COVER STORY, DECEMBER 2009
2010 BROKER OUTLOOK
What will be the leading property types, the key measures and the most active players in each market?
compiled by Brian A. Lee
From the Mile High City to Maui and Seattle to San Diego, Western Real Estate Business has teamed up with its broker friends to give you a comprehensive outlook on the coming new year in commercial real estate.
Demand is low in all of San Diego’s commercial real estate markets. Leasing values continue to decline 20 to 30 percent across the board, and concessions are abundant.
Despite negative absorption in the retail and industrial markets, San Diego’s office market has absorbed space in the second and third quarters of 2009. This recent rise in gross absorption is largely due to the recent occupancy by a few larger office tenants, with the most notable being Bridgepoint Education.
The industrial market has experienced 5 consecutive quarters of negative absorption, with large spaces and secondary markets hit the worst. Rental rates have come down by more than 15 percent across the market, with some areas seeing higher reductions. Due to serious overbuilding, North County has the highest vacancies of all submarkets in all product types.
The retail sector is stagnant with huge losses in absorption in the big box sector and no prospects for filling the vacant inventory. Retail rental rates have dropped by 20 to 25 percent.
San Diego’s diverse economy has a high concentration of life science, technology, alternative energy, education and defense companies, giving it a positive outlook for the future. With eligibility for government grants from the stimulus package, many of these companies may begin hiring more employees, allowing these businesses to expand and eventually absorb more space.
Anticipate seeing tenant demand return to more healthy levels by the second or third quarter of 2010. However, the looming commercial CMBS debt maturities may keep the regional and national markets down and extrapolate the recovery by months, quarters and potentially years. It will take substantial job growth in this dynamic area to turn the tide on the real estate value deterioration. However, San Diego is in a good position to recover first.
— Brian Mulvaney is a senior vice president at Voit Real Estate Services.
Unquestionably, Phoenix market fundamentals, including job growth, remain under significant pressure as the local and national economies limp toward recovery. However, an up-tick in user activity and increased value opportunities inspire optimism for 2010, particularly in the office market.
Office tenant decision-making in the third quarter increased to a level not seen for nearly 2 years, as gross activity, driven primarily by insurance, legal, technology and education users, reached 1.175 million square feet. Roughly 50 prospects, propelled by steep rent discounts and other concessions, are actively scouting metro Phoenix for office product larger than 25,000 square feet. Note to landlords: toss out any perceived rental growth assumptions in your ARGUS evaluation for at least 2 years. While most owners have already adjusted to current market conditions, others will continue to see negative rental growth, depending on realistic versus unrealistic economic assumptions.
Meanwhile, industrial market strength remains weak due to over supply and under demand. Vacancy rates, hit hard by a one-two punch of corporate downsizing and new construction, will climb through the fourth quarter but should stabilize as the last of 1.2 million square feet in speculative product hits the market later this year. Leasing will remain slow into 2010, but will pick up towards the second half of the year when the capital markets recover.
Sluggish housing construction continues to stall retail growth. The third quarter saw only 367,869 square feet of new retail space, with another 1.9 million square feet still under construction. Big box vacancies — representing 285 spaces greater than 10,000 square feet or 8.4 million square feet — remain a concern, but replacement leases by Hobby Lobby, Total Wine & More and others show promise.
Overall, present conditions have forced Phoenix to return to its trademark affordability — a notion not lost on companies looking to relocate where quality of life and population growth come together with affordable housing, lower commercial real estate occupancy costs and labor costs. This combination will ultimately drive the state of Arizona’s success.
— Craig Henig is senior managing director and the Arizona market leader for CB Richard Ellis.
The Honolulu business environment appears to be stabilizing, and many believe that the market will hit bottom before the end of 2009. Cautious optimism reflects the mood of Honolulu businesses after hunkering down and adopting conservative practices to weather the economic down cycle. Tentatively, businesses are back exploring real estate options, which bodes well for 2010.
The travel sector, Hawaii’s primary economic engine, faced a 6.8 percent decline in visitors, resulting in drops in hotel occupancy, hotel room rates and resort retail sales. Bottom lines have become lean, and for marginal hotel operators defaults and foreclosures are looming on the horizon. Already several hotel properties that were purchased during the CMBS boom period have already entered special servicing with problematic loan situations.
Having posted its healthiest growth in new occupancy in more than a decade, Honolulu’s retail shopping center market has not faced the huge vacancies that plague overbuilt markets such as Sacramento, Phoenix and Las Vegas. Vacancy rates remain below 4 percent and although rents are beginning to soften, no major fallout is anticipated for 2010. Similarly the industrial sector remains resilient despite slowing construction activity and weakened industrial sales. Vacancy rates will likely remain below 6 percent for the coming year.
Honolulu’s office market is transforming into a tenant market as vacancy rates rose by 200 basis points during the past year, surpassing the 10 percent equilibrium point. The increase in private sector job losses coupled with government furloughs and budget cuts will likely boost vacancy rates beyond 12 percent by year-end 2010.
The resultant real estate market will differ from the existing paradigm as conservative underwriting will shift the pendulum from lax to restrictive. Opportunistic buyers will be able to capitalize on deep discounts on overextended properties or purchase notes from troubled borrowers. Honolulu’s real estate market remains vulnerable should poor economic conditions persist, but it has remained relatively unscathed by the downfall that has stricken many of its mainland counterparts.
— Mike Hamasu is director of consulting and research at Colliers Monroe Friedlander Inc. in Honolulu.
Frank Russell and Howard Hanson were the headliners this past quarter and will continue to be in the Seattle spotlight in 2010.
The Frank Russell Company made the long-awaited decision to relocate its 300,000-square-foot corporate headquarters from Tacoma to downtown Seattle next year. The move was facilitated by the opportunistic $130 per square foot acquisition of the former Washington Mutual Tower building by Northwestern Mutual, which is the parent company of Frank Russell. This decision was the highlight in an otherwise gloomy office leasing market that will soften further next year as several properties come on line, additional sublease space hits the market and tenant demand is curtailed by further projected employment losses. Tenants with leases expiring next year will be able to negotiate very aggressively as landlords strive to maintain occupancy.
Concerns about the damaged Howard Hanson Dam’s ability to regulate water flow into the Green River, which meanders thru the 104 million-square-foot distribution center of the area known as the Kent Valley, has triggered industrial movement. Flood possibilities have resulted in a flurry of leasing activity at properties located outside the area and a significant need for planning and preparation by property owners and tenants in the valley. This issue will remain at the forefront in 2010 as we head into the winter rainy season with a permanent fix of the dam possibly taking several years.
The opening of Schnitzer West’s The Shops at The Bravern in Bellevue has highlighted the Seattle area’s retail market activity. Anchored by Nieman Marcus and a lineup of nationally prominent, high-end specialty shops and restaurants, the project was conceived to appeal to Bellevue’s high-end demographics. Early sales figures have been strong.
Apartment building owners are facing declining demand and increased competition from unsold houses and condos now offered for lease. Many renters are now consolidating or moving home with their parents to save money, while others are taking advantage of government incentives, low interest rates and depressed housing prices to become first-time homeowners. Multifamily vacancy rates are projected to reach 30-year highs next year, meaning 2010 will be a great time to be an apartment renter as rates continue to decline, concessions increase and there are numerous options available.
— Scott Coombs is the executive vice president of brokerage for GVA Kidder Mathews in Seattle.
The office market will be the main attraction in Denver commercial real estate in 2010. There are at least 20 users larger than 50,000 square feet in the market today. Because they largely represent companies currently leasing space in the market, the transactions do not translate into net absorption. The 97,000-square-foot Catholic Health Initiatives lease in late 2009 broke open a logjam of companies pursuing large block opportunities in the southeast suburban submarket. The combined effect of this activity, construction delivery and further corporate contraction will result in an overall office vacancy rate increase of 40 basis points. Asking rates are anticipated to decrease by 2 to 3 percent.
The industrial market has remained stable. A large volume of owner-user space on the for-sale market remains the largest unknown for this property type. Further economic deterioration would result in rising vacancy for this sub-sector.
New retail construction in Denver during the past 3 years buoyed asking rates for a time, though asking-rate declines in older centers resulted in 20 percent plus reductions in 2009. Restaurants and discounters remain the strongest players. Non-traditional tenants are also taking a run at retail spaces.
Overall investment spending slumped to $1 billion in 2009, down 87 percent from 2007’s high. Small properties continue to trade with slight declines in pricing. Retail made up nearly half of all transactions and multifamily an additional quarter. Absent large investment deals, Denver has fallen off the radar as an investment destination. Most transactions involve local players.
As a corporate destination, Denver’s reputation is growing, partially on the heels of large relocations such as Vestas and ConocoPhillips. The city’s stable tax and policy platforms compare favorably to states facing serious budget issues.
— Mark Ballenger is executive vice president and managing director in Grubb & Ellis’ Denver office.
Countywide employment will be the primary property performance driver for Los Angeles apartments in 2010. We forecast the loss of 12,000 jobs for next year, a modest 0.3 percent decline following the reduction of more than 250,000 positions since the onset of the recession. As employers cut jobs throughout the downturn, renters doubled up, moved in with family or left the area, driving a 180-basis-point increase in vacancy since year-end 2007 on negative net absorption of 8,200 units.
The pace of vacancy increases will slow in 2010 as more modest job cuts filter through the economy. In 2010, apartment vacancy is forecast to tick up just 50 basis points, and asking rents will drop 1.3 percent. With renter demand for space expected to ease slightly, operators will offer greater concessions to fill units. Concessions are expected to total nearly 3 weeks of free rent by the end of 2010, nearly twice as high as the rate at the most recent market peak.
The labor market will also impact office, retail and industrial properties. Office-using employment, the key driver of tenant demand for office space, is forecast to contract by approximately 4,000 jobs in 2010. Vacancy rates will creep higher in 2010 and into 2011, as tenants will be cautious about taking on new space commitments even if they are actively expanding head counts.
The retail trade employment sector has contracted by nearly 35,000 positions since the end of 2007, driving a 320-basis-point rise in vacancy to 6 percent. In 2010, the sector is expected to expand modestly, with the addition of a few hundred jobs, and vacancy should begin to stabilize.
The manufacturing, construction, and trade, transportation and utilities sectors serve as the primary drivers of industrial space demand. Combined, these sectors are forecast to contract by 6,700 workers in 2010, following the loss of nearly 160,000 jobs during the recession. Space demand will likely remain fairly flat in 2010, and with construction of new space limited, industrial vacancy should inch higher.
— Stephen Stein is the regional manager of the Los Angeles office of Marcus & Millichap Real Estate Investment Services.
WHAT'S HOT, WHAT'S NOT IN 2010
2009 was a tough year in commercial real estate. Some economists have indicated that the slump will soon be over, if we can weather the storm in 2010. There is light at the end of the tunnel; in fact, some markets are picking up.
• Best markets to consider:
1. Multifamily: while this has been impacted, there has been an increased demand due to families who have lost their homes. A lack of rebound in the job market for people in their 20s, however, could hurt this sector. In order to save money, echo boomers may move back home or alternatively add more roommates; in either case fewer apartments may be rented.
2. Grocery-anchored retail: a product type that is still able to obtain decent financing, basic-necessities retail remains strong.
• Worst markets to watch out for:
1. High-end retail: the only thing fashionable in the current economy is frugality; it’s impacted the high-end retail market, which isn’t likely to rebound soon.
2. Commercial: both office and industrial sectors have taken a hit. Due to job losses and company bankruptcies, both markets may hit bottom in 2010. It may be another 12 to 24 months before a true settling takes place.
— Richard Parent is a vice president at Gumbiner, Savett Inc.
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