OFFICE MARKET ANALYSIS: DAVID WEST RMLS Fellow Certificate of Real Estate Development Student Masters of Urban and Regional Planning Candidate While the Portland office market continues the slow recovery begun in mid-2010, most major indicators point to a somewhat slower pace of growth in the first quarter. Local indices show steady vacancy and modest absorption numbers, with suburban markets outperforming CBD despite continued high demand for Class A space, most prevalent in the CBD. Nationally, REIS reported the first drop in office vacancy across classes in over three years and the second consecutive quarter of positive net absorption. With metropolitan unemployment nudging down to 9.6 percent from the previous quarter and down 1.3 percentage points since last year, the job recovery has held steady, but progressed slower than many forecasts. Positive signs continue at the national level including strong consumer spending and consumer confidence, but several major risk factors are in place for the coming quarters. Most notably, political unrest in Northern Africa and the Middle East have led to considerable uncertainty in the oil markets, with per barrel crude prices jumping from the $70 to $90 range per barrel in the first quarter with spikes over $100 since. While rising fuel prices are a sign of a growing economy, the recovery could suffer if gasoline prices for consumers continue their rise over $4/gallon. Despite these concerns, strong corporate profits through the first quarter have sustained growth in private sector demand for office space. Employment growth was relatively well distributed across sectors, with business services and manufacturing standing out at annualized first quarter growth rates above 3 percent. Center for Real Estate Quarterly Journal, vol. 5, no. 2. Spring 2011 60
OFFICE MARKET ANALYSIS WEST 61 Square Feet (in thousands) 1,600 1,200 800 400 0-400 - 800 Figure 1: Overall Net Absorption (SqFt) and Vacancy (%) for Portland Office Market - 581 16.6% 744 1,396 1,105 887 869 795 11.7% - 778 15.5% 453 Net Absorp+on Vacancy Rate 14. 20% 16% 0% Vacancy (%) 2002 2003 2004 2005 2006 Source: Grubb & Ellis, Office Quarterly Reports 2008 2009 Q1 10 Q2 10 Q3 10 Q4 10 Q1 2011 Counteracting the moderate growth in private jobs, however, were widespread legislative initiatives to reduce budgets and staffing at all levels of government. As government employment retracts, concerns of softening public sector demand grow in many regional markets. Thus far, this trend has played out most dramatically in government-dependent markets like Washington DC, 1 but as tight budgets persist in future years, nationally as well as in Oregon, it may be an key component to consider in office market projections. METRO PORTLAND TRENDS Grubb & Ellis reports a slight drop in market-wide vacancy to 14.4 percent in the first quarter, led by a drop in Central Business District (CBD) Class A vacancy to 6.3 percent, exceeding forecasted rates of just below 7 percent. Grubb & Ellis continue to call the Portland downtown a national standout which will be competitive for the foreseeable future due in part to a lack of sizable projects under construction. Strong demand for downtown Class A space continues to drive these low vacancy averages. At 6.3 percent CBD Class A vacancy to 14.4 percent class and market-wide, the gap between these two numbers (8.1 percent) is, by far, the greatest seen in 10 years, and continues to widen each quarter. (See Figure 4). 1 Troianovski, Anton. Government Cuts Clip Office Market Wall Street Journal, March 23, 2011.
OFFICE MARKET ANALYSIS WEST 62 Construc=on Employment (in thousands) 70 60 50 40 Figure 2: Unemployment & Construction Employment 11.3% 10.2% 9.6% Construc+on Employment Total Unemployment 42 10% 6% 2% 0% Q1 08 Q2 08 Q3 08 Q4 08 Q1 09 Q2 09 Source: Oregon Employment Department Q3 09 Q4 09 Q1 10 Q2 10 Q3 10 Q4 10 Q1 11 Permit Value (in millions of $) $300 $250 $200 $150 $100 $50 $0 $208 Figure 3: Portland Construction Permits & Metro Unemployment $96 $180 $51 11.3% $44 $68 Total Permits ($) New ConstrucCon Permits ($) Total Unemployment $45 $75 9.6% $50 16% 1 10% 6% 2% 0% Q3 08 Q4 08 Q1 09 Q2 09 Q3 09 Q4 09 Q1 10 Q2 10 Q3 10 Q4 10 Source: Portland Development Services and Oregon Employment Department Q1 11
OFFICE MARKET ANALYSIS WEST 63 Cushman & Wakefield also reports tightening market-wide vacancies in the fourth quarter while Norris, Beggs & Simpson report a 50 basis point market-wide vacancy rise with CBD Class A vacancies remaining stable at 8.5 percent. Cross brokerage vacancy numbers for the first quarter varied significantly in magnitude, but showed relatively consistent direction with suburban vacancy dropping a median value of 130 basis points across reports. Notably, Grubb & Ellis reports a rise in suburban Class A vacancy of 20 basis points to 23.1 percent, despite a 60 basis point drop across all suburban classes. While improvements in the employment picture have led to some positive shifts in the office market, a total lack of newly constructed office product has led to some strange trends across submarkets. In line with no newly completed construction in the first quarter (Figure 7) and very little in 2010, construction employment remains at historically low levels in the metropolitan area, as indicated in Figure 2. City of Portland new construction permits in Figure 3 remain steady with a small dropoff from the previous quarter, with continued low levels of investment in new development ($50 million) which remains at a fraction of the levels seen in 2008. While not specifically an office property, nearly $17 million of this total is represented by a more than 400,000 square foot Subaru facility to be constructed at 14510 N Lombard St on land leased from the Port of Portland, which will include significant office space along with warehouse space and a distribution facility. 1 16% 1 10% 6% 2% 16.6% 14.5% Figure 4: Office Vacancy (%) Metropolitan All Classes & CBD Class A 11.5% 5.1% 14.6% 14. 7.1% 6.3% Metro All Classes Downtown Class A 2002 2003 2004 2005 2006 2008 Q1 09 Source: Grubb & Ellis, Office Quarterly Reports Q2 09 Q3 09 Q4 09 Q1 10 Q2 10 Q3 10 Q4 10 Q1 11
OFFICE MARKET ANALYSIS WEST 64
OFFICE MARKET ANALYSIS WEST 65 Suburban submarkets showed absorption numbers not seen since before the recession at 244,842 square feet with net absorption for the CBD barely breaking even at 399 square feet according to Grubb & Ellis. Norris, Beggs & Simpsons numbers lined up with this as suburban markets posting only the third quarter of positive absorption since. Rankings of vacancy by submarket from Grubb and Ellis numbers (Table 3) show few dramatic shifts from the fourth quarter. Tualatin/Wilsonville replaces the small Camas market at the top of the list with a 32.6 percent vacancy, up 60 basis points from the fourth quarter. Next is Sunset Corridor at 24.5 percent and Columbia Corridor at 23.9 percent. Vancouver Mall currently carries the lowest suburban vacancy rate at 8.6 percent followed by Northwest at 9.5 percent and St. John s/vancouver at 10.3 percent. Hazel Dell saw a large rise in vacancy from 7.7 percent to 11.0 percent.
OFFICE MARKET ANALYSIS WEST 66 One likely explanation for the improvement in suburban markets is the high demand for Class A and Class A+ space while the supply of such properties in the CBD has been dwindled, forcing tenants which might otherwise have located in a downtown location to consider a peripheral location. Grubb & Ellis forecasts this trend to continue through 2011, particularly if CBD Class A vacancies approach the 5 percent mark. At this point, very little new supply is imminent. As of April, only one Class A+ vacancy above 30,000 feet exists in the CBD, with little guaranteed new supply in the construction pipeline. Financing remains tight for developers and while many projects are currently being pitched to fill this niche, few have been able to move forward. Park Avenue West serves as the most visible example of constrained lending. It is still sitting vacant nearly two years from the day that work was halted due to its construction loan falling through. Despite the apparent demand for Class A space, Grub & Ellis reported drops in Class A asking rents in both the CBD and suburban market, continuing a multi-year trend. However, brokerage data was split as Cushman Wakefield reported healthy increases in Class A asking rents for both CBD and suburbs, both in the +$.50 range. This split represents the first compelling signs of a stabilization in rents since the recession. Square Feet ( in thousands) 550 450 350 250 150 50-50 - 150 Figure 5: Class A Net Absorption (SqFt) & Vacancy (%) for the Central Business District 14.5% 171 11.0% 267 217 516 205 Class A Net Absorp+on Vacancy Rate 9.2% (124) 174 6.3% 85 16% 0% 2002 2003 2004 2005 2006 Source: Grubb & Ellis, Office Quarterly Reports 2009 Q1 2010 Q2 2010 Q3 2010 Q4 2010 Q1 2011
OFFICE MARKET ANALYSIS WEST 67 SqFt Available (in millions) 8 6 4 2 0 Figure 6: Vacant and Occupied SqFt, by Submarket Vacant SqFt Occupied SqFt Source: Grubb & Ellis, Q1 2011 Office Quarterly Report SqFt Completed (in thousands) 2,000 1,500 1,000 500 0 Figure 7: Office Construction Completed by Year for All Classes 2,072 1,415 1,404 1,417 674 501 324 613 822 868 805 529 0 1999 2000 2001 2002 2003 2004 2005 2006 Source: Grubb & Ellis, Office Quarterly Reports 2008 2009 2010 Q1 2011
OFFICE MARKET ANALYSIS WEST 68 Notable lease transactions (see Table 4) include only one new lease greater than 100,000 square feet, as Hewlett Packard moves into a 164,000 square foot space in the Columbia Tech Center. The Wells Fargo consolidation and relocation to the top floors of the KOIN Center represents 25,000 square feet within the CBD.. CONCLUSION While indicators continue to paint a mixed picture moving forward, the first quarter of 2011 presents some encouraging signs of a recovery that continues, albeit tentatively. In particular, big net absorption numbers and drops in vacancy for suburban markets suggest that constraints on new supply across submarkets have had metro-wide effects. While asking rent data is inconsistent across brokerages, mixed results show the first hints of a halt to the steady decreases in rent of the past two years. Along with the sustained strong performance for the Class A market, these indicators will be important to watch in order to gauge demand in a market that appears to be led by tenants who desire high quality space in the Central City. Moving forward, there may be opportunities in place for developers who are able secure credit.