2006 Commercial Real Estate Report

Transcription

1 2006 Commercial Real Estate Report Des Moines Waterloo Cedar Falls Cedar Rapids Iowa City Coralville Values Trends Opportunities Cedar Rapids Marion Hiawatha Statewide cropped area

2 NAI Iowa Realty Commercial is pleased to present our Eighth Annual Commercial Real Estate Report. The report summarizes results from ongoing surveys of the office, warehouse, retail and investment submarkets. We gather facts and figures on over 1,300 properties which collectively represent over 40 million square feet. We then apply our own analysis to the results of the research so that we may accurately examine the area s activity and better predict its future performance. Making the right facilities or investment decision depends on a number of variables. We believe that a comprehensive analysis is an important element in advising our clients so that they make the wisest and most profitable choices. A special thank you is extended to all who respond to our requests for information each year and for the efforts of our summer intern, Craig Byers, a commercial real estate and construction management major at the University of Denver. Scott G. Byers, CCIM, SIOR President NAI Iowa Realty Commercial cropped area (back of cover) The information contained in this report is believed to be reliable, but not guaranteed. Reproduction of this publication, in whole or in part, is prohibited without permission of NAI Iowa Realty Commercial.

3 Investment Investment Recap In 005 investment real estate benefited from improving market fundamentals and continuing infatuation with brick and mortar. Huge amounts of money continued to seek income producing real estate as a preferred component of an investment portfolio, in part due to continued disappointment over stock market returns. Lenders and investors continued to pour money into property investments. Liberal bank underwriting high loan to values, low debt service coverage, extended fixed rates and little or no reserves permitted buyers to leverage their investments and minimize their risk. The collective outcome of this hyperactivity was some significant appreciation in values. Owners that availed themselves of this pricing surge and chose to sell were able to rack up significant gains. These gains are included in the various statistical analyses of real estate performance, which further moves the dial favorably in comparison with other investment alternatives. The NCREIF Property Index benchmarks the investment performance of properties owned by institutional investors, such as pension funds. It reported an annualized return of 18.7% for all property categories, though the Midwest was less robust at 13.41%. The national returns were consistent throughout the apartment (19.68%), industrial (18.98%), retail (18.66%) and office (18.0%) sections. Locally, the best indicator of investment performance is the trend line in cap rates paid by Buyers. The lower the cap rate (basically the unleveraged rate of return a buyer will earn on their purchase) that Buyers are willing to accept, the higher the price a Seller can command. Since the capital gains profits made by Sellers so dramatically impacts investment performance, a cap rate analysis is revealing. Cap Rate Examples Shadowood Apartments Retail: Lindale Crossing (retail project anchored by Bed, Bath & Beyond) sold for a cap rate of 11 in 003, resells at a 8.5 cap in 006, a change that translated into a $,600,000 resale profit. Office: Two single tenant (Rockwell Collins) properties, one on Council Street and one on North River Boulevard, sell for sub 8 caps. Industrial: Newly constructed Amana Maytag distribution facility in North Liberty is already flipped by developer, First Industrial Trust, at a 7 cap, one year after being developed at an 8 cap. Multi-Family: Woodcrest Apartments on Blairs Ferry Road sell at a 7.5 cap CAP RATE RANKS Low 2005 High 2005 Avg. Rank Property Type (%) (%) (%) 1 Suburban Multi Family Urban Multi Family Regional Mall Community Mall Neighborhood Strip CBD Office Office/Warehouse Suburban Office Bulk R&D Manufacturing CBD Lodging Airport Lodging Suburban Lodging Values Trends Opportunities Cedar Rapids Marion Hiawatha Statewide Source: Integra Realty Resources, Inc. 1

4 Investment Forecast Hold: High income apartments, leased up CBD office 2006 will remain a sellers market, and yet investors continue to hang on to their core properties (locked in credit tenants with good income streams). Consequently, particularly in the relatively restricted Eastern Iowa markets, buyers will struggle to find acquisitions that make sense. The following sections of this report provide a more detailed analysis of each submarket s investment potential, but as a snapshot, we offer the following: Buy: Industrial, land, apartments with condominium conversion potential The vacancy continues to evaporate in the industrial sector, giving Landlords a reliable income stream and pricing power. Land prices continue to escalate, particularly along I-380. Residential development ground has steadily appreciated as well, though a cooling off of the housing cycle may temper future price increases. Higher home prices, rising mortgage rates, satisfactory job growth and higher single-family construction costs all bode well for apartments, particularly those that can eventually be converted to condos. Sell: Well-tenanted retail, moderate income apartments, leased up B & C suburban office buildings Retail appreciation will be hard to come by at current stratospheric pricing levels. Additionally, the discount super centers will continue to erode the underpinnings of smaller retailers. Lastly, we may be approaching a saturation in retail supply, particularly of strip centers. Apartments that are aging or susceptible to the continued allure of affordable first time buyer syndrome won t be worth the headaches. Smaller B & C office buildings (10,000 square feet or less) in the suburbs continue to suffer from slow demand, alternative workplace strategies and lack of building amenities. Seek an owner-occupant buyer. High income apartments that have weathered the tenant exodus into home ownership remain intriguing, both from potential rent AMONG RESPONDENTS WHO SEE A PRICING BUBBLE IN COMMERCIAL REAL ESTATE, A LARGE MAJORITY SAY THE BUBBLE IS MOST PRONOUNCED IN THE APARTMENT SECTOR. Apartment Retail - grocery/drug anchored center Retail - mall Retail - lifestyle/power center Office - downtown Office - suburban Undeveloped land Retail - urban/main street Industrial Hotel Mixed-use Other 6% 15% 13% 23% 20% 18% 17% 26% 26% 30% 29% 63% 0% 20% 40% 60% 80% increases and condo conversion perspectives. Leased up CBD office buildings presumably will benefit from the next leasing cycle at higher rates, though owners run the risk of fickle tenant demand for downtown space. Overall, modest property cash flow improvements can be expected in most property sectors. Quoting from the 2006 Emerging Trends in Real Estate report issued by the Urban Land Institute and Price Waterhouse Coopers, The consensus forecast suggests that real estate can maintain a relative edge over stocks and bonds. Expect capital to begin backing off during the second half of 2006 as a touch of buyer fatigue finally sets in over interest rate advances, possible cap rate erosion and even heightened development. What do the Financial Markets Tell Us? Total return percent MARKET INDICIES AS OF 1-YEAR 3-YEAR 5-YEAR 10-YEAR 3Q 05 Consumer price index 3.21% 3.42% 2.76% 2.49% 2.52% 10-year Treasury bond* 4.19% 4.20% 4.15% 4.46% 5.20% Dow Jones industrial average -0.34% 7.23% 14.19% 1.91% 10.33% Nasdaq composite -1.09% 13.44% 22.45% % 7.50% NYSE composite 5.28% 16.17% 17.46% 1.72% 8.71% S&P % 12.25% 16.71% -1.49% 9.48% NCREIF index 13.93% 19.25% 13.19% 11.06% 11.68% NAREIT index 6.94% 22.63% 24.90% 19.43% 14.24% investment *Based on average end-of-month T-bond rates Sources: Morningstar, NCREIF, NAREIT

5 CBD Office Recap The most recent chapter in the CBD takes a few pages out of an old playbook. Consider this quote from Jane Jacobs 1961 book The Death and Life of Great American Cities; Cities need old buildings so badly it is probably impossible for vigorous streets and districts to grow without them for really new ideas of any kind no matter how ultimately profitable or otherwise successful some of them might prove to be there is no leeway for such chancy trial, error and experimentation in the high-overhead economy of new construction. Old ideas can sometimes use new buildings. New ideas must use old buildings. The most visible manifestation of this approach is the retail incubator on nd Avenue, although adaptive reuse of existing structures was found throughout the downtown district. OPN s dramatic overhaul of the five year vacant Hutchinson building and the architectural firm s announced relocation from the Great America Building is an eye-opener. Similarly, architectcum-entrepreneur-cum-landlord Steve Emerson is completely gutting the historic Paramount Building to convert it into the retro-themed office location of choice. Midway through the project, the building has pre-lease commitments for 50% of the 44,000 square feet total available space. Emboldened by this success, Emerson has placed the 30,000 square foot Palmer Building on the corner of nd Avenue and 5th Street SE, formerly occupied by MCI, under contract. Residential developers are part of the bandwagon as construction has begun in earnest on the much publicized 46 unit Water Tower Place condominiums. Drawing on that project s apparent success, the Smulekoff interests announced plans to convert its four-story downtown warehouse into eighteen sizable loft condominiums. The result of this renovation activity is reflected in improved occupancy percentages, despite the dearth of any new large footprint tenants. Though vacancies still remain uncomfortably high in downtown Cedar Rapids not unlike most CBD s across the country the incremental improvement is a reflection of start up businesses and entrepreneurs availing themselves of the favorable rents available, particularly in the Class B and Class C office buildings. Vacancies dropped below 0%, ending the year at 18%. Class A office space was 90% occupied, though that represented some slippage over the previous year. Class A rents also regressed albeit modestly, from $11.40 to $11.5. Class B space rents averaged $9.80, although vacancy in class B still topped 0%. Class C space again registered little change at $7.3 per square foot, although occupancy improved to 8% Definitions Average Rents - CBD $11.25 $9.80 $7.32 Class A Class B Class C Class A Space: Prominent buildings with excellent location, high-quality tenants and high-quality finish, which are wellmaintained and professionally managed. Class A buildings are usually new, but can be older buildings that are competitive with new buildings. Alliant Tower, Great America, MCI Tower, Town Centre. Class B Space: Buildings having good location, professional management and fairly high-quality construction and tenancy. Class B buildings may show slight functional or economic obsolescence. APAC, Armstrong Centre, True North, US Bank, etc. Class C Space: Older buildings having functional or economic obsolescence and/or more transient tenancies. Many Class C buildings have had upgrades to finishes and are distinguished from Class B primarily by age and layout. Dows Building, Iowa Building, Guaranty Bank, etc. Triple Net (NNN) Lease: One in which the tenant assumes all operating expenses of the lease premises, except roof and structural repairs. Operating Expenses: Outlays pertaining to real estate operation, exclusive of tenant s on-going business costs. Includes items such as real estate taxes, insurance maintenance and repair, utilities and janitorial services. Office 3

6 Retail 13% Industrial 4% CBD Concentration of Space (Other* - recreational, church, museum, etc.) Warehouse 7% Other* 4% Office 72% Office Retail Industrial Warehouse Other Significant Events CBD Alliant Tower sells for $8,000,000 - $106 per square foot Despite construction delay until 009, MidAmerican Energy building is razed to make way for Federal Courthouse River Place apartments begin conversion to condos Grant Wood exhibition a colossal success Great Furniture Mart positioned for re-development Diversity Focus Group to headquarter downtown MCI/Verizon merger completed with no adverse ramification New and expanded medical buildings dot 8th Avenue Restaurants, bars and coffee shops continue to sprout Holmes Murphy occupies 9,00 SF in CRBT building. CBD Forecast 006 is an important, possibly even a watershed year for the CBD. By 007, downtown property owners will decide whether to continue to self impose a twenty year old tax (which is in addition to regular city and county taxes; and is known as SSMID) on their properties to help fund improvements to the district. The property owners will be closely monitoring the support, both financial and otherwise, that they can expect from the new city council. If the council places importance on the viability of the downtown and budgets accordingly, the owners will follow suit and continue the tax. Lack of council support will likely doom the program. 006 also will witness the staying power of the many new bar and restaurant venues in the CBD. The cliché about success breeding success is particularly apt in the food and entertainment business. Look for office vacancies continuing to decline as the relative cost of retrofitted space continues to be significantly less than new construction in the suburbs. With increased absorption there typically follows an increase in rental rates, but that will not be the case in the CBD for 006; rates will remain flat. However, if momentum can continue in a positive direction, rates will eventually follow. 8th Avenue Medical Building Suburban Office Recap Real estate analysis and forecasting is to an extent, a debatable and subjective exercise. Nevertheless, there can be no debate that the suburban office market has witnessed the most significant positive accomplishment of the various submarkets that are the subject of this report. Using baseball parlance, if the growth within the CBD was the result of some bunts and scratch singles, the suburban office market was blasting triples and home runs. Rockwell Collins was Ruthian in its impact, having barely unpacked the boxes in its new 100,000 square foot facility on Cimmie Avenue NE before announcing another 100,000 SF building to be built by the Ryan Companies on Rockwell s main campus. Extending the baseball analogy probably one sentence too many was the grand slam home run that nobody saw. When McLeod USA and Aegon announced their building swap, the suburban office market was rewarded with two major victories: 1) the 317,000 square foot former McLeod headquarters did not go dark and flood the market with excess space. Quite the contrary. Aegon officials now indicate that virtually the entire structure is slated to house their employees leaving little if any vacant space and ) McLeod USA remains a major tenant with nearly 100,000 square feet in their new Boyson Road headquarters; the former home of Parsons Technology. office 4

7 The other major story of the suburban office market emanated from North Liberty and Coralville. The corridor concept has been embraced by the real estate community for the last three years or more, and North Liberty in particular has become a very active suburban submarket. Companies like Compleware, Revenue Cycle Partners and National Genecular Institute, as well as Mercy Rockwell Cimmie Avenue Rockwell Intertrade Medical Center, Liberty and Corridor State Banks have or will account for over 40,000 square feet of positive net absorption. Heartland Express s announced move will further boost these numbers. Occupancy levels ended the year at 86%; ie. a 14% vacancy factor. The NE quadrant, composing over 70% of the available supply of space, currently has a vacancy level of 1.6%, which is healthier than its sister quadrants and the nation. Weighted average rents enter 006 at $10.5 per square foot, a rather sobering 5% below national average. Suburban Office Forecast Although the office market is healthier than it has been in a long time, the sector still faces headwinds. It still remains more of a tenant market, despite shrinking vacancies. Development activity bears watching as it has been basically dormant for the last five years. The office condominium phenomenon that has captured developers fancy in other Midwest markets will remain less of a factor in Eastern Iowa. Speculative building, if any, will amount to less than 30,000 square feet, centered NE and in Hiawatha. Significant Events Suburban Office Hall and Hall moves from NE Cedar Rapids to new,000 square foot offices in Hiawatha Former CMF&Z building goes from 90% vacant to 90% full McLeod headquarters sells to Aegon for $85.00 per square foot Positive net absorption tops 150,000 square feet, largely due to Rockwell Collins continued growth. Suburban Office Space Concentration 5% 21% 73% 1% SE SW NW NE 5 office

8 Retail Recap Retail once again defied predictions that it had reached the end of its reign as the most active commercial sector. Retail properties continued to enjoy substantial gains in property valuations during the last three years, with one-year appreciation returns for NCREIF s index of retail properties reaching 6.38 percent, 1.54 percent and percent in the third-quarters of 003, 004 and 005 respectively. At the same time, cap rates $8.50 range, whereas the CBD and Marion submarkets came in at $7.50 per square foot. The submarket with the highest retail vacancy was easily the CBD at 19%; no other quadrant registered in double digits. The number of sale transactions for retail properties slowed to a virtual standstill, due at least in part to local buyer reluctance to pay sub 7% cap rate prices. One sale of note was Lindale Crossing. The seller, a Chicago investor who purchased the property approximately three years earlier for $6,00,000, resold for $8,800,000; over $00 per square foot! If the number of properties being sold took a year off, the number of properties being built most certainly did not. The big boys continued to flex their muscles, with Wal-Mart and Hy-Vee recently opening new stores that totaled over 50,000 square feet. Both companies have on-going projects in the pipeline, Edgewood Hy-Vee Marion Super Wal-Mart Gordmans have fallen from 8.3 percent to 6.6 percent. Translation the same property with a net operating income of $100,000 that sold for $1,00,000 in 003, will now sell for over $1,500,000. The strength in valuation is, of course, directly related to continued high occupancies. Nationally the retail vacancy rate rested at just 7% entering 006, whereas locally the vacancies were quite comparable at 7.5%, net of Westdale Mall. And even Westdale enjoyed a significant increase in occupancy, thanks to the addition of the 10,000 square foot Steve & Barry s. Quadrant NE NW SE Retail Average Rents Comparison $6.05 $6.54 $9.02 $8.46 $8.50 $11.32 $10.64 $11.38 $12.37 $10.49 $10.10 $ The NE quadrant continued to benefit from 95%+ occupancy, as well as substantially higher rents than any other quadrant with an average of $11.3 per square foot. The SE and SW quadrants reported rents in the SW $8.50 $8.41 $8.66 $10.24 $0.00 $5.00 $10.00 $15.00 retail 6

9 Wal-Mart in Anamosa and Hy-Vee on Wilson Avenue, as well as new Hy-Vee Drugstores. Lowes continues to move forward, as does the 00,000 square foot lifestyle/power center known as Marketplace on First, across from Lindale Mall. Additionally, there are a half-dozen new higher end strip centers currently under construction, adding another 100,000 square feet of store space to the mix. Boyson Road (from C Avenue to Hiawatha) is the primary gateway to three of the projects, while Edgewood Road both north of the Cedar River and south of it is the address of four more. The developers engaged in these projects are familiar names: Hunter Companies, Ambrose, Byers, Drown, Ahmann, Pfeiler, Butschi and others. Retail Forecast The retail real estate investor reads and sees it everywhere prices portend in-migration from rural areas. As such, resilient consumer demand should help bolster the sector. However, rent rates in Linn County have remained static for nearly three years, a result of the continuing new supply of store space. Don t expect 006 to change that dynamic. The new strip retail centers will command rents in the $14.00 triple net range. Big boxes such as Gordmans and Dick s Sporting Goods will sport rents in the $11.00 range. Meanwhile, secondary locations and/or older properties will have to compete on a price basis, anywhere from $6.00 to $9.00 per square foot. New development will be notably more restrained in the ensuing 1 months, although Johnson County will continue Retail Sell now. How much higher can prices get? Price Waterhouse Coopers We expect a first-quarter slowdown in retail John Bucksbaum, CEO of General Growth Do not expect the level of realized returns seen in the past several years CCIM Institute Any number of factors, including fuel prices, could diminish consumer demand over the next few years, and subsequently shape the strength of the retail sector National Real Estate Investor/Marcus & Millichap Certainly the drumbeat of the national trade publications suggests that retail investors should consider heading to the sidelines. However, the local view isn t so clear cut. Job formation continues to strengthen, and even higher fuel To what extent do you feel the following issues will impact the retail investment market? Overdevelopment 1031 tax code change Demographic changes in population Residential housing bubble Increase in stock market valuation Personal/corporate tax code change TIC rules Changes in political party control New Federal Reserve chairman None of the above/no answer 19% 17% 22% 31% 36% 34% 40% 38% 44% Do you believe cap rates for retail properties will increase or decrease over the next 24 months? Decrease 17% No answer 8% 50% 0% 20% 40% 60% No Change 14% Increase 61% Source: Reza Investment Group on a blistering pace for awhile. The modest new construction activity that does occur in Linn County will be in familiar locales, although Furniture Row is rumored to be planning a relocation next to the Highway 100 Menards. Westdale Mall will continue to muddle along, and new restaurants will continue to tempt we Iowans (not wee Iowans). 7 Source: Reza Investment Group

10 Industrial Industrial Recap The industrial sector delivered above average performance throughout Eastern Iowa all along the I-380 corridor from Cedar Falls south through Iowa City. Buoyed by the continued strength in the food sector think Quaker Oats and General Mills coupled with Proctor and Gamble s remarkable run, and you begin to fill up the space that remains available. According to some estimates, Proctor and Gamble and Quaker Oats combine to occupy over 3,000,000 square feet of warehouse space in Linn and Johnson counties. Since some of that space had been built speculatively or had gone vacant from previous tenant moves, the choices remaining for smaller tenants are reduced. Less vacancy translates into higher rents and smiling landlords. Warehouse rents in the NE quadrant surpassed the $4.00 per square foot mark for the first time in three years, averaging $4.8. Vacancy rates dropped to below 5%, both NE and SW. Warehouse rents SW stayed at $3.77, exactly the same as the previous year. Industrial Forecast Industrial/warehouse real estate should enjoy a very solid year, $60,000,000 $50,000,000 NE SW Cedar Rapids New Construction Starts Industrial & Warehouse Rent Comparison NE & SW Quadrants $3.60 $3.77 $4.78 $4.28 $0.00 $1.00 $2.00 $3.00 $4.00 $5.00 $ marked by continued strong absorption, occupancy rates in the 95% range and positive rental growth of 3% to 5%. In the second half of 005, there was positive net absorption nationally of well over 100 million square feet, the strongest performance in the last 10 years. National occupancy rose 50 basis points, a very significant improvement. Companies nationally, regionally and locally are expanding facilities, building new ones or staying in existing space longer. Industrial Warehouse Interest in industrial land on the south side of Cedar Rapids is stronger than it s been in years. This revved up demand will be difficult to satisfy in the immediate term. There is virtually no industrially zoned ground that is shovel-ready along I-380 in Linn County. Furthermore, infrastructure deficiencies could further limit growth, specifically the utility services and roadbeds on the two major East-West arterials south of Highway 30; those being 60th and 76th Avenues. The city will also need to address an increase in the sewer capacity south of ADM. The northern tier of NE Cedar Rapids and Hiawatha is in a similar situation. Less than twenty-five acres is zoned and ready for construction. Given the recent attention that I-380 has received from national developers and logistics/distribution companies, lack of available land may retard some otherwise achievable economic activity. On the investment side, prices will remain high, a function of the improving fundamentals. $40,000,000 $30,000,000 $20,000,000 $10,000,000 $ $14,785,283 $15,685,000 $16,751, $54,653,299 Significant Events Industrial Clipper Windpower blows into town, occupying former Goss plant Amana Maytag facility sold to institutional buyer less than one year after completion Engineered Seal Products expanding Alternative fuels momentum bodes well for local growth for stainless steel manufacturers and ADM 8

11 Multi-Family Recap The national fixation and spotlight on the baby-boomers has missed a very salient point the Echo Boom generation (ie. children of boomers) is moving into marriage and homeformation, and in record numbers. When this phenomenon is coupled with higher interest rates and restrained development activity, it creates an improvement in multi-family market fundamentals. To point out the obvious, younger members of the work force will likely rent vs. buy, at least for the near term. Chapel Ridge Apartments Average rental rates for apartments rebounded favorably in 005, registering an across the board increase of %. Improving cash flow was also a function of lower vacancies which had crept up to 13% in early 005, but has since receded to slightly above 11%. Though still higher than many comparable U.S. markets, and nearly double the vacancy numbers at the Johnson County end of the corridor, occupancy numbers are trending in the right direction. Sales activity was extremely active, with a number of large projects exchanging ownership. The 154-unit Woodcrest complex, for example, sold for $6,000,000, roughly $38,900 per unit for a project with a preponderance of two bedroom units. Shadowood, an 84-unit complex on Edgewood Road also featuring mostly two bedroom units, sold for slightly over $37,000 per unit. These and other sales translated into cap rates between 8.5% and 9%, compared to the average cap rate of 9.9% reported last year. Multi-Family Forecast Overall price appreciation is likely to continue this year, although an upward change in interest rates creates an unusual conundrum. Higher home mortgage rates generally benefit apartment owners, yet increased capital costs puts downward pressure on appreciation. However, revenue growth is expected to counteract the effects of higher debt service, and therefore prices will continue a slow, albeit unspectacular climb. Development activity will remain modest. It is noteworthy that less than 100,000 units were built nationally in 005, with less than 100,000 again projected for 006. The dominant theme will continue to be strong buyer demand and reasonably flat yields. Private vs. institutional buyers still accounts for the vast majority of purchase activity in Eastern Iowa, including the aforementioned baby boomers who are seeking relatively safe income-producing investments prior to retirement. The uptick in prices is also encouraging the flow of 1031-exchange capital, as some owners are cashing out built-up equity on other investments and leveraging these dollars into apartment properties. Overall, the apartment market, after weathering historically low interest rates and the subsequent single-family home boom, is in the midst of a recovery Multi-Family Average Rental Rates Comparison bedroom 2-bedroom 3-bedroom Multi-Family 9

12 Individual Memberships 116 Third Street SE Cedar Rapids, Iowa fax 220 Ridgeway Ave., Suite 100 Waterloo, Iowa fax Second Street, Suite 201 Coralville, Iowa fax