With a construction boom well under way, the Puget Sound region is on track to dramatically alter and expand its office market during the next three years. These are heady days for local office developers, who have roughly 6 million square feet under construction and more than 12 million square feet planned or proposed. In the unlikely event that all of the projects on the drawing board are built, the region’s total office inventory will grow by more than 25%. Far more plausible is that total office inventory will increase by about 15% during the next two to three years.
The Puget Sound office market began the year with the lowest central business district vacancy rate (1.2%), and the fifth-highest average Class A asking rate ($32.50 per square foot annually, full-service) in the United States. Overall, office numbers have changed little since then, and vacancy in the Seattle central business district actually has declined in the second quarter by one-tenth of a point. Demand for office space still far outpaces supply, particularly in the dot-com-laden Eastside and downtown Seattle submarkets. And although the market is confronting more office space in the pipeline than it has seen since the mid- to late 1980s, most projects are upwards of 70% pre-leased and will do little to ease the short-term space crunch. Many tenants needing large, contiguous spaces are being forced to sign leases on planned buildings that are two to three years from completion, with high-profile spaces now costing in the neighborhood of $50 per square foot.
Meanwhile, industrial vacancy rates have declined sharply since the first quarter, now down to a remarkable 2.9% regionwide. However, for the most part, asking rates have not yet caught up with the demand for space. Telecommunications firms such as WorldCom and Qwest have shown their willingness to pay top dollar for telecom facilities, triggering a surge in the value of warehouse space located on or near fiber-optic cable routes. Unable to compete, traditional users of warehouse and distribution space are being pushed further south and east to more remote industrial submarkets.
Developers and owners could not have asked for a faster recovery in Portland’s Sunset Corridor. Vacancy rates dropped again this quarter a remarkable 15%, ending the quarter at 6.0% overall and 6.4% for Class A product. This can be attributed to the record 270,000 square feet of Class A absorption. Class A average rental rates jumped 80 cents this quarter, to $21.83 per square foot annually. Some of the major leases signed this quarter include: Corillian (120,000 square feet), Volkswagen (44,000 square feet), WCI Cable (35,000 square feet), WebBridge (25,000 square feet) and Veritage (14,000 square feet).
Developers are starting to gear up for construction as they try to capture the pent-up market demand for Class A office space. Several projects currently under development willdeliver over 500,000 square feet by the end of 2001. Despite this new supply, vacancy rates should remain below 5% throughout this year and next.
Downtown posted impressive net absorption this quarter, at 173,000 square feet. Vacancy rates remain extremely low and rental rates for Class A space have jumped 75 cents this quarter. Fox Tower, which will be complete next quarter, will most likely be over 90% leased when the doors open. WebTrends just leased three floors for a total of 58,000 square feet; this is in addition to its space across the street at Pacific First Tower. RiverTec delivered and was close to 100% leased with Intel taking a full floor and US Webb taking a significant amount of space.
Several new developments were announced this quarter in the Pearl District; CE John will be building a new 150,000-square-foot Class A office building, dubbed 10th @ Hoyt, in the heart of the Pearl District. Prendergast will be developing an office building with a residential component, The Pearl Block, which will have 80,000 square feet of Class A office space.
Old Town will also see development activity in the near future. PDC has entered into negotiations with Kalberer for a site for the Creative Services Center at 234 NW Fifth. The Center will be home to the Creative Services Alliance and will have incubator space for creative start-ups. In a related deal, Venerable Properties recently purchased the Oregon Casket Building, one block from the Creative Services Center, with plans to develop a 100,000-square-foot office building.
In what may be the only cloud over the Portland metropolitan area office market, Clark County is testing the depth of its office market. Several new buildings delivered in Clark County this quarter, pushing vacancy rates for Class A space up 12% to 14.6%. The Class A market there is still maturing; however, the test will be how fast the market is able to absorb this new product.
For the fifth consecutive fiscal quarter, there was an increase in rental rates and a decrease in vacancy rates in the San Francisco office market. More impressively, rental rates have once again shown a double-digit quarterly percentage increase. The remarkable quarter completes a six-month period in which San Francisco commercial rental rates have grown a staggering 55%.
CNet Networks’ leasing of 283,400 square feet at 235 2nd St. highlighted the quarter’s leasing activity. Absorption citywide was down for the first time in five quarters. The decrease was due primarily to being vacated more than 400,000 square feet at 555-575 Market St.,the Chevron Buildings,as Chevron completed its move to San Ramon.
New owner Tishman Speyer is quickly leasing the space vacated by Chevron. Internet companies in Multimedia Gulch/SOMA continue to dominate the leasing landscape. Nine of the 10 largest lease deals of the quarter were Internet-related and all nine were in Multimedia Gulch/SOMA. At the same time, most of the scheduled large blocks of space available through 2002 are found in the Multimedia Gulch/SOMA submarket. The $212 million sale of 303 2nd St. to Ellis Partners for a price of $302 per square foot punctuated the investment activity for the second quarter. The investment market is one to watch for the remainder of the year as approximately 25 buildings worth an estimated 2.5 billion are for sale in the downtown market alone.
The biggest issue facing the San Francisco office market as we enter the third quarter is whether or not it has seen the crest of the record-breaking wave. The Federal Reserve raised both federal fund and discount interest rates a half-point during the quarter, the sixth rate increase in the past year. The cumulative effects of the rate hikes are beginning to appear. The tech-heavy Nasdaq market had declined as much as 25% this year and the national unemployment rate increased in May. Most important for the Bay Area economy is the return to earth of the dot-com industry, which has recently seen several layoffs and business failures.
Vacancy rates for the I-680 Corridor in Oakland/East Bay have dropped to a historic new low of 2.55%, down from 3.23% in the first quarter. The largest percentage decrease occurred in downtown Walnut Creek and Dublin where the vacancy rates dipped more than 50% from the previous quarter. Developers are expediting construction of new projects which are being leased prior to completion. Vacancy rates in the I-680 Corridor are headed even lower for the foreseeable future. Tenants are finding a landlord-dominated marketplace.
Construction in the I-680 Corridor is on the march with about 1.8 million square feet of office space under construction. This new construction, when added to the existing 26 million square feet of non-owner-occupied product, will increase the inventory by another 7% and the planned inventory of another 2.4 million square feet will add 8.67%.
Of the office space under construction, approximately 1.46 million square feet is committed to tenants or otherwise off the market. Most of the tenants for these new buildings are not dot-coms, but household names such as Chevron, Hitachi, Cisco, Simpson Manufacturing and Shea Homes. The balance of the space under construction,some 350,000 square feet,in all probability will be committed prior to completion of these buildings.
Rental rates increased 8% to 15% in the second quarter. Pleasanton saw the largest increase in Class A rental rates: from $2.75 to $3.10 per square foot per month. It was followed closely by downtown Walnut Creek. Spurred by continued strong demand, rental rates are projected to continue their spiral upward throughout the year. By year’s end the first $4 rental rates may be seen in downtown Walnut Creek and the Pleasant Hill BART areas. Pleasanton will likely experience $3.50 to $3.65 rental rates in the same period.
Activity in the Tri Valley market is on a rampage with 50,000-, 80,000- and 100,000-square-foot requirements commonplace. At Tri Valley Tech Park alone, 106 acres of the 122.5 acres available are under contract to owner-users and developers or real estate speculators.
The I-680 Corridor is the least expensive market in the Greater Bay Area. The San Francisco and Peninsula office markets average $7 to $9 per square foot per month with 3% to 4% increases per annum. TI allowances are $3 to $7 per square foot, with landlords requiring tenants to pay rent during the construction/renovation period. Palo Alto, Mountain View and San Jose rental rates average $12.00, $8.00 and $5.00 per square foot per month, respectively.
Employment, housing, transportation and relatively inexpensive I-680 corridor office rents all contribute to increased demand in the near term.
During the second quarter, interest and activity in the I-80/I-880 corridor of Alameda County remained strong. From December 1999 through the second quarter, Class A vacancy rates in the central business district decreased from 6.3% to a record low of 2.3%. During the same period, Class A average rental rates increased from $2.75 to $3.71 per square foot. Rents for many Class A buildings are no longer quoted; the highest offer from the best credit tenant sets the market rent. Lease comps do not dictate the current rental rates. Landlords offer their space as-is, or with minimal improvements.
In addition to existing tenants expanding within the I-80/I-880 market, tenant pressure from San Francisco continued in this market as tenants moved from across the Bay. The migrating tenants are seeking to escape astronomical rents or simply seeking available office space. While the ‘dot-commers’ and other tech-related users have driven all market rents to new highs, many traditional users,including architects, engineers, accountants, nonprofits, etc.,have been unable or unwilling to compete for the limited supply of space. As a result, many of these tenants have left.
As expected, the office market in Sacramento is showing signs of stabilization in the wake of five consecutive quarters of heavy speculative construction. By the end of the second quarter, the vacancy rate dropped to 9.45%, a decrease of roughly 1.3% from the first quarter. This is the result of much of the newly completed Class A speculative space in the region being leased up, as completions in the second quarter dropped back to what is now called a “moderate” level: 397,000 square feet.
Construction activity reached nearly 2.7 million square feet by the end of the second quarter. This was an increase of nearly 711,000 square feet from the end of the first quarter. This increase, however, was primarily due to the expansion of Intel’s 5,000-employee research and development facility in Folsom. This expansion, along with the re-announced $1.4 billion expansion of the NEC chip manufacturing facility in Roseville, shows that computer hardware and chip manufacturing sectors are finally coming out of a market lull.
During the quarter, net absorption jumped to 767,626 square feet, the highest quarterly level the market has experienced in several years. This is a strong indicator that demand is still intact and leasing up much of the space that hit the market during the construction surge of the last five quarters. This is also a return to a more healthy demand-supply balance with a limited amount of new space coming available.
The metro Denver office market has outdone itself once again. Shrugging off the notion that the market had reached its peak, strong activity during the first half of the year dropped the vacancy rate nearly 1% from year-end 1999. Fueled by a strong local economy, businesses continued to emerge and expand, resulting in more than 1.6 million square feet being absorbed during the first six months. This continued to cause upward pressure on lease rates as Class A lease rates have increased $1.14 since the fourth quarter of 1999, to $24.84 per square foot annually. In addition, new construction reached a significant milestone as more than 4 million square feet of space is under construction, the highest level since the great boom of the early 1980s.
Unlike the boom of the 1980s, the office market has been able to maintain its stamina over the past decade because of its strong diversity and breadth to the market. While Denver continues to be a hotbed for high-tech tenants, other sectors such as financial services continue to grow at an unprecedented rate. In addition, all classes of buildings are benefiting from the vibrant economy as the overall vacancy rate has decreased across the board, dropping nearly one percentage point in both Class A and Class C buildings and 0.6 point in Class B space during the first half of the year.
Absorption should continue to remain strong throughout the remainder of the year as new buildings continue to be delivered to the market. As a result, 2000 absorption is expected to surpass last year’s record-breaking 2.5 million square feet.
Lease rates continued to tick up during the first half of the year however, lease rates are expected to flatten out towards the end of the year as the market tries to digest several million square feet of new space that will be delivered over the next six months. However, if the economy continues to roll along, look for lease rates to begin to climb once again in early 2001 and for several more projects to make their way off the drawing board.
With an overall vacancy rate of 5.7%, the metro Denver industrial market is on pace for a record year. The year-to-date absorption of 3.25 million square feet is approximately 300,000 square feet short of the total absorption in 1999. The metro-wide weighted average lease rate reached an all-time high, ending the quarter at $6.20 per square foot, triple-net. With the exception of new construction, large, contiguous blocks of space (50,000-plus square feet) are increasingly difficult to find in the Denver market. The timing and delivery of new product reaching the market will be the barometer of future activity in Denver.
Huge demand for new office space was the highlight for Phoenix during the second quarter of 2000. More than 1.2 million square feet were absorbed during the quarter, bringing the midyear total to more than 1.5 million square feet. This is three times the amount recorded for the first half of 1999. During the second quarter, all areas of metro Phoenix experienced positive absorption, and once again North Scottsdale led all submarkets.
This high demand for office space is truly an indication that the market is very healthy and if this trend continues in the second half of 2000, the metro Phoenix area could see more than 3 million square feet of absorption for the year.
Another indicator of a healthy market is new construction. During the first half of 2000, 16 new office buildings became ready for occupancy and on average these projects were nearly 60% leased at the close of the second quarter. This new space, totaling more than 1.7 million square feet, has increased the total office inventory to more than 46.7 million square feet. This impressive growth in inventory will continue as all but three submarkets throughout metro Phoenix had new construction in nearly 30 different office projects at the end of the quarter. In addition to the new construction, approximately 40 projects were in some stage of the planning process.
Despite the large amount of new space brought to market, the Valley’s vacancy ratedipped to 11.2%. This decline is directly related to the previously mentioned demand for office space experienced during the first half of the year. As vacancy rates lowered, the trend of higher rental rates continued throughout the quarter.
When considering all submarkets, the average rental rate rose to $20.75 per square foot. Rates in all classes rose from midyear 1999, with Class A rates pegged at $23.76 per square foot, up from $23.60 a year prior. Once again the Phoenix office market has outperformed expectations and is well on its way to making 2000 another banner year.
The Phoenix industrial market also saw more growth during the second quarter. The popularity of office product in traditional industrial parks has increased, and construction remains strong as newly developed business parks set a new trend. Vacancy rates continue to stay low, even as lease rates and land prices increase slightly, due to high demand of industrial space
In Dallas/Fort Worth during the first half of the year, office space absorption and tenant demand saw strong gains throughout the metroplex as the vacancy rate plunged from 20% to just more than 17%. Dallas/Fort Worth’s current office vacancy has sunk below a level unseen since 1998, good news for a market generally regarded as “overbuilt” by industry analysts across the country.
The year-to-date absorption level for the entire Dallas/Fort Worth office market is approximately 3.7 million square feet, three times that of Houston for the same period. The predominant submarkets continue to be the “Big Three”: far North Dallas, Irving/Las Colinas and Richardson/Plano, with a combined absorption level by midyear of 3.1 million square feet. Area employment growth, a key indicator of tenant demand, surged as approximately 91,000 new jobs were created during the first six months of 2000.
The central business district saw general construction increase recently due to companies requiring broadband fiber installation. Downtown city streets are being demolished, causing a temporary inconvenience, but the long-term advantages of the new fiber lines and the improved street conditions are expected to enhance the appeal of the area.
Interestingly, there is speculation that one street running through downtown, Commerce Street, will see a name change to “eCommerce Street” primarily as a result of the concentration of technology and Internet companies located in the eclectic surroundings of nearby Deep Ellum.
Second-quarter absorption left the San Antonio market feeling giddy, as midyear absorption eclipsed total absorption for 1999. With the market expected to register its best performance since 1997, real estate professionals are cautioning themselves against displays of “irrational exuberance.”
This quarter, there was good news on almost every front. Citywide vacancy declined nearly a full percentage point, and most of the major submarkets experienced increased occupancy rates. Class A vacancy dropped more than two points, and Class B vacancy inched downward, as well.
Absorption was strong in nearly every submarket and product type, with Class A absorption topping 260,000 square feet for the year to date. At the same time last year, Class A absorption was a negative 54,049, and citywide absorption was 80,000 square feet. With such drastic improvement, many believe that the “bump in the road” San Antonio’s market experienced in 1999 is now a distant sight in the rear-view mirror.
Yet the question on everyone’s lips is: Can it last? As vacancy rose in 1999, large tenants had choices in their search for space. With the dramatic absorption so far in 2000, large blocks of contiguous space are quickly disappearing. In the Class A market, for example, there are only five properties that can accommodate a 20,000-square-foot tenant. While there are still large spaces available in the Class B and Class C markets, average deal size may shrink in the second half of 2000. This could slow absorption somewhat, but won’t derail the momentum in the market. Watch for developers to dust off plans for new construction as space tightens up throughout the year.
San Antonio’s industrial market took off in the second quarter, registering a staggering 565,000 square feet of net absorption and more than 700,000 square feet of total net absorption for the year. Considering that average annual net absorption hovers around 450,000 square feet, the market is experiencing a banner year. High-end R & D;/flex product is fueling much of this demand, and with several new projects under construction, expect absorption in this product type to continue in the second half of 2000.
