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COVER STORY, APRIL 2004
THE HIGH-RISE’S LAST GLEAMING
Downtown office markets are primed to shine again with
the light of job growth.
Brian A. Lee
With more and more focus on the nation’s jobless recovery
from the recent economic downturn, it’s easy to see why
the office sector has lagged behind its commercial real estate
counterparts. Western Real Estate Business decided to look
at the downtown office markets in several western cities to
see what trends are evident in this unusual economy.
While each market has its own unique traits, many commonalities
did surface. In general, there has been ample leasing activity
as office tenants scramble to take advantage of the renter’s
market. Many brokers listed law firms among the most active
tenant types. Conversely, central business district (CBD)
office development is down, a direction justified by high
vacancy rates. Amidst all the trends, the bottom line is that,
while positive absorption is possible in this office market,
full recovery will only come when there’s real job growth.
Portland, Oregon
For Portland’s biggest office movement, one must look
to the Brewery Blocks, a five-block, mixed-use development
in the city’s Pearl District. “The Pearl District
is on the fringe of downtown and has become the hot place
in Portland,” says Michael Nye, vice president at Trammell
Crow Company’s Lake Oswego, Oregon, office. “The
reason the Pearl District and, specifically, the Brewery Blocks
have seen the bulk of the activity is because Gerding and
Edlen Development has done a great job building such a unique
project, which is difficult to compete against because of
the quality shops, restaurants, housing, parking and office,
all in a close-in location.”
Construction is ongoing on two of the blocks with renovation
scheduled for another. The completion date for the entire
development is May 2005. The Brewery Blocks office tenants
include Tyco Telecom, M Financial Group and two law firms.
Nye says that the bulk of office tenant activity in Portland’s
downtown market has involved law firms, government agencies
and schools. “The trend that we are seeing in the downtown
market is that landlords are doing whatever it takes to keep
tenants or attract new ones,” says Nye. Most large companies
in Portland explored their relocation options but decided
to stay put and renew their office leases. On the other hand,
some mid-size tenants are making lateral lease moves or downsizing
their space requirements to take advantage of a down office
market. “Companies have eliminated a significant amount
of overhead during the last couple of years and now that they
have weathered the storm, so to speak, tenants are crafting
their long-term real estate plans,” adds Nye.
Current rental rates in Portland’s downtown office submarket
vary from $14 to $29 per square foot and average $18.41 per
square foot. While the overall office vacancy rate in 2003
increased about one percentage point, the CBD measure decreased
nearly a third of a percentage point, to 13 percent, in the
fourth quarter, according to the CoStar Office Report. CBD
net absorption (59,648 square feet) accounted for 17.3 percent
of the Portland office market’s total in fourth quarter
2003. Although incremental gains may be made, Portland’s
downtown office sector will not make a full recovery until
significant job growth occurs, the report asserts.
“We are going to see a slight improvement but nothing
real exciting,” says Nye. “Rental rates will stay
flat, and tenants are going to be pushed back on concessions
such as tenant improvements, free rent, and moving allowances.”
Phoenix
It appears the migration of office tenants out of Phoenix
is really an exodus from its midtown area. Companies are relocating
either north to the Scottsdale suburbs or closer in to the
city’s core, says Charles Miscio, first vice president
at CB Richard Ellis in Phoenix.
“By far, the downtown core is the most active [Phoenix
submarket],” he says. “Because the Phoenix office
market has been soft, tenants from midtown, who want to move
to the downtown financial district or near the courts, can
do so and take advantage of discounts in rent of as much as
25 percent due to greater concessions [compared to] those
from 3 to 4 years ago.”
As a result, leasing activity has been very vibrant in Phoenix’s
CBD. Downtown office vacancy was 12 percent at the end of
2003. By contrast, the vacancy rate for the entire metropolitan
Phoenix area was 18.3 percent, and midtown saw its vacancy
increase to 25.6 percent, up from 23.1 percent in 2002. Rental
rates for downtown multi-tenant office buildings at the end
of last year ranged from $10 to $28 per square foot. Miscio
forecasts that the downtown area will experience a decrease
in vacancy — “possibly into the single digits”
— by the end of this year. On the other hand, the midtown
market will continue to struggle with vacancy, increasing
by as much as 3 to 4 percent due to several large tenants
moving downtown or to the suburbs.
“Phoenix’s new light rail system will start construction
this year, and the anticipated disruption of traffic has been
of great concern for many office tenants,” says Miscio.
“Some have left the midtown area entirely rather than
endure the inconvenience caused by 3 to 5 years of construction.
Downtown tenants are more optimistic about the light rail
project and feel it will be a benefit when done. Overall,
most of the real estate community is on the fence and unsure
about how it will affect leasing velocity in the CBD.”
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101 North First Avenue in downtown
Phoenix has undergone interior
renovations. The 31-story high-rise office building
is located in the heart of
Copper Square.
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With office developers focused on suburban projects, downtown
Phoenix has gone 2 years without any new multi-tenant office
construction. To a large extent, commercial development activity
in the CBD has been limited to construction of the Translational
Genomics Research Institute and the $600 million expansion
of the Phoenix Civic Plaza. “Instead, redevelopment of
existing office buildings has been more prevalent,” says
Miscio. “New, expanded lobby areas with more amenities
have been added to buildings, such as the one at 101 North
First Avenue.”
The genomics research park, to be located on 24 acres in the
city’s core, will open Phoenix’s door to the bio-medical
field and bring a fresh variety of tenants to downtown. In
the city’s governmental corridor, the General Services
Administration is currently redeveloping a project to house
the bankruptcy courts and the USDA. Also, The Arizona Center,
a mixed-use office and retail complex, has transformed its
food court into multi-tenant office space. Such activity bodes
well for the health of Phoenix’s office market, especially
as it welcomes new industries and efficiencies in the next
few years.
Los Angeles
The downtown Los Angeles office market is experiencing two
major trends currently — a substantial amount of investment
sales of mid- and high-rise office buildings and the adaptive
reuse of older Class A and B office space into multifamily
product and mixed-use developments, says Michael Weiner, senior
vice president at Colliers Seeley International in Los Angeles.
He notes that 73 percent of the office product in central
L.A. was built prior to 1980.
On the other hand, West Los Angeles, which experienced a major
construction boom from 1998 to 2003, is a relatively young
office market with 56 percent of its product coming on line
in the last 20 years. The wave of new development has tapered
off as West L.A. experiences one of the highest vacancy rates
in the past decade.
The West Los Angeles market, which includes the cities of
Beverly Hills, Brentwood, Century City, Culver City, Marina
del Rey/Venice, Olympic Corridor, Santa Monica, West Los Angeles,
West Hollywood and Westwood, is composed of 46.5 million square
feet of office space. Despite a vacancy rate of 19.1 percent,
rental rates in West L.A. are still strong, ranging from $270
to $300 per square foot. “Excluding New York City, these
are some of the highest rentals rates seen in the major CBD
markets in the U.S.,” says Weiner.
The downtown market, which consists of more than 33 million
square feet of office space, is experiencing decreased vacancy,
flat rates that are trending upward and slightly positive
absorption. Traditionally the weaker of the two markets, downtown
has recently posted rental rates in the high-end office buildings
that are comparable to those in West L.A.
“Downtown Los Angeles is currently experiencing a kind
of social and real estate renaissance as the city, its residents
and businesses work towards revitalizing it into a true, urban
24-hour city,” says Weiner.
Many different projects reflect this downtown renaissance.
The $1.2 billion, 3.2 million-square-foot Grand Avenue redevelopment
will include an office component among its extensive mixed-use
offerings. Last month, The Ratkovich Company, a Los Angeles-based
commercial real estate firm, acquired 800 Wilshire, a 16-story,
213,518-square-foot boutique office building for $30 million.
The company will spend $3 million to renovate the body of
the building, its elevator lobbies and public areas. The 800
Wilshire building is more than 80 percent leased.
The major new office project in West L.A. will be known as
2000 Avenue of the Stars. Recently approved, the 790,000-square-foot
development will be part of Trammell Crow Company’s Entertainment
Center, which also includes the twin Century Plaza Towers.
Demolition of the former ABC Entertainment Center on site
is anticipated to begin in the next few months. The mixed-use
project will include a new 15-story Class A office building,
a portion of which has been pre-leased to Beverly Hills-based
Creative Artist Agency.
Big-time investors feel right at home in the more dense downtown
office market. DIFA, a German-based conglomerate, made a major
play in the market with its acquisition of the Sanwa Bank
Plaza for $325 million ($312 per square foot). The 1 million-square-foot
office building, located at 601 S. Figueroa, is “arguably
the finest building in downtown,” says Weiner.
Mani Brothers, a family-owned commercial real estate investment
company with a portfolio of Class-A trophy buildings, recently
sold 660 S. Figueroa for $63 million ($225 per square foot).
Also, Jamison Properties purchased the 350,000-square-foot
L.A. World Trade Center for $50 million ($143 per square foot).
San Francisco
Increasingly, landlords in San Francisco’s downtown office
market are standing pat in 2004 with regard to rent concessions,
says Greg Fogg, managing partner at NAI BT Commercial in San
Francisco. As opposed to 2003 when owners of office space
conceded early renewal or “blend and extend” deals,
landlords are showing less of that tendency this year, choosing
instead to take their chances on lease contracts that expire
in 2005 and beyond.
Despite this trend, office leasing activity is brisk with
tenants taking advantage of a renter’s market. “Flight
to quality is a major trend, with tenants coming off high-rent
leases realizing that they can have it all — better space
and lower rent,” says Fogg, who singles out law firms
as the most active tenants in San Francisco’s CBD market.
Fogg says the office market continues to see positive migration
into San Francisco’s downtown sector. A good example
is Gymboree, which aims to relocate its headquarters to San
Francisco from Burlingame, California. As a result of such
influx, a streak of 11 consecutive quarters of negative net
absorption was halted in third quarter 2003. “We look
for this trend to continue, although we are still awaiting
job growth and thus believe net absorption, while positive,
will be less than 1 million square feet this year,” says
Fogg.
Due to such a high level of vacancy — 20 percent —
in San Francisco’s core, there is very little new office
construction taking place. “With about 17 million square
feet of vacant space, it’ll be a long while before new
development is justified,” says Fogg. Instead, the current
downtown construction comes in the form of high-density residential
projects. With its affordable housing shortage, San Francisco
is seeing residential developers buy old industrial buildings,
which were converted to office in the late 1990s, and adapt
them for residential use.
Office sales in the CBD have been virtually nonexistent. For
those few properties that have changed hands, there is a huge
spread between what buyers paid for vacant versus stable assets.
For example, the 770,000-square-foot Market Center, which
was 80 percent vacant, was bought by Divco West/RREEF for
about $105 per square foot. On the other hand, 500 Howard,
which is 100 percent leased to Sun Microsystems, was sold
to Utah Pension for about $510 per square foot. Sun Microsystems
subleases the entire building.
The majority of San Francisco’s CBD office activity is
taking place in the Class A and B core sector, the area bordered
by Kearny and 3rd to the west, Broadway to the north, Embarcadero
to the east and Harrison to the south. Tenants are moving
to higher quality space with access to transit and various
amenities. Opportunity and pension funds constitute the most
active investors in the market.
“We expect that this year the market will remain fairly
steady, with no real appreciation in rents and a small decrease
in vacancy,” says Fogg. “The exception will be the
market for high-end view space. The good news for San Francisco’s
CBD is that it is now a bargain compared with other Bay area
and national markets. We look for San Francisco to continue
to benefit from relocating companies, which recognize the
historic opportunity that today’s rents present.”
Seattle
Like many other downtown office markets throughout the West,
Seattle’s CBD is experiencing many lease renewals and
lateral moves by its office tenants, says James Keating, senior
vice president at Grubb & Ellis in Seattle. This activity
originates from the huge volume of office space leased in
2000 and 2001.
Office occupancy in the downtown area will not be helped by
the departure of large firms to build-to-suit properties.
NBBJ and Tommy Bahama will relocate their office operations
to South Lake Union. “This will put some large chunks
of space on the CBD market during the next 3 years, stifling
any rally the landlords may hope for,” says Keating.
In addition, Washington Mutual will be consolidating its office
presence in Seattle’s CBD into an 890,000-square-foot
property that connects to the Seattle Art Museum, reports
Chris Vay, a Grubb & Ellis research analyst.
The majority of office activity is well distributed with the
city’s financial district having the most absorption.
Equity Office Properties is the largest landlord in downtown
Seattle. Rental rates for Class A office space range from
the low to mid $20 per square foot. Vacancy is around 15 percent.
Keating says that job creation will be the major determinant
of the future of Seattle’s CBD office market.
©2004 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.
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