Center, an 18,000-square-foot building. Poznan, one of the largest cities in Poland, is home to about 30 domestic and international banks.

Nevertheless, despite the opportunities in the smaller cities of Poland, few investors are suggesting that the Warsaw play is at an end. AIB's fund plans to invest in the capital city and MGPA is receiving requests to sell its stake in Rondo 1 on an almost daily basis. For now, however, the firm is turning away potential buyers as it believes that rents can be further increased and it sees no immediate sign of tenant demand ebbing away, says Harris.

As he takes the lift down from the top of Rondo 1, Harris stops to visit one of the latest tenants to move into the building: Aareal Bank. The German bank has just moved out of the Warsaw Financial Tower, which is visible just out the window, to take up residence in Rondo 1. And from the looks of things, the firm appears pleased with its new home.

The bank's staff is busy sorting through boxes and paperwork as it settles in. And somehow all the activity seems symbolic of the demand for space. As Harris points out, approximately 10,000 people are moving into Warsaw each month.

In the capital city, the Western-style office towers are quickly filling up with tenants looking to prosper in Poland's growing economy; others are using the city as a staging post for countries further east. A decade from now, visitors to Rondo 1 may have an even more thrilling view than they do today. Warsaw's skyline, which has developed so dramatically in the past decade, shows no signs of slowing down.