Strong activity during the third quarter once again lifted the market, resulting in absorption gains practically across the board.
Nine of 11 metro submarkets in Denver have had positive overall occupancy gains this year. The northwest, central business district and southeast suburban submarkets led the charge with more than 100,000 square feet of absorption.
In fact, the southeast suburban market alone has absorbed nearly 1 million square feet this year, and the northwest and central business district will likely reach three quarters of a million square feet apiece by year-end.
Market Assessment
More than half of the 2.3 million square feet of net absorption for the year was recorded during the third quarter. While the 4 million square feet absorbed in 2001 is unreachable, 2005 will easily surpass net absorption totals for the several years prior.
However, several more years of strong positive absorption will be needed to push vacancy rates down to pre-recession levels,19% of metro space is currently standing empty.
Conservatively, it will still be mid-to-late 2008 before vacancy rates approach the 10% range.
As class A space continues to tighten at a more rapid pace than other categories, it has caused class B lease rates to edge upward. Six submarkets have recovered sufficiently to keep class A rates stable while class B rates are beginning to increase.
Class B rates in these submarkets have increased by an average of 35 cents. Class C rates in a few of the markets may see a corresponding increase by year end as the overall positive trend continues.
Many markets had active leasing led by smaller tenant activity, while some significant third-quarter moves included Leopard Communications’ lease at 390 Interlocken, Gambro’s lease at Denver West and TIAA-CREF’s renewal and expansion at 1670 Broadway.
The end result of increased activity was the lease-up of several buildings during the quarter, as well as others that have already succeeded in signing leases on space vacated during the quarter.
Investment sales remain strong, with nearly half a billion dollars of large office transactions during the third quarter. Many high-quality buildings are being snapped up by new investors to the Denver market. This is especially true in the central business district and southeast suburban markets where barriers to entry for new construction are higher.
Many new buyers are looking to upgrade properties and add value, while others are simply seeking positive returns. Regardless of buyer type, the trend will eventually lead to rate increases and concession decreases.
Several recent economic forecast reports for Oregon indicate that continued moderate growth is to be expected with solid job growth in many sectors.
Despite high unemployment, Oregon has outperformed the nation in job growth since March 2004, with average year-over-year gains exceeding 3% each month since the start of 2005.
Unemployment in Portland remains relatively unchanged during the past several months, and currently stands at 6.2% with Oregon’s rate slightly higher at 6.3%.
The Portland office market recorded another quarter of improvement. The metro area vacancy rate has dropped again this quarter, marking the sixth consecutive quarter of expansion. The rate now stands at 12.7%, down 50 basis points from last quarter and down significantly from its peak of 17% in 2003.
The office market recovery continues in almost all submarkets with all but two recording positive net absorption and declining vacancies in the period.
Demand continues to move west as tenants seek out space. Washington Square/Kruse Way remains the tightest submarket. Class A vacancy is below 6% and net absorption was minimal due to lack of availability.
The Sunset Corridor, however, recorded impressive net absorption and saw a significant drop in vacancy.
Construction deliveries remained minimal though activity is beginning to pick up in the tighter submarkets and tenants looking for 30,000 square feet or more in the central business district or Kruse Way will have to consider new construction if they want class A space.
Forecast
Demand will continue to move west to the Sunset Corridor, which posted an impressive 93,000 square feet of net absorption during the third quarter.
Class A vacancy dropped a significant amount from 31.6% to 26.4% while recording more than 130,000 square feet of net absorption. Sunset Corridor bellwether companies,Intel Corp. and Nike Inc.,both contributed this quarter, either renewing or adding additional space both on and off campus.
Nike leased almost 100,000 square feet at Woodside, while Intel renewed several leases and announced plans to add a new 700-worker building to its Ronler Acres Campus.
Just 56,000 square feet of construction wrapped up in the third quarter. Activity is beginning to pick up, however, in response to lowering vacancy rates and increasing rental rates in specific submarkets.
Kruse Oaks II will deliver 107,000 square feet to Kruse Way at the end of 2006. Pre-construction activity is picking up in the central business district in anticipation of a significantly tighter leasing environment in 2007 and beyond.
Opportunities and Challenges
Average lease size in the Portland office market is beginning to grow slightly. Leases this quarter averaged slightly less than 7,000 square feet, while they have been averaging between 5,000 and 6,000 square feet in the past.
Despite the tightening market, tenants in this size range will continue to have numerous choices when considering any specific submarket. But they may begin to see generous concession packages begin to shrink and rental rates begin to firm up.
Tenants looking for more than 30,000 square feet of class A space will be forced to look at alternate submarkets or new construction to accommodate their needs.
Sublease space is becoming less and less of an issue for landlords. Portland’s most desirable space already has been leased and taken off the market, while much of the rest of the space has returned to the landlord.
There is slightly more than 600,000 square feet of sublease space currently on the market, less than half the amount that was on the market three years ago.
The economy in the Seattle area maintained its strong growth in the third quarter, even as the unemployment rate both statewide and locally moved upward.
The rise in the unemployment rate can be attributed to an increase in the number of people re-entering the job market. Washington’s payroll employment increased in August for the 12th consecutive month.
According to seasonally benchmarked data, payroll employment in Washington increased by 72,000 jobs,or 2.7%,during the past 12 months. This compares to only 1.7% nationally.
The office vacancy rate fell 80 basis points in the third quarter, nearly matching the 90 basis point drop in the second quarter. At 13.8%, vacancy is at its lowest point since the fourth quarter of 2001.
The market posted more than 900,000 square feet of positive net absorption in the quarter. This was the second consecutive quarter of more than 700,000 square feet, the highest back-to-back numbers since the end of 2000.
More than 46% of the positive net absorption occurred in the Bellevue central business district. Class A asking rates rose sharply by 39 cents to $25.66 per square foot and class B asking rates rose to $19.60 per foot, an increase of 18 cents.
The vacancy and price trends that began in earnest last quarter appear to be gaining momentum as leasing fundamentals continue to improve.
Washington Mutual Move
By this time next year we should begin to see the real effects on Seattle’s financial district of Washington Mutual’s move from their current locations scattered around downtown to their new home at the WaMu Center.
Washington Mutual currently leases nearly 1.4 million feet of space and is the largest user in downtown Seattle. Public perception of the move seems to have shifted from dire predictions of skyrocketing vacancy rates two years ago to a feeling of a negligible impact offset by improved market conditions for landlords.
Only a small amount of Washington Mutual space has been claimed at this point and for vacancy not to be significantly affected, activity must pick up substantially to absorb the approximately 900,000 feet of space they will be vacating.
Forecast
With continued strong economic growth, tenant movement and the lack of large speculative construction projects slated to be completed this year, the pattern of declining vacancy should continue in the fourth quarter.
Looking ahead to 2006, the WaMu question remains the most pressing issue affecting the office market and it remains to be seen if the demand for space can absorb the increase in supply when the move occurs next year.
Opportunities and Challenges
While the market remains favorable to tenants in the northend and southend, the balance is tipping back toward landlords in Seattle and Eastside submarkets.
Concessions such as free rent, parking and tenant improvement allowances are declining in prime submarkets and the scales are balancing.
Landlords can expect that trend to continue. With rising rates and declining vacancy, tenants should consider taking advantage of any concessions and low rates while they are still available.
