On the northern fringes of metropolitan Madrid, four new state-of-the-art skyscrapers soar between 220 and 250 metres into the air, dwarfing most other structures in Spain.

Built on an expanse of re-zoned land previously owned by Spanish football club Real Madrid, the 45- to 56-storey towers have redefined the capital’s skyline and consolidated its northern districts as the financial and business hub of the city.

Municipal authorities and letting agents enthusiastically promote the “Cuatro Torres” as among the most exclusive new commercial real estate in Europe. Although the timing of their inauguration could not be worse, the buildings were conceived in response to a severe shortage of prime office spaces of 1,000 square metres or more.

For now, however, downsizing and corporate failure has depressed demand in this segment and made finding lessees for the floors not taken by proprietary occupiers and other pre-signed tenants a monumental headache for owners and property agents.

With the Spanish economy tipped to contract by more than 4 per cent this year, and little prospect of a quick recovery, demand for office space is likely to remain soft at least until the end of 2010, say most sector analysts.

First-half take-up rates for all office space in Madrid fell about 60 per cent year-on-year, according to Savills. It expects total absorption this year of 225,000 sq m, less than half of last year’s take-up. Vacancy rates, meanwhile, are creeping up towards double digits, from a low in the latest cycle of 6 per cent.

Reflecting this, one of the four new towers, owned by Spanish insurer Mutua Madrileña, is completely vacant. With 57,000 sq m of prime leasable office space, it looks set to become the arena for a rental price war in the Spanish capital, according to sector specialists.

A similar, though not as lofty, office tower development on the highway between central Barcelona and its main airport also has would-be tenants sharpening their bargaining tools.

“When you have three or four towers that are exactly the same or with similar space, one next to the other, then you know that it is a good time to push for discounts,” says Ian Cassidy, head of the Barcelona office of Savills.

Whereas two years ago, prime properties in Madrid were fetching rents of up to €41 ($60) per sq m, wily would-be tenants are now negotiating down to below €30. In Barcelona, meanwhile, prime rents have dropped from about €24 to €20 over the same period.

The decline in Madrid began in earnest at the end of last year, with a 15 to 20 per cent softening of prime rents in the second quarter alone, according to Knight Frank. As in other European cities, capital values have been falling for nearly two years.

Income yields – which have climbed from around 4.25 per cent to 6.5 per cent since the 2007 financial crisis erupted – are unlikely to shift much more, according to Edward Farrelly, head of research at CB Richard Ellis in Madrid.

“In prime Madrid, we’ve seen capital values come down by 47 per cent since the third quarter of 2007,” he says. “However, it’s only really in the last six months that the rental decline has kicked in, and there’s still some (downward) movement to come.”

Mr Farrelly says properties are more likely to re-price further than cede yield as rents continue to fall. “If you look at the last recession in the early 1990s, capital values came down 69 per cent,” he says.

Despite the dramatic drop in property prices, sales remain elusive, with transaction volumes down heavily.

Financing remains tight and expensive, with potential buyers being asked to put up 40 per cent or more of the sale price. Uncertainty about the Spanish economy, and the country’s typically short leases, are keeping some large German funds and similar institutions away, although there has been foreign interest in top-quality sale and leaseback deals. Opportunity funds have also entered the Spanish market. All consultants have noted a resurgence of interest from rich Spanish investors, who are back in search of assets which promise to retain wealth and deliver a reasonable and stable return over the long term.

Supply, however, remains restricted. Banks and other creditors which have acquired commercial property through debt-for-asset deals and wound-up funds are reluctant to depress prices further by releasing all their stock at once.

They have “dribbled” a few properties on to the market, according to Savill’s Mr Cassidy, but will continue to sit on the bulk of them, gradually writing down their values until market conditions improve. Nor are lenders likely to proceed with projects planned by the troubled developers.

“With banks now holding equity in most of the property developers, we can assume that developments planned for the next couple of years will have been put on hold,” says Knight Frank in a recent report.

According to Savills, the volume of sales in Madrid offices totalled €378m in the first six months of this year, almost 60 per cent down on the year-ago period, and almost 80 per cent less than in the first half of 2007. In Barcelona, according to Aguirre Newman, there was a 31 per cent drop in deal volumes, to €205m.

Despite broader uncertainty about the depth of the Spanish recession, investors are counting on a relatively slim development pipeline to work in their favour. This should also help Mutua Madrid fill its new tower before the shine wears off.

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