• Sub-prime is the catalyst, not the cause of the recent turmoil in the financial markets.
• The ensuing uncertainty will have a profound impact on property markets throughout the world.
• The pricing power has returned to the occupier in many markets. This shift will continue in the medium term, as property is re-priced. This provides occupiers with a major source of opportunity.
• Demand from the financial sector is likely to be depressed during 2008 by 15-20%.
• There is little evidence of a direct impact on demand levels outside the financial sector, or indeed, major CBD markets. Nevertheless, occupiers will continue to remain cautious and cost conscious over the medium term.
• Cost management and the background of uncertainty will mean a softening of rental levels in major CBD districts in 2008-09.
• Occupiers will need to treat occupational incentives with caution having regard to their accounting treatment.
• Not all landlords are equally affected by "subprime." One of the most significant sources of opportunity to the occupier is, therefore, to ensure they know the landlord, the drivers of the investment market, and how these will impact on different types of investors.
• Cost of capital will remain much higher in 2008-09 than in the recent past. This may increase the value of the occupational portfolios as a potential source of cheaper capital.

The sub-prime issue and the effect of the credit squeeze has thrown up considerable headlines and comment worldwide since July. Much of this has focused on capital markets and the anticipated impact on the investor.

The purpose of this note is to highlight the major implications of the credit squeeze and, the subsequent fall-out in terms of uncertainty so far as corporations, and the occupational market in general, is concerned.

This dimension has largely been ignored by the real estate industry despite the fact that the spillover from the credit squeeze will be of considerable importance to the occupier, both in terms of new risks as well as providing a source of opportunity.

Sub-prime is a red herring. It was simply the most stretched segment of an over stretched debt market. As such, it has to be seen as a catalyst rather than the cause of the recent turmoil.

This is an important observation because it will, in effect, determine the type of economic and property market scenario most likely to unfold in the short to medium term. In essence there are two opposing scenarios at present:

The rose tinted scenario essentially views sub-prime as the cause of the current uncertainty in the financial and property markets. It suggests a relatively short period of uncertainty (3-6 months) during which the "debt problem" will unwind fairly benignly. This will be followed by a return to the "status quo" of the last few years.

This views sub-prime as a catalyst. The real cause of current conditions lie in the policy response 6-7 years ago when central banks were forced to cut interest rates sharply and aggresively in response to the bursting of the dot.com bubble that sparked a recession (later exacerbated by the 9-11 terror attack).

The easing of monetary policy coincided with a dramatic rise in the savings behaviour of China, Russia, the main oil producers, as well as Japan. This led us to some fundamental imbalances in the global economy, which will necessitate a much longer and drawn out period of recovery. Something that won't really happen until the "super-saving" countries are encouraged to "spend" rather than "save."

The risk, therefore, is not that "sub-prime" will extend to the rest of the economy, but that it won't. The recent aggressive interest rate cuts will certainly alleviate conditions in the world's debt markets and avert the possibility of a recession in the short-term, but arguably, it could also fuel the inflation of a larger bubble 2-3 years out.

For the purposes of this paper we have, therefore made the following assumptions:
• Global growth will decelerate in 2008-09 and the US economy will not dip into recession.
• There are no further "surprises" to come out of the financial sector.
• Uncertainty will continue to prevail over the first half of 2008 and that will continue to impact on both the investment and occupational markets.
• Debt is available but at a price. In other words the cost of capital will be substantially higher in 2008- 09 than has been the case over the last 4-5 years.
• Weakening occupier demand will coincide with the peak in new supply moderating the prospect for rental growth in markets throughout the world.

The air of uncertainty will mean that occupiers will be seeking to review existing investment proposals. It may mean that new initiatives are postponed or delayed as a result. With the exception of the financial sector, though, it appears likely that investment programmes committed to 5-6 months ago will continue, albeit with a much greater emphasis on cost management.

The financial sector and, in particular, investment banks have already made substantial provisions against losses from sub-prime. Further provisions will be necessary and many have, in fact, already reported substantial losses in Q3. Pressure on earnings and the outlook for lower global growth, will inevitably lead to a more cautious approach and the postponement of new space requirements in the short to medium term.

Hedge fund and private equity firms will be under similar pressure. Financial occupiers have, therefore, "paused for thought" and that will certainly impact on levels of demand in the main global office markets.

As yet, there is no indication of the concerns with the financial sector extending to either other sectors, or indeed, in markets less reliant on the financial sector. Impact in these markets can not be excluded but will essentially be a function of the duration of the "financial crisis."

Given the momentum we are currently observing, it is reasonable to expect a fall in demand for office space in major financial markets of up to 20% in 2008. Other markets will record a more moderate level of demand as a function of the slow down in global growth rather than as a direct result from "subprime."

Lower levels of occupational demand in 2008 will coincide with increases in supply and the peak in development activity in most of the major global markets. This will soften rental levels and constrain rental growth in 2008-09. Such a trend will be reinforced by the increased importance of cost management evident across all sectors. This will impact on the willingness, and the ability, of certain companies to pay prime rents.

Increased caution on the part of the occupier and peak levels of new supply will lead to an increase in incentives available from landlords. Rent-free periods will increase particularly from those landlords that need to maintain headline rental levels. However, occupiers need to adopt a cautious approach to the whole area of incentives and, in particular, be minded of their treatment under US GAAP.

The balance between supply and demand has and will continue to shift in many markets. The pricing power has moved to the corporate/occupier. This will provide a major source of opportunity for those occupiers able to take advantage of their market position.

While the pricing power is passing to the occupier, it is important to note that "sub-prime" has not affected all landlords in the same way, or to the same extent. Some will be under pressure and will undoubtedly be looking for an exit route. It may be appropriate, therefore, for occupiers to re-evaluate their buy-rent option as this may well have changed dramatically over the last few months.

In either case, it is imperative for occupiers to be aware, and seek to understand, the drivers shaping the investment market and, therefore, the relative position of their landlord. Knowing the landlord is a source of opportunity.

One direct effect of sub-prime is a higher cost of capital through 2008-09. This will impact on the ability of some corporations to raise debt capital. In such circumstances it may be more appropriate to consider raising funds by releasing the value of the property portfolio.

Those occupiers that have recently considered releasing value from their portfolio (sale and leasebacks for example) need to be careful as some investors will be looking to review their positions and seek to renegotiate price.

Those occupiers with surplus real estate may need to reassess and restructure their portfolios (for example with more aggressive sub-letting strategy) to enhance potential value.

Joe Valente is Head of Research for DTZ. Since 1984, he has been involved with a wide range of research projects for occupiers, developers and investors. The global research team employs a total of 150 analysts worldwide. Of these, 45 staff are based in London, 40 are located in European markets and a further 60 in Asian markets. The U.S. market is covered by a team of five analysts based in New York.