T h e P r o p e r t y A d v i s o r s

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1 Eston International Property Advisors 2006/2 T h e P r o p e r t y A d v i s o r s Economic Overview In April 2006, for the first time since 1990, the incumbent governing coalition remained in power after the general elections. Its position, however, was weakened by the announcement of a stabilisation package and by the prime minister s leaked speech, which caused a confidence crisis and resulted in street demonstrations. This climate contributed to the opposition s spectacular victory in the October municipal elections, apparent everywhere except for the capital where the coalition that had been governing for 16 years was able to retain its lead. Rocketing public spending and real wages seen before the elections led to the austerity package announced by the new-old government in May, with the short term goal of curbing the deficit and putting the brakes on domestic consumption, and thus on imports. According to preliminary figures from the Finance Ministry, the general government deficit amounted to 9.4% of GDP in 2006, remaining single-digit in spite of previous expectations. In light of the measures taken, the coming years are expected to bring a dramatic improvement. % June 2004 GDP, inflation and HUF/EUR exchange rate Exchange rate * June June 2006 Qarterly GDP growth HUF/EUR exchange rate Consumer price index Source: HNB, CSO, market consensus * Average for 2007 (Eston forecast) However, restoring balance takes a toll on the economy. The real wage growth of 7.5% seen in the first half of 2006 turned into a y-o-y 2.5% decrease by November, while the unemployment rate rose to 7.5% (from 7.3% a year ago). A moderate increase in consumption and falling capital expenditure, already seen in the second half of 2006, slows down GDP growth. Fortunately, the favourable international business climate helped maintain high export growth, while robust industrial production (which increased by 11%) was strong enough to even resemble the boom years of 1997 and All in all, 2006 produced an overall GDP growth of 4%, only slightly below the previous year s pace (4.4%). Analysts expect this ratio to temporarily fall to around 2.5-3% in An export-driven, though slower, growth is one reason for optimism regarding the sustainable development of the economy. The Hungarian forint began to gradually weaken before the spring elections. It plummeted to 283 HUF/EUR in June, but recovered with the same surprisingly high speed during the autumn months to HUF/EUR. The other short-term victim of the austerity package is the inflation rate. Direct and indirect tax increases, heavy cuts in social subsidisation, a dramatic increase of regulated prices included in the package, together with higher import prices due to the weaker forint were responsible for the year-on-year inflation rate jumping from record lows of 2.3% in April 2006, to 6.5% in 2006 (with the annual average inflation rate at 3.9%). Regulated price hikes effective from January 2007 have caused a further (but smaller) inflation shock, with the y-o-y rate expected to peak at around 9% in the spring months, and to recuperate to below 5% by year-end. Following increasing inflation and ECB rate hikes, the Hungarian central bank had raised its base rate by a total of 200 basis points to 8% by The ECB interest rate was increased in five steps to 3.5% from 2.25% in This, together with decreasing yields seen on the office market (assuming a common 20% own contribution, and financing available at ECB prime rate+1.5%), halved the return on own-capital invested from 20% at end 2005.

2 Modern offices In 2006 we saw a record-breaking year again, with leasing contracts for a total of almost a quarter of a million square meters (new office demand was 150,000 sqm). In line with previous forecasts, developer activity has increased dramatically during the past twelve months, and builders are expected to switch to high gear in Last year brought more than 220,000 sqm of new office space to the market, (in comparison to deliveries just exceeding 180,000 sqm in 2005), with the vast majority (78%) built on the Pest side of the Danube. The dominance of the Vaci út corridor and its vicinity remained indisputable (close to 40% of the total). The Duna Tower office building (27,100 sqm), the second phase of Center Point (22,000 sqm), BC 30 (12,400 sqm) and Kinnarps House (7,500 sqm) were all completed in this area. above the market average. According to our short survey, demand for offices offering upgraded services and luxury fit-out should strengthen in 2007, justifying prime rents above market rates. In 2006 two of the four largest new contracts (altogether 24,000 sqm) were completed with the participation of Eston International. The Vállalkozói Támogatásközvetítô, which is the Hungarian Development Bank s subsidiary for handling EU corporate support, signed a long term leasing agreement for 4,500 sqm at Center Point II. Eston also took part in the deal for a total of 7,500 square meters of office space for the State Motorway Management Co. and the National Motorway Co. at Atrium Park (which is 43% rented at the moment), to be delivered in July Further rental agreements have been negotiated for the Millenáris Office Building (7,000 sqm, expected handover in May 2007) and the Studium Office Building Studium Office Building Center Point Vaci út and its vicinity is becoming more attractive with the planned Governmental Quarter, which was selected to be built next to the Western Railway Station by We expect that companies, especially those providing services to governmental organisations, will prefer the physical proximity of the Quarter. The Lágymányos area on the Buda side, also saw an improvement in quality supply. Two phases of IP West were delivered, the first in early 2006 with 8,200 sqm, and the second 7,600 sqm in November, two thirds of which were already occupied by tenants including Quintiles (1,100 sqm), Brau Union (1,000 sqm), Whirlpool (700 sqm), and Avnet (600 sqm). Across the bridge, TriGranit has completed the first phase (18,500 sqm) of its Millennium Office Towers. Financial giant Morgan Stanley (2,900 sqm) and German pharmaceutical company Boehringer-Ingelheim (1,100 sqm) have decided to move in. With an outstanding location, the Roosevelt 7/8 office building also entered the market in Office space and exclusive services are offered at a rental fee of 21, well 2 (12,000 sqm, expected handover in September 2007). Another larger 2,000 sqm transaction was also mediated by Eston: Sodexho Hungary s move into the Material Center, while early last year OTP Bank signed on for 2,800 sqm at the Danubius IV office building, also represented by Eston. Other transactions well above the average deal size of sqm included MÁV Cargo s space at Kinnarps House (5,400 sqm) and the relocation of the Budapest Stock Exchange to the Andrássy Center (2,750 sqm). Meanwhile, large-scale expensions have happened at Science Park (Ericson Hungary s 10,500 sqm), at MargitPalace (Magyar Cetelem 3,600 sqm), EDS Hungary (Metrotech office building 3,500 sqm) and at ECB Dévai Center (Vodafone 3,100 sqm). Due to the strong market absorption seen in 2006 the vacancy rate was not able to rise dramatically, only climbing from 11% in 2005 to 13% in We expect this ratio to further increase in 2007, due to accelerating development activity and a lower

3 E s t o n I n t e r n a t i o n a l P r o p e r t y A d v i s o r s 2006/2 /sqm/month) Average rent and typical yield for A-category offices Average rent Typical yield 2007* proportion of new demand; in 2006, lease extensions, and tenants that moved from one modern office building to another became more common. These tendencies suggest a slowdown in the fall of returns on the office market. Thus, in order to ensure an adequate pace for office leases, the role of the professional property consultant will receive greater emphasis in % 8% 6% 4% 2% 0% 2008* *Eston forecast slightly more intense year than in According to our calculations, new deliveries reached about 140,000 sqm, not taking into account companies private developments (ALDI/60,000 sqm, DHL/13,000 sqm, and HOPI/10,000 sqm). This volume is on par with the level seen in 2005, but lags significantly behind the all time high of 200,000 sqm completed in Total leased volume amounted to 150,000 sqm in 2006, exceeding the volume of 2005 (119,000 sqm). The three largest deals accounted for more than 33% of the year s volume: Wincanton rented a total of 28,100 sqm and Diebold another 19,000 sqm, both in Prologis Gyál Logistics Park, while Kühne & Nagel signed for 13,000 sqm at Europolis s M1 Business Park. Other significant transactions of the year included Lekkerland s 8,600 sqm lease at Harbor Park and Rossmann s contract for 7,500 sqm at BILK, Soroksár. The Euro Business Park was completed with the 29,000 sqm IP West Atrium Park Millenáris Office Building East Gate Business Park Except for some market niches where a slight increase was seen, the massive demand of 2006 kept monthly rental fees stable at /sqm for class A offices and /sqm for class B offices, the average levels for the last two years. We expect a moderate decrease in rental fees in 2007, since with the dramatically increasing competition amongst developers, tenants will be likely to prefer savings in rental fees over other commonly used tenant incentives (such as customised fit out offered at a small fee or free of charge). Though we do not expect investors to lose interest in the Budapest office market in spite of all the temporary hiccoughs anticipated for 2007, deals are expected to take longer to finalise and to require more comprehensive preparations. Industrial properties Thanked to a strong 4Q 2006 industrial and logistics property market of Budapest and its agglomeration had a delivery of Camel Park. The most active tenant was Cemelog, renting a total of 7,000 sqm during The final phase of the M1 Business Park in Páty was also completed. Out of the total developed area of 61,000 sqm, only the last delivery of 6,750 sqm was still available at the end of the year after 17,500 sqm was leased out in At West Gate Business Park in Törökbálint, new tenants of the year included Tesco (2,200 sqm) and Adesco (1,300 sqm). In the latest large developments south of the capital, Parkridge built 45,000 sqm in its park in Szigetszentmiklós, half of which was pre-leased by September. Prologis was mainly active in its Gyál Park, delivering a total of 15,000 sqm in 2006 and completing a further 25,000 sqm in the early months of In East Gate Business Park 6,500 sqm was built-to-suit for Volán, and 6,000 was soon taken from a further speculative 10,000 sqm. The 10,000 sqm second phase is to be delivered in the first half of Demand for logistics space in the area is seen to be flourishing, now that the completion of the North-East section of the M0 ring can be expected 3

4 with intense developer activity throughout the year. Meanwhile, in the higher office-content business parks, an increase in rental fees is even possible. Accelerating demand at the end of 2006 is a reason for optimism in early On the other hand, retail sales are expected to decelerate in 2007 due to the Government s stabilization package, and there may even be a significant drop. If this occurs, it will cool down the market of logistic properties that depends largely on retail sales. Retail In 2006 on the market of Budapest retail properties the most dynamic development activity was seen in the core of the city as well as on its outskirts; while there was no significant movement on the market of shopping centers, 1 East Gate Business Park 1 2 Airport Business Park 10 3 Prologis Park Budapest 11 4 BILK Parkridge 6 Prologis Harbor Park 7 Euro Business Park 8 Rozália Park 2 9 M1 Business Park Aquincum Logistic Center 11 Teve Center 12 Dél-Pest Business Park Office Building, Szervita tér within a reasonable time. Plans call for the delivery of the section by the end of Another project counting on the continuation of the ring is Terra Invest s Europa Center, located at the planned M0 bridge in Újpest. This park targets tenants with relatively moderate space requirements of 300-1,500 sqm. Within the boundaries of the capital, Southern Pest is also thriving. There are pre-lease agreements for 80% of the 8,000 sqm expansion in the South-Pest Business Park, to be delivered in two steps in April and November 2007; tenants are typically looking for 400-1,000 sqm spaces. Convergence Capital has launched its 19,000 sqm Citypoint 9 Business Park. The latest development in the area is the InNove Business Park (Eston is its joint exclusive agent), and the first phase of its 17,000 sqm warehouse capacity will be available in Q4 of In line with previous expectations, the heavy concentration of logistics park developments around the capital seems to have loosened, with more attention given to potential regional centres in the country. Prologis is developing on 32 ha in Hegyeshalom, with plans to serve the logistics needs of three capitals: Budapest, Vienna, and Bratislava. The first speculative phase consists of 23,000 sqm and should be completed in May While on the Southern border of the European Union, the Masped Group is developing the Szeged Industrial and Logistic Park on 45 ha. A total of 5,200 sqms has already been handed over, and a further 20,000 sqm is expected to be completed for In 2006 competition remained strong, thus rental fees continued to decrease. Typical levels were between /sqm/month at logistics parks, while business parks within the city boundaries were able to achieve significantly higher, /sqm/month levels, thanks to their location and the smaller spaces available. We foresee stable or slightly decreasing rental fees for logistics parks in 2007, and expect a strong demand for the first months, which are in fact responsible for bulk of retail sales. Downtown developments have got a new impetus in the past months. There is practically no retail space available in the Northern Váci street what however cannot be stated about the neighboring streets while busy construction is going on at its both ends. Though parking capacity enlargements are by far not in line with current developments, in this pedestrian area it might not be that critical a factor. ING s project on Vörösmarty square is expected to be launched after some delay in Its 6,000 sqm retail capacity has already been taken by tenants like H&M and New Yorker. In the adjacent Deák Ferenc street finishing touches of Immobilia s Fashion street are in full stream. 90% of its 9,000 sqm has been let at a price level of /sqm, significantly below the level seen in Váci street). Benetton, S. Oliver, Sisley, Puma and Tommy Hilfiger are expected to open their shops from Spring 2007 next door to Boss and Max Mara. At Vörösmarty square the previously announced overhaul of Luxus department store is seen to suffer further delay, 4

5 E s t o n I n t e r n a t i o n a l P r o p e r t y A d v i s o r s 2006/2 while Orco plans to open an 18,000 sqm department store resembling to Harrods or Lafayette in the former Stock Exchange building. Another high-end project of Orco, the Paris Department Store in Andrássy Avenue is expected to open in This development is in line with strengthening expectations to greet more luxury brands in the area after Louis Vuitton s 2006 debut. Despite its transportation and parking problems during the day, the high prestige, special marketing value Avenue with its street portals and attractive /sqm rental fee level is a favorite place for just entering or expanding restaurant and cafe chains. Leaving the city center we find significant new developments including retail space in district VIII, such as the mixed-use Europeum of Ablon (6,000 sqm retail) on the place of the former press HQ on Blaha Square and Corvin Atrium (30,000 sqm) of Futureal to be started in early the new strategy of Tesco and Office Depot to open around 300 sqm stores in town centers. On the market of Budapest supermarkets, celebrating its tenth anniversary in 2006, the jubilee year passed without major events. Dominance of the triumvirate West End, Árkád and Mammut has not been jeopardized. Some urge older supermarkets to go on a rejuvenating cure, similar to the one Sugár built back in 1980 will be over soon. While no new openings took place in 2006, the total stock of almost half a million square meter modern shopping center area will be enhanced by 65,000 sqm with the Q opening of Aréna Plaza. In addition, by end of 2008 a new shopping and entertainment center will emerge where Skála Buda stands now. Some pre-lease agreements for its space were already signed in late The relative silence of the capital was more or less offset by developers activity in the countryside: Vértes Center in Tatabánya and Gyôr Árkád opened. Árkád s developer ECE is going to build its next shopping center in Debrecen but already plans its Miskolc and Szeged shopping centers too. Looking at rental fees no major movement was seen in High-end downtown rates were at /sqm, however one can find halving fees within 50 m vicinity. Shops of Andrássy Avenue and the Ring were usually let at /sqm, but in the most demanded category of sqm spaces higher rental fees were recorded. Investment properties A smaller scale shopping centre is Sybil Holding s New Buda Centre in district XI., its first 15,000 sqm phase opened in with tenants like Tesco, Office Depot, Jysk and DM. Savoya Park was enlarged with a two-storey, 9,000 sqm building, where next to an Office Depot store, the first Hungarian store of Turkish home improvement chain, Asko has opened. In the second phase of Premier Outlets Center in Biatorbágy 30 new shops were delivered in summer 2006, and further 20 of the third phase are getting ready in early Ablon opened two Buy Way strip malls in 2006: one in Soroksár, the other in Dunakeszi. Around year end AIG Lincoln started to develop a 44,000 sqm commercial park, Ferihegy Market Central, next to the airport, where Tesco and Praktiker will be the magnet tenants. German DIY chain, Bauhaus is building two 20,000 sqm stores in the outskirts of the capital, before moving to the country. Hard-discount chain Aldi is also busy building its country-wide coverage. Demand for city stores should arrive from expanding drugstore, Schlecker, as well as from 5 Premier Outlets Fashion Hall Investors soaring interest for Hungarian properties remained unbroken in 2006, local real estate funds even got a new though temporary momentum due to the implementation of the interest rate tax. The volume of transactions completed was around the 1bn level, seen also in previous year, the strong demand resulted in further however slowing decrease of yields. Most deals were signed on the modern office market just as before while significant part of the investment volume stemmed from retail property sales. This latter market saw the 100 million plus deal between Morley Fund and the developer consortium of Raiffeisen Real Estate and Miller Development covering the first two, fully-let phase as well as the third phase planned for 2007 of Premier Outlets Center. Dawnay Day acquired Interfruct, C&C chain of 22, at a yield of 7,8% according to press information. SCD Group was the seller of this 105,000 sqm portfolio of 82.5m. On the office market there were three transactions of high priority closed in Morley Fund bought Alkotás Point and Science Park from SachsenFonds for 145m, HGA Capital purchased IVG s portfolio of five buildings (three

6 2006/2 at Infopark, two on Andrássy Avenue) for 99.8m, while GLL Partners acquired the exclusively located Roosevelt 7/8 office building for 99m. One of the major deals in Q was when Wallis Real Estate agreed to sell a 30,000 sqm portfolio, consisting of Danubius office buildings Bajor and Polar Centers, to CIB Lízing for 60m. Some deals also happened in the market segment of logistic properties, for example Rozália Park was sold in two steps. In H Immorent purchased 32,000 sqm for 17m and by the end of the year Hannover Leasing has signed for the remaining 60,000 sqm at a price of 60m. In the first half of 2006 the increase of real estate investment funds net asset value was slower than the pace seen in previous years, but it got a new impetus with the implementation of the interest rate tax in August Data however indicates that the jump was a one-off phenomenon. By the end of the year the net asset value of all the three largest Hungarian real estate funds well exceeded the HUF 100bn mark. Erste Real Estate managed a total of HUF 130bn, recording more than 250% year-onyear growth from net asset value of HUF 50bn at end The former top performer, Raiffeisen was able to produce only a slower increase, its NAV went up to HUF 122bn from HUF 92bn, while OTP also done well growing from HUF 73.8bn to HUF 120bn during the same period. The dramatic inflow in August did not hit the funds as a surprise, still their real estate content suffered from it. Due to the low real estate content real estate funds performance is largely influenced by money market developments, and lacking the sufficient market supply of investment products they are more likely to opt for own developments (like Europa Real Estate Fund). At those funds, where own development activity is not an option since their mother bank has its developer arm, e.g. Raiffeisen real estate content can be increased via forward purchase agreements, but we have seen cases where the mother bank s headquarter was included in the portfolio for the same reason (OTP, Erste). Billion HUF The asset value of three major property funds in 2006 Jan Febr March April May June July August Sept Oct Nov Dec ERSTE Property Fund OTP Property Fund Raiffeisen Property Fund Source: BAMOSZ Moderation of average yields has continued in all market segments, though at a constantly slowing rate. The largest fall, 1.2 percentage points, was seen at the niche of shopping centers, with its average yield closing the gap to the one achievable on the office market. As of year-end 2006 modern offices were sold with a yield expectation of 6.5%, though in the case of top-quality buildings with exclusive features the rate could slide below 6%. While the yield of retail properties declined to below 7% by year end 2006, we expect the largest drop in this segment for Logistic property yields fell to around 8%, but it could plummet further with the potential sale of larger scale logistic parks. Investors activity is seen to remain high in 2007, so yields could slip further, their fall is not likely to come to a halt before year-end. On the other hand the spread to Western markets diminished, while financing became more expensive after several ECB rate hikes during the year. We see these factors to hinder any fast increase in investment property prices for the coming twelve months. A characteristic of the Hungarian market is that transactions are usually signed not on the open market. In the fierce investors competition however we believe that direct bids received by property owners are not necessarily the best achievable ones. Calling for tenders and using the service of professional advisors could result in realizing optimal selling conditions. Increasing property market transparency is therefore the basic interest of sellers, and it is prone to hit the market not later than yields stop falling Budapest, Váci út 141. Tel.: (+36 1) Fax: (+36 1) info@eston.hu