THE stand-off between developers and tenants appears to be continuing as Dublin faces a shortage of new, third-generation office space. Industry sources say developers will not build any substantial new office blocks without first securing tenants, or until rents hit £18-£20 per square foot.

Agents say the supply of space has dwindled and some estimate the vacancy rate is at its lowest level - around 4 per cent of total office stock. They estimate only about 500,000 square feet of space is available to rent.

However, developers have around one million square feet of new office space ready to go. Agents predict the shortage will put upward pressure on rents across the board, including second-generation (older) office buildings.

"If somebody wanted third-generation office space [i.e., offices which have raised floors and are suitable for hi-tech industries] of more than 20,000 square feet, they would find that it is just not available at the moment," says Tony O'Loughlin of Jones Lang Wootton.

Two other factors are also holding back development, according to agents a reluctance by financial institutions to lend money for speculative developments; tenants have been seeking earlier break clauses in leases.

Agents say there is a number of sites which are owned by developers who cannot finance them on their own, but the banks are reluctant to advance them credit.

Observers also believe office developers are hesitating because so many of them were left with empty buildings during the last recession. The market is still reacting cautiously to the general uplift in the economy, according to some observers.

"I don't think there is a general reluctance to lend on the banks' behalf," says Mr O'Loughlin, "but at the same time, they don't want to see the market overheat. All it takes is 10 developers starting schemes near each other to tip the balance. It is still quite a small market."

The shortage is already beginning to work in favour of office owners. Prime city centre office rents were running at around £15.50-£16 per square foot, but the deals include rent-free periods and fit-out costs in many cases, according to Roland O'Connell of Hamilton Osborne King.

Developers are seeking longer leases, 25 years in many cases, without break options, but if they want to do business, in some cases they have to agree on break options after about 10 years. Much of the pressure for regular lease breaks has come from US and other overseas companies which refuse to take long leases.

"In real terms, rents have risen more dramatically than figures would seem to indicate," says Mr O'Connell.

Richard Barrett of Treasury Holdings, which is building a 40,000-square-foot office block in Herbert Street in the expectation of leasing it to solicitors Matheson Ormbsby Prentice says tenants will not pay the rents needed for developers to embark on speculative schemes.

He says £20 per square foot is the level needed to restart developments. He feels tenants have not been paying attention to the way the market has moved, especially in the last two months. "They are still thinking of rent levels and conditions which applied three years ago," he says.

Like others, he says developers learned their lessons from the office building boom of the late 1980s. Fuelled by credit, he says, the tenants never materialised.

"The only space which is being built now is pre-let space," he says.

Mr Barrett says people are not paying extra for office space - there is no premium level, so developers may as well wait until the market improves further. "Why risk your own money if you can wait?" he asks.

John Bruder of AIB Investment Managers says every space shortage in the past 30 years has been followed by a boom and then an overhang of office buildings. He is sure that will happen again, but the boom will be less pronounced this time because break options in leases will substantially reduce the degree to which developers can raise finance.

One agent points out it is not only rental levels which are holding back speculative developments. "Built into that assumption is that you can sell the building off at a yield that is representative of what is prime for the location - but with a number of break clauses, you won't be able to do that," he says.

"Once you build an office development, the interest on your money is ticking away. It doesn't matter that you have built a wonderful edifice, your negotiating hand is a little weaker once you've finished," says the agent.

Another problem is the shortage of suitable sites in prime office locations in Dublin 2 and 4 and building costs are rising very rapidly this year, according to Sean Davin of John T. Davin and Co. He says there will not be much speculative building until two or three tenants are battling to lease the same building. By next spring, there should plenty of activity, he says.