COVER STORY, JUNE 2008

ALOHA STATE TRENDS
Hawaiian experts study the state's current patterns of real estate activity so that they can catch the next wave.
Mike Hamasu

Hawaii commercial real estate participants are experiencing the following four major trends in the islands.

Industrial Condominium Development

Tight market conditions continue to persist in Honolulu’s industrial marketplace. Vacancy rates have remained stubbornly below 4 percent for the sixth consecutive year and have reached a point that Honolulu has the dubious honor of posting one of the lowest vacancy rates in the country. Average asking rents have risen from $0.71 per square foot per month at year-end 2002 to $1.33 per square foot per month for first quarter 2008. Despite this 87.5 percent increase in rents, the rising cost of construction and the rapid appreciation of industrial land inhibited many developers from building for-lease warehouse space.

As an alternative, developers have focused on constructing industrial condominiums. More than 500,000 square feet of new industrial condominiums are being built, targeting industrial tenants seeking a fee-simple alternative to leasing or building their own site. Units at new projects in west and central Oahu such as Kapolei Spectrum, Waipio Business Park and the Sugar Mill Center at Milltown are currently being marketed for sale. Tenants frustrated with record-high rents, obsolete buildings and a severe shortage of available properties have found these condominiums as an attractive alternative.

Pricing levels are in excess of $320 per square foot, and demand appears to still remain healthy despite lenders’ increased scrutiny and tightened underwriting standards that have increased borrowing costs.

Kapolei Development

Kapolei Spectrum Business Park, Phase I, on the island of Oahu reflects the state's increased industrial condo development trend.

Labeled Oahu’s “Second City,” the transformation of Kapolei from a sleepy agricultural-based community into a burgeoning city is phenomenal. Located on the southwestern end of Oahu, this area was identified by city planners nearly 20 years ago as the primary location for the island’s residential development. Since 1990, Kapolei’s population has nearly doubled, having risen from 43,000 to 84,000 in 2005. It’s this explosive growth that has caught the attention of the development community.

The area now boasts planned residential developments of more than 30,000 new homes and projects a 2025 population base of 173,000. This projected growth has enticed developers to consider more than 5.3 million square feet of retail projects and nearly 1 million square feet of office projects there. A regional mall, two lifestyle centers, several neighborhood shopping centers, two mid-rise office complexes, a state judiciary building and numerous street retail projects are planned for the market.

After nearly a decade of little activity, the boom in Hawaii’s economy sparked renewed interest in Kapolei during the early 2000s, resulting in a surge in development activity. Currently, there are increasing concerns about the direction of Hawaii’s economy. The economy’s vulnerability to declines in air passenger arrivals and rising fuel oil costs is likely to result in the shelving of a number of commercial projects until conditions stabilize.

Transaction Volume Decline

Hawaii’s commercial real estate market transaction volume skyrocketed between 2001 and 2005. During this time period, sales more than quadrupled, rising to a record $4.3 billion as hotels, office buildings, shopping centers and industrial land became prized investment acquisitions. Subsequent to 2005, sales volume fell off precipitously, having recorded an 11.6 and 21 percent decline in transactions for 2006 and 2007. For 2008, transaction volume is down 9.25 percent from first quarter 2007 figures.

A combination of a dwindling supply of available prime properties, the turbulence in the financial markets and increased concerns over the uncertainty about real estate markets has slowed both national as well as local commercial real estate transaction activity. Despite these factors, Hawaii’s commercial real estate market appears to have remained healthier than other markets. While sales volume has declined, transaction velocity remains strong with a 14.3 percent increase in the number of transactions for first quarter 2008 versus first quarter 2007.

Institutional investors appear to have curtailed their acquisition activity, especially among large big-ticket properties, but this void is being filled by active local investors placing capital into smaller properties. In fact, multifamily/apartment sales are up 50 percent from last year’s figures. Similarly, development land and small retail properties have boosted their sales activity for 2008. Only 20 percent of the 56 properties that sold for this year were purchased for more than $10 million.

Leasehold Tenure Tidal Wave

Much of Hawaii’s industrial land is tenured as leasehold property. The underlying fee for much of this land is retained amongst a few notable Hawaiian land trusts. Lessees purchase the right to develop this land for a fixed number of years with ground rent renegotiations typically scheduled in 10-year increments. The underlying ground rent is generally based on a fair market land value factor of 7 to 8 percent.

Much of the leasehold land between downtown Honolulu, the Honolulu airport and Aiea is coming up for rent renegotiations from 2009 to 2012. This land has appreciated rapidly during the recent boom period of 2002 to 2008. It is not uncommon for land valued at roughly $30 per square foot in 1999 to have quadrupled in value to $120 in 2008. As a result, ground lease rents will likely jump dramatically from the previous negotiation period. Many lessees will find themselves in difficult financial circumstances, unable to generate enough building rents to cover the costs of the increased ground rent. Sub-lessees (i.e., building tenants) will likely be forced to bear the brunt of the ground rent increase. For those lessees not fortunate to secure additional rent, many will find themselves underwater.

Mike Hamasu is director of the research and consulting division for Colliers Monroe Friedlander in Honolulu.

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