2003 started well but ended badly as oversupply and vacancies in the suburban office market caused a rapid decline in prices. Tenants, however,are getting better deals.

The Dublin office sector has ended 2003 on a sour note with suburban occupancy falling away and lower returns overall. The office sector went into a cyclical and rapid decline as 2003 drew to a close.

Tenants got tough on rental negotiations, investors rushed to offload ageing property stock due to high running costs and these and other factors served to hammer the sector.

Some commentators describe the current suburban Dublin market as being in "meltdown" with too much vacant stock depressing prices and allowing tenants to seek better returns. Central Dublin prices are also faltering but holding up somewhat better, given the ongoing and chronic shortage of availability in the prime city centre space.

A "two-tier market" has developed in Dublin, according to Peter Stapleton, director of Lisney. Only a third of vacant property is located in the city centre but more than half of this year's take-up has been in central Dublin.

Commentators are now predicting an end-of-2003 uptake figure of about 150,000 sq m (1,614,585 sq ft) slightly down on the 157,930 sq m (1,699,942 sq ft) reached in 2002. The current vacancy rate for the Dublin area as a whole is about 19 per cent on the basis of an availability of almost 460,000 sq m (4,951,394 sq ft), amounting to a three-year supply, given the anticipated 2003 uptake.

Headline rental levels on city premises have fallen from a peak of €528 per sq m (€25 per sq ft) in 2000 to €484 per sq m (44 per sq ft) in 2003. Suburban levels vary depending on the location but range from €128 to €194 per sq m (€11 to €18 per sq ft), according to figures provided by Lisney.

Returns for the year are languishing at about 3 per cent according to property commentators, very low indeed compared to the retail sector, which returned the strongest figures at 22 per cent. Yet the office sector mopped up about 54 per cent of the total investment turnover of about €800 million according to Ann Hargaden of Lisney.

The IPD/SCS Irish Property Index Third Quarter 2003 indicated that capital values in the office sector fell by 2.5 per cent during the previous 12 months but the overall return for the sector was 3.3 per cent. If anything, this has slowed somewhat as the year comes to a close.

In contrast, things looked fairly bright as 2003 arrived. Green Property disposed of the Setanta Centre in Dublin 2 at the end of 2002 for €88.5 million, delivering a yield of 6 per cent. This was quickly followed by the disposal of the AIB International centre in the IFSC, Dublin 1, in the second quarter for about €78 million, giving a yield of about 5.3 per cent.

Large chunks of the Royal Liver portfolio also reached the market in two large tranches with combined prices ranging up to €95 million. This included Chatham House on Chatham Street, Dublin 2, Grattan House on Lower Mount Street, Dublin 2 and the Adelphi Centre in Dún Laoghaire and Unit 2, South County Business Park in Leopardstown.

Yet all this availability and the failure to let suburban properties in satisfactory volumes has put the skids under the market at the close of 2003 and is expected to depress the market for at least a year if not longer. A number of factors are at work, according to property commentators.

Landlords are accepting lease surrenders at significant reverse premiums and then deciding to offload older properties in a process of retooling and upgrading their portfolios.

Nervous developers also faced difficulties finding tenants when the occupancy boom fizzled earlier in the year and are also dropping modern buildings onto the market. The whole serves to fuel vacancy rates and depress returns. Only the top end of the office sector seems to be holding its own, particularly those with strong covenants and long-term leases.

The buyer's market, particularly in the suburbs, has emboldened tenants to push the envelope and work for better deals. Tenants are undercutting the market in order to recover outlay on existing lease commitments, according to property sources.

They are also examining existing lease commitments and taking up opportunities either to go for better terms, move to fancier accommodation or go for buildings with lower running costs.

This somewhat new-found almost environmentally-friendly response is surprising, but a genuine indicator of how the market is going at the end of 2003, according to property commentators. With plenty of stock available, tenants have the chance to weigh up heat, power and general running costs.

This move is being pushed along by talk of carbon taxes but also insurance issues and repair obligations. "Rent reviews and lease renewals are being vigorously fought with most reviews being referred to arbitration," according to Peter Stapleton.

The oversupply, particularly in the suburbs, is likely to weigh down the sector for the foreseeable future. There is nothing on the horizon to absorb the slack as investors shed older buildings in the hope of attracting tenants to newer office stock in better locations closer to the city.

The question is, when will the sector rebalance and start to move out of the doldrums, and what factors will influence this move.

The general recovery of the European and US economies will be a positive influence, according to Ms Hargaden, with signs of improvement already visible.

This recovery, if and when it comes, will tend to push interest rates, serving as a negative influence on both investment and the ability of tenants to keep their commercial shows on the road.

Any improvement in the Irish economy should lead to a return to positive rental growth "which has been non-existent in the office and industrial sectors since 2000", says Ms Hargaden.

She also predicts that institutional investors may be tempted back onto the market given the expected availability of good value modern properties.

The general view is that capital values will return to positive growth as we move into 2004. Less clear is what impact an oversupply of ageing office stock and a shortage of tenants, at least in the suburbs, is likely to have on that positive growth in the coming year.