COVER STORY, JUNE 2008

WESTERN OFFICE REPORT
Which office markets in the West are bucking the trend?
compiled by Brian A. Lee

San Francisco, Seattle and Denver received special mention for decreasing vacancy, space under construction and absorption, respectively, in Grubb & Ellis' first quarter 2008 report. Western Real Estate Business recently checked in with office experts from the Mile High City to Phoenix and all the way up the West Coast.

Denver

• Market Measure: In first quarter, the central business district had 377,292 square feet of positive net absorption, which shows continued local market strength. This growth represents just more than one-third of the total metro absorption, with organic expansions from a number of companies fueling demand.

• Mode: Downtown Denver’s economy is outperforming the national economy largely behind the strength of the energy industry. Metro Denver has six office buildings underway, which will deliver a total of 1.2 million square feet (1 percent growth) between the end of 2008 and the end of 2009. These buildings have nearly all achieved 25 to 75 percent pre-leasing, attracting strong demand from tenants eager for new product. Lease rates are, in fact, increasing, and landlords in the area have not been forced to offer above-market concessions.

Westfield Development Co. has started construction on the Denver CBD's first high-rise in more than 20 years at 1800 Larimer St.

• Manifestation: The six new buildings downtown and one building in the suburbs that are nearly complete are 1515 Wynkoop (Hines), 1400 Wewatta/1401 Wynkoop (Opus), the 112,274-square-foot 1755 Blake (Haselden/First Century), 1555 Blake Street (Sugar Cubed/Urban villages), 1900 16th Street (Kennedy & Associates), Palazzo Verdi at 6325 S. Fiddlers Green (Madden) and 1800 Larimer (Westfield Development). Xcel Energy has signed a lease for 350,000 square feet of Westfield’s 500,000-square-foot project, representing the largest lease so far in 2008.

• Most Wanted: The lower downtown office submarket is the most popular in the Denver metro area. Five of the six new developments are in or directly adjacent to this submarket, and vacancy rates for Class A space there have consistently been below 5 percent for several years.

— David W. Morrison is a senior vice president in Grubb & Ellis Company’s Denver office.

Phoenix Metro

• Market Measure: The overall vacancy rate has increased 2.5 percentage points from the same period in 2007. The Class A vacancy rate rose nearly 5 percent, reflecting the tremendous amount of new office product that has hit the market in the last 12 months. As a result of new construction deliveries, the Class A asking rental rates have increased approximately 3 percent during the same period. Problematic will be slowing job growth and anticipated weak tenant demand at a time when an abundance of new buildings are coming online.
• Mode: The Phoenix office market is falling in line with the slowdown occurring at the national level. It may even be more pronounced in light of the trickle-down effect from the housing slowdown. The amount of sublease space has more than doubled in the last 12 months, mostly as a result of downsizing from mortgage, title and homebuilding companies.

• Manifestation: Pulte Homes executed a lease for 96,000 square feet at Terra Verde One in Scottsdale, reflecting its long-term positive view of the Phoenix housing market.

• Most Wanted: The Scottsdale office sector represents the most vibrant submarket in the Phoenix area. Almost 50 percent of all the office space built and leased in the Phoenix metro has occurred in the three submarkets that comprise the Scottsdale area.

— Michael A. Beall is executive director of Cushman & Wakefield of Arizona Inc. in Phoenix.

San Diego (Del Mar Heights submarket)

• Market Measure: Positive absorption in first quarter 2008 reached 105,000 square feet and rents have held up with direct vacancy currently at 7.6 percent.

• Mode: San Diego’s Del Mar Heights submarket has bucked the national trend lately with positive strong absorption. This market is following the general movement nationally with vacancy going up. However, this is mainly due to recently completed construction.

• Manifestation: The 200,000-square-foot Gateway at Torrey Hills completed construction at 45 percent pre-leased.

• Most Wanted: Class A leasing, development and investment are the most popular office targets in Del Mar Heights.

— Rick Reeder is an office sales & leasing specialist/owner in Grubb & Ellis|BRE Commercial’s Carlsbad, California, office.

Orange County, California (John Wayne Airport)    

• Market Measure: The Orange County airport submarket was the primary scene of the crime for the subprime mortgage meltdown with many companies downsizing or closing their doors altogether. The situation was exacerbated by the delivery of several new Class A office buildings in the submarket. The result has been the loss of office-related jobs, negative absorption and a dramatic increase in the vacancy rate.  

• Mode: As the home of so many mortgage companies, Orange County was on the leading edge of the softening in the office market, but it is still one of the most desirable in the country for Class A office users. This downturn will provide an opportunity for tenants to upgrade and/or expand their space in a leading market that is under-priced compared to other metropolitan areas.

• Manifestation: For its West Coast headquarters, Waterfield Bank, a Midwest-based federal savings bank, leased two floors of office space totaling approximately 30,000 square feet in an 18-story high-rise located at 18881 Von Karman Ave. in Irvine. The building was renamed Waterfield Tower in honor of its newest tenant, which relocated from 10,000 square feet. The increase in vacancy gave Waterfield the opportunity to expand and get naming rights for the building, something that would have been much more difficult to achieve in a tight market.

• Most Wanted: Office product in Newport Center, a submarket of the airport area. This submarket has the lowest vacancy rate and highest lease rates in Orange County. There is no shortage of tenants willing to pay top dollar for office space with an ocean view.

— Greg May is a senior vice president in Grubb & Ellis’ Newport Beach, California, office.

Los Angeles (Beverly Hills)

• Market Measure: In Beverly Hills, rental rates are the biggest story. They are beginning to catch up to the rest of the Westside’s premier markets — Santa Monica, Westwood and Century City. However, because few buildings in Beverly Hills were involved in the massive office portfolio sales of the past 18 months, rents here have remained lower than in the aforementioned submarkets. The lower rental rates have attracted a steady stream of tenants, and as a result this submarket has maintained one of the lowest vacancy rates in Los Angeles in the past few quarters.

• Mode: Los Angeles, and the Westside in particular, seem to still be one of the strongest markets in the country and have not seen too much fallout from the forecasted downturn in the economy. Asking rates are still increasing, although not with the same fervor of several quarters ago. Since Beverly Hills has a very strong image, it should be one of the better insulated submarkets even if there is a severe downturn in the near future.

• Manifestation: Construction is underway on The William Morris Agency’s new six-story, 201,000-square-foot headquarters in the heart of Beverly Hills. Designed by Gensler, the structure will be a showcase for green architecture, with recycled materials and energy-efficient water and lighting systems. The new building keeps WMA, its sole  office tenant, in Beverly Hills, where it has been headquartered since 1955.

• Most Wanted: Medical office space for lease seems to be the hottest commodity in Beverly Hills. With the booming plastic surgery field and the appetite and deep pockets of the local residents for that service, Beverly Hills has become the Mecca for plastic surgery.

— Neil Resnick is executive vice president in Grubb & Ellis Company’s West Los Angeles office.

San Francisco

• Market Measure: Overall office vacancy decreased 110 basis points on a year-over-year basis to 9.5 percent at the end of first quarter. In San Francisco’s CBD, vacancy plummeted two percentage points on a year-over-year basis, reaching 12 percent in first quarter 2008.

• Mode: San Francisco’s office market can be described as bifurcated. In terms of supply and demand, unemployment is still low compared to the rest of the nation, and our technology sector continues to expand. There are many growing companies and start-up ventures currently in the market to lease space. On the investment side, velocity has slowed tremendously. In previous years, we had ample opportunities to locate buyers with some degree of ease, but today the brokerage community is aggressively searching for buyers.

• Manifestation: The biggest office development currently rising is Tishman Speyer’s 555 Mission, a spec building leased to a few large tenants.

• Most Wanted: There has been a flight to quality and location: Investors and tenants are seeking downtown core locations, corner locations and prime, highly-trafficked locations.

— Chris Economou is an office investment specialist in Marcus & Millichap Real Estate Investment Services’ San Francisco office.

Portland, Oregon

• Market Measure: Portland’s overall vacancy rate dropped 50 basis points from first quarter 2007 to 11.3 percent in first quarter 2008. CBD vacancy is at a low 9 percent, which represents a 110 basis-point drop from first quarter 2007.

• Mode: The Class A office market remains strong, while the Class B and C segments have not recovered as quickly as predicted last year. Leasing activity is slow, which has impacted the recovery of the Class B and C segments. In terms of transaction velocity, investment sales have slowed for Class B/C suburban office assets. There is still high demand for urban and near-city office product. Cap rates have moved above 7 percent for suburban office buildings, but overall velocity has slowed due to a bid-ask gap between buyers and sellers.

• Manifestation: Shorenstein Properties LLC is developing a new office building in downtown Portland.

• Most Wanted: Downtown office assets remain popular, as does office product in Lake Oswego (near Kruse Way), Tigard Triangle and Tualatin near the Bridgeport Lifestyle Center.

— Michael Kapnick is vice president, investments, in the Portland office of Marcus & Millichap Real Estate Investment Services.

Seattle

• Market Measure: After jumping up by as much as 40 percent in 2007, rental rates were relatively flat during the last quarter. The vacancy rate, which was 8.41 percent at the end of first quarter, is expected to continue downward through 2008, as there will be no major deliveries of new inventory until 2009.

• Mode: Leasing activity is expected to remain steady through the next year as regional absorption continues to be fueled by job growth that exceeds most U.S. markets. According to the Washington State Employment Security Department, employment during first quarter was up more than 30,000 jobs from 1 year ago in the Seattle metropolitan area, an increase of 2.2 percent. In 2008, the city’s employment is expected to grow by 1.9 percent compared to 0.9 percent for the U.S.

• Manifestation: Microsoft continues to expand its presence in downtown Bellevue, recently announcing that it had pre-leased the entire City Center Plaza building. Owned by Beacon Capital Partners, the 26-story, 572,000-square-foot building is slated for completion this summer. This building offered the last large blocks of contiguous space in the CBD market.

• Most Wanted: One of the brightest spots in the regional office market is the technology industry, which continues to fuel demand for space. Microsoft, Google and Expedia.com pre-leased a combined 2.8 million square feet on the eastside during the past 12 months, while Amazon.com pre-leased 1.5 million square feet near downtown Seattle.

— Scott Coombs is executive vice president, brokerage, for GVA Kidder Mathews in Seattle.

Five Leading Design Trends of New Western Office Buildings An FME design, The Esplanade in Alameda, California, will incorporate all of the above design characteristics when completed in 2009. 1. Green – Sustainability is here to stay. Many cities insist on it and developers say it gives them a competitive advantage. 2. Building or Condominium Ownership – More businesses want to own their workplace so that they have control over one of their largest expenses. 3. Smaller Buildings – These spec office buildings appeal to owners of smaller businesses. 4. Quality Construction – The small building owners intend to stay in these buildings for a while. Because of this and the fact that they own them, they are more concerned about the quality of construction. 5. Higher Design Profile – Cities are pushing for this as well. Prospective buyers care about pride of ownership. — Stephen Fee is a principal at FME, Architecture + Design in San Francisco.

©2008 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.