The commercial office real estate sector is experiencing growing leasing demand from state institutions. Class A office buildings, featuring sophisticated technologies and a variety of ergonomic and ESG solutions, not only enhance work efficiency but also bolster the image of government offices as modern, accessible and innovative, according to Marcin Kowal, Associate Director, Office Department, Newmark Polska.
State institutions are increasingly vacating obsolete, state-owned buildings that require refurbishment, fail to meet modern OHS standards or no longer align with the image of state-of-the-art facilities and are costly to maintain.
“There’s nothing new about public institutions and state-owned companies leasing modern commercial space. Many began making enquiries and even finalising transactions years ago. However, due to the pandemic, followed by high inflation and the war in Ukraine, state institutions have also taken longer to make decisions or, in some cases, put decision-making processes on hold. The public sector has become significantly more active over the past year or so, with leasing activity naturally concentrated in the Polish capital, where the machinery of the state is most developed. Regional cities have also experienced a rebound, exemplified by the commercial lease signed by the National Health Fund (NFZ), which moved into its new office at Malta Office Park in PoznaÅ„ midway through last year,” says Marcin Kowal, Newmark Polska.
In 2024, public institutions leased nearly 55,000 sqm in Warsaw, with another 20,000 sqm transacted in regional cities. Major transactions in the Polish capital last year saw the General Directorate for National Roads and Motorways (GDDKiA) extend its lease of nearly 13,000 sqm at Green Corner B and the Foundation for the Development of the Education System (FRSE) renegotiate its lease of nearly 5,200 sqm at West Station I.
Why a modern office for tax authorities?
Public administration must evolve and adapt to the changing demands of citizens. Modern society expects government offices to operate efficiently and to provide an opportunity to complete paperwork in accessible locations and in appropriate conditions. To fulfil these expectations, state institutions need spacious, comfortable and well-designed offices.
“With a few exceptions, public institutions tend to opt for modern and functional buildings for their offices, but not necessarily the most spectacular or eye-catching ones. Before making a location decision, they also take into account factors such as easy access and proximity to public transport stops and metro stations,” explains Marcin Kowal. He adds that although Warsaw’s central locations are most attractive to public servants, public sector tenants also consider other districts. Examples of the latter trend include the office building acquisitions by the Provincial Administrative Court in Jana Kazimierza Street and the Institute of Environmental Protection in SÅ‚owicza Street, as well as the lease agreement for office space at GdaÅ„ski Business Center signed by the Masovian Institute for the Implementation of EU Programs.
Currency as an area of disagreement
Although both parties - commercial landlords and state organisations - are interested in cooperation, the process of searching for the right space is much more complicated in this case, with negotiators needing to navigate many challenges. During the early stages of negotiations, it often seems that their interests are irreconcilable. One of the contentious issues is the rent currency.
“Rent paid in euros is standard on the modern office market, as most office developments are financed in this currency. This practice allows office building owners operating on the international market to avoid the risk of exchange rate fluctuations. Developers who take out euro-denominated loans to fund office construction also rely on the euro. In contrast, the state budget uses the Polish zÅ‚oty, which is also the preferred currency for transactions by public institutions,” explains Marcin Kowal.
What could advisers active on the office market suggest in such cases? “If a tenant cannot pay rent in euros, we look for a building whose landlord might be willing to accept payments in Polish zlotys. This is possible particularly for smaller leases in large buildings - it requires landlords to deviate from the requirements of their loan agreements with financing institutions. It becomes more challenging when a state organisation is seeking a large space, as the landlord assumes a higher risk in such cases. One common practice in these situations is to establish a cap on the euro exchange rate, setting upper and lower limits on the currency exchange rate for the conversion of dues into zÅ‚otys. This limits and controls the impact of euro exchange rate fluctuations on rent amounts. Another option available to office landlords is currency hedging, which enables them to mitigate their foreign exchange risk,” explains the expert.
Flexibility versus obligations
Another issue in lease agreements requiring flexibility from both parties is the settlement of rent-free periods that landlords offer tenants as an incentive. “In line with market practice, rent-free periods are typically granted at the beginning of the lease term, after which tenants pay the full rent. However, state institutions which operate within fixed annual budgets would prefer to spread the discount evenly over the entire lease term to maintain equal rent payments year-to-year. Investment funds owning office buildings tend to reject such arrangements because they can negatively affect future property valuations. If an office building is to be sold, its valuation will be based on the base rent, and spreading out the discount would result in a lower valuation,” says Marcin Kowal.
Lease negotiations will also cover office fit-outs. Due to the recent surge in the prices of building materials and construction services, this has become quite a hot topic on the office market. For state institutions, fit-out costs are likely to be higher as these tenants prefer cellular layouts that will require leasing more space and building costly partitions and additional installations. Moreover, state organisations which are prohibited from investing in third-party fixed assets cannot contribute to the cost of fitting out spaces they do not own. As a result, landlords are fully responsible for all office fit-out work for such institutions.
“State-owned companies are increasingly opting to lease office space with full fit-outs and advanced infrastructure such as videoconferencing equipment and even with a broader range of services, including cleaning. This enables them to relocate to turn-key offices quickly and seamlessly begin operations in their new location,” says Marcin Kowal, Associate Director, Newmark Polska. “All these additional measures generate costs. Meanwhile, most institutions seek to include a break clause in their lease contracts to account for potential changes, such as statutory liquidation. This creates another challenge in landlords’ Excel calculations because the high costs of office construction and fit-outs have to be amortised over the entire lease term, which currently spans seven to ten years. Generally, the more expensive the fit-out, the longer the lease should be. So, what can be done? If early lease termination is essential for an institution, we return to the negotiation table to discuss security options for the building owner. These may include reimbursing unamortised costs or imposing contractual penalties,” comments the expert.
Agreement must be reached
Most importantly, both landlords and tenants want to reach an agreement. State institutions can no longer operate in old, outdated buildings and will therefore increasingly need to explore other options on the office market. For landlords, a government office is a reliable tenant with secure payments, backed by State Treasury guarantees.
“Our experience has consistently shown that, under favourable market conditions, it is possible to incorporate the seemingly impossible requirements of state institutions into a commercial lease agreement. Experienced teams of advisers are able to assist tenants in navigating challenging negotiations. Our role is to continually think of out-of-the-box solutions and compelling options for tenants. If an institution requires non-standard market solutions, we always recommend properties which, due to the planned refinancing of their property portfolio, can accommodate some of these solutions that might be unacceptable to other landlords. A good understanding of needs and, ultimately, the recommendation of suitable solutions that are acceptable to both property owners and state institutions are key to the success of lease transactions,” concludes Marcin Kowal.