MARKET HIGHLIGHT, APRIL 2004

Rainbows & Real Estate: Hawaii’s Pacific Prominence
Mike Hamasu

Strong economic growth, fueled by a robust construction industry, supports the claim by Moody’s Investor Services that Hawaii is the nation’s top real estate market. Contributing to this bold statement is the forecasted expansion of the state’s primary industries: government/military, hospitality and construction.

Late in 2003, the government/military sector welcomed more than $2 billion in military housing contracts that will boost the construction industry for the next decade. The addition of a new Stryker brigade and the potential for another aircraft carrier group joining current forces in the area are signs that Hawaii’s position as a prominent leader in national security is growing.

Additionally, the state and local governments plan to spend hundreds of millions of dollars on public works projects in the near term.

The hospitality sector, which generates nearly a quarter of the Aloha State’s gross product, has recovered from the dramatic declines in air travel during the past 2 years. The state’s current occupancy rates and revenue per available room lead the nation. There is a high level of investor interest in Hawaii’s hotel properties, with more than a dozen purported to be on the market.

Driven by low interest rates and pent-up housing demand, the construction/real estate sector posted another record year in home sales and housing permits.

Construction spending for both private and public projects is on the rise. The state forecasts a need for more than 7,000 construction workers in the next 4 years.

In addition to the bright outlook for Hawaii’s major industries, economic forecasts predict healthy job and personal income growth for the next 3 years, boosting consumer and business confidence.

Office

After 3 years of rising vacancy rates, Honolulu’s office market posted positive absorption in 2003. Most of this growth in occupancy occurred during the last half of the year when vacancy rates fell from a mid-2003 high of 13.75 percent to 11.84 percent at year’s end. For a market that averaged a mere 1,300 square feet of absorption per year during the past decade, the tremendous year-end 2003 growth rate is welcomed relief.

Landlords will likely continue to offer concessions of several months of free rent and tenant improvement allowances to prospective tenants until the forecasted job growth becomes reality. The Oahu full-service asking rate grew from $2.12 per square foot in 2000 to $2.15 per square foot in 2003, with most of this increase attributed to higher building operating expenses. Colliers Consulting-Honolulu anticipates a slight increase in rents during the remainder of the year with solid rental rate growth forecasted for 2005.

Hawaii’s economists are forecasting 2 percent job growth in the next few years, led by the burgeoning construction and residential real estate sectors. Most believe the secondary and tertiary impacts of the $2 billion in federal military housing contracts will result in an economic stimulus that will spur additional job growth in the finance, insurance, real estate and business services sectors. These developments bode well for recovery and growth in Oahu’s office sector.

The largest office transactions in 2003 came as a result of the Shidler Group’s $125 million sale of the Waikiki Galleria and its subsequent $90 million purchase of the Pan Am Building and Davies Pacific Center. Both transactions appear to be well-timed as the office market appears primed for improvement.

Industrial

Tight market conditions continue to exist in the industrial sector as vacancy rates remain less than 3 percent. Spurred by a recent 35 percent jump in asking rental rates, speculative construction is increasing, but it’s unlikely that the new product being built will satiate the tremendous pent-up demand. Record home sales, the surge in construction spending and a jump in retail sales continue to fuel the need for warehouse/distribution facilities.

The number of owner-user, build-to-suit and design-built projects is on the rise as prospective tenants determine that the most cost effective solution to the recent increase in rental rates is to purchase their own properties. In Kalihi, where many properties are zoned IMX-1 (industrial mixed use), single-family residential homes are often located adjacent to industrial warehouses. As a result, older residential properties become targets for gentrification by industrial users.

The scarcity of industrial-zoned vacant land in Honolulu’s urban core has prompted developers to expand their search criteria to include Waipahu and Kapolei to the west. Mill Town, an industrial park located in Waipahu, recently sold out its vacant industrial parcels, resulting in a dramatic increase in sales activity in Kapolei Business Park. Industrial land prices in metropolitan Honolulu rose to $75-$90 per square foot and a similar trend is evident in outlying parcels as well.

Topping the list of industrial investment transactions was the sale of the former Damon Estate portfolio. Consisting primarily of improved industrially zoned land, this portfolio, which constitutes nearly a quarter of the industrial properties on the island, garnered tremendous interest among many national real estate investment firms. HRPT Properties Inc., a Massachusetts-based REIT, secured the portfolio with a bid of $480.5 million.

Retail

Hawaii’s retail market is composed of the visitor and island resident segments. Shopping centers that focused on the visitor market encountered a protracted period of difficulty after the September 11, 2001, terrorist attacks. Ailing Japanese and U.S. economies, a skittish travel market, and other global concerns such as the SARS outbreak in Asia contributed to the instability. Despite these economic shocks, the resort retail sector proved to be resilient. Hotel occupancy rates, air passenger arrival figures and retail spending posted solid gains in the past year.

A paradigm shift is underway in Waikiki. For the past 15 to 20 years, Japanese visitors could be relied on to purchase luxury goods and other high-priced items. In fact, Waikiki’s Kalakaua Avenue was highly prized by luxury retailers because it outperformed many other top retail destinations in sales. Unfortunately, many of these goods are now available in Japan, and international air passenger counts have not returned to the high numbers experienced in the mid-1990s.

To survive, many retailers have had to incorporate a different merchandising mix, one that caters to westbound or mainland U.S. visitors. Now, the travel market has fully recovered and currently posts higher air passenger counts than prior to September 11, 2001. Although these retail customers spend less per capita than the Japanese, they constitute the majority of Hawaii’s visitors.

Four major retail projects are underway or planned in Waikiki and should rejuvenate its retail environment. The Royal Hawaiian Shopping Center is undergoing a $40 million renovation; the International Marketplace is slated for a major renovation in 2005; Consolidated Amusement Company’s Waikiki I, II and III theaters are being converted into retail; and Outrigger Enterprises’ Waikiki Beach Walk redevelopment project will add 110,000 square feet of new retail space to the area. In anticipation of these improvements, many of these properties will incorporate a higher percentage of restaurants, entertainment venues and contemporary fashion stores into their tenant mixes to target the growing domestic travel sector.

JC Penney’s departure from Hawaii caused Honolulu’s year-end 2003 retail vacancy rate to rise to 8.53 percent, from 5.3 percent in 2002. Formerly at three regional malls, JC Penney’s closure increased the vacancy rate for that property type from 1 to 11 percent during the past year. Despite this sudden rise in vacancy in Hawaii’s regional malls, community and neighborhood shopping centers performed well throughout 2003, with year-end vacancy rates of 5.64 and 5.57 percent, respectively.

During the next 3 years, Aloha State economists predict that Hawaii will have an annual personal income growth of 4.5 percent or better, a healthy 2 percent job growth rate and economic improvement in nearly every business sector. Both business and consumer confidence indexes have shown improvements resulting in a boost in retail sales.

Hospitality

After September 11, 2001, Hawaii’s hotel occupancy rate declined so drastically that it became the worst performing hotel market of the 35 major travel sectors in the United States. Its recovery is nothing less than miraculous as Hawaii’s hotels now lead the nation in occupancy and revenue per available room.

Several trends contribute to a rosy outlook for Hawaii’s hotel sector — namely, the strong recovery and growth of U.S. air passenger counts, the shift towards marketing hotels to the higher-spending U.S. East Coast traveler, the proliferation of timeshare offerings and the significant renovations and capital improvements made at aging Waikiki hotels.

Nationally, hotel transactions are on the rise, a trend reflected in the high investor interest level in Aloha State assets. With little resort development anticipated during the next few years, the supply-side risk is minimized for investors looking to purchase a hotel in Hawaii. As a result, it is rumored that more than $1 billion in hotel properties are “in play” as potential sales for 2004. The last time the sector achieved this level of hotel sales volume was in 1999 when eight hotels sold for $964.5 million.

Investment

Low interest rates, capitalization rate compression and the tight real estate investment market on the U.S. mainland contributed to a record of more than $2.1 billion in commercial real estate transactions in Hawaii in 2003. While the top four transactions constituted nearly 50 percent of the total sales volume, there were an additional 137 transactions, nearly double the 2002 total for commercial real estate transactions valued at $1 million or more.

Demand for commercial real estate rose dramatically during the past 3 years as a direct result of stock market volatility. Real estate investments experienced 3 years of positive returns during a time period when many stocks posted negative yields. Realizing that real estate appeared to serve as hedge against declines in stock values, investors showed an increased zeal in the market. The rise in demand drove real estate asking prices higher and, as a result, capitalization rates fell. This increased appetite for real estate also resulted in a shortage of available properties and forced many real estate funds to consider secondary and tertiary markets for their investments. This heightened interest benefited Hawaii, which historically has been considered a secondary investment market.

In fact, the placement on the market of the Damon Estate Portfolio’s 182 parcels of leased-fee land resulted in a reported 22 bidders placing offers in excess of $400 million each, a tremendous level of interest considering that most Hawaii investment transactions of this magnitude are limited to major resort hotels or regional malls, not industrial land.

Mike Hamasu is director of consulting and research at Colliers Monroe Friedlander Inc. in Honolulu.

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