MARKET HIGHLIGHT, APRIL 2008

SEATTLE
Jeff Crane, Michael Hemphill, Barry Kelly and Joe Levin 

The big question on everyone’s mind is — will there be a recession in 2008 and what will it mean to commercial real estate in the Seattle/Puget Sound market? Economists believe there is a 40 to 50 percent chance of slipping into a recession in 2008. Compared to other cities in the country many would love to be in Seattle’s current market situation. The key drivers for Seattle’s commercial real estate market are gross domestic product growth and job growth. Even though both are expected to slow moderately in 2008, it’s estimated that the Seattle/Puget Sound area will outpace a majority of the nation in both categories. According to the U.S. Bureau of Economic Analysis, Washington State has been rated in the top 10 states with the fastest growing GDP during the past 5 years. The Department of Labor states that Seattle has experienced 12.5 percent employment growth over that same period. A lot of Seattle’s economic fortune is tied to an influx of a diversified, well-educated and young employment base, activity through the ports of Seattle and Tacoma, key links to the Asian markets and a booming high-tech industry.

— Jeff Crane is a principal at The Andover Company/CORFAC International in Seattle.

Office

The Seattle metropolitan office market sustained its strong roll in 2007. Solid employment growth continued to fuel the Puget Sound economy with approximately 3 percent job growth in 2007, compared to the national average of 1 percent growth. Unemployment in the Seattle metropolitan area is only 3.8 percent.

The Puget Sound area is home to numerous Fortune 500 companies including Boeing, Microsoft, Costco, Nordstrom, Amazon.com, Alaska Airlines, PACCAR, Safeco, Starbucks Coffee and Washington Mutual Bank. It enjoys a highly diversified economy supported by strong growth in computer technology, transportation and international trade, aviation, biotechnology, tourism, and retail. The bottom line is people want to live and work in this marketplace.

Microsoft is Puget Sound’s marquee employer, with a market cap exceeding $230 billion. It is the area’s second largest employer, with more than 35,000 employees in the Seattle area and approximately 71,000 employees worldwide. In 2007, Microsoft announced plans to expand its workspace by 3.1 million square feet in Bellevue and Redmond. Their first step in implementing this plan was a mammoth pre-lease of 1.3 million square feet of space in The Bravern project (748,000 square feet in the Bellevue CBD) and Schnitzer West’s Advanta (600,000 square feet in the Interstate 90 corridor). Both of these projects are located in the Eastside suburban office market.

Lease rates for Class A office space range from $26 to $34 per square foot annually on a gross basis. Vacancy in downtown Seattle is presently at 6.3 percent. Amazon.com announced an agreement to lease a campus of up to 1.6 million square feet to be built by a partnership of Vulcan and Schnitzer West in South Lake Union; delivery is to begin in 2010. Onvia.com signed a 40,000-square-foot office lease in the Medical Dental Building.

The Eastside office market had a scorching 2007. With the vacancy rate at 4.4 percent, Class A office space rents from $28 to $35 per square foot on an annual gross basis. Besides Microsoft’s pre-lease of the 1.3 million square feet in the Bravern and Advanta projects, Expedia.com has preleased 346,000 square feet at Tower 333, Google 195,000 square feet at Lakeview Plaza and Yahoo 115,000 square feet at One Twelfth @ Twelfth – East Building.

In South King County, office lease rates for Class A buildings range from $20 to $25 per square foot on an annual gross basis, vacancy has dropped to 11.1 percent. The FAA expanded its regional headquarters, leasing 79,000 square feet in BlackRock Realty’s Landmark office project.

Investment activity remains substantial in the Puget Sound area, even with tougher scrutiny by lenders. Park Place Building, a 310,000-square-foot mid-rise in downtown Seattle sold for $373 per square foot on a 4 percent capitalization rate. Ridge Pointe, a 49,000-square-foot suburban Bellevue office building, sold for $425 per square foot at a 4 percent capitalization rate. The FAA regional headquarters building in Renton sold for $180 per square foot at a 6.4 percent capitalization rate.

Expect good leasing activity in the Puget Sound office market in 2008 even as the national economy cools. The rental rate increases will not be as steep as tenants look more carefully at expansion plans in more expensive buildings. Overall, 2008 should be another solid year for the Seattle metro office market.

— Michael Hemphill is a principal for The Andover Company, Inc./CORFAC International in Seattle.

Industrial

Seattle’s industrial market is well positioned to weather any kind of recession storm. Development activity in 2008 is showing signs of slowing from the frantic pace during the last 3 years, which included more than 15 million square feet of new high-bay, bulk industrial product that was pre-leased before project completion. The bulk of the new construction took place in the south end and Tacoma submarkets. Some of the more notable recent industrial projects include AMB Valley DC, a 766,245-square-foot development by AMB Property Corporation; Rainier Park of Industry Building 7, a 506,000-square-foot development by Panattoni Development Co.; Snoqualmie Building, a 503,534-square-foot development by Knapp Development; and Pacific Coast Corporate Park Phase II, a 501,250-square-foot development by Opus Northwest. Most of the new development is catered to larger users, but one emerging trend is the construction of divisible industrial buildings designed to be sold as smaller condo units. This product is being sold between $140 and $160 per square foot shell only and appeals to a wide local market that historically has had many potential buyers and very little product to buy.

The Seattle/Puget Sound area industrial market has experienced a tremendous amount of positive net absorption in the last 5 years, exceeding 26.7 million square feet. This absorption has not only been the driving force behind the construction, but has also contributed to the lower vacancy rates and higher prices during that same period. Industrial vacancy at year-end 2007 stood at 5.6 percent, compared with 6.2 percent at the end of third quarter 2007. Average rental rates now stand at $0.55 per square foot per month NNN; this average rental rate is a slight increase from the same period last year. Rates are expected to flatten and vacancies are expected to increase slightly in 2008.

Industrial properties tend to hold their value through a mild recession due to lease terms that average close to 5 years. Seattle has been a hotbed of industrial investment activity in the last few years, and that activity is expected to remain at those levels in 2008. Cap rates have increased slightly during the last 6 months and now average between 6 and 6.5 percent. Some of the recent notable sales include the $254 million sale of the Calwest/Walton Street portfolio, which exceeded 2 million square feet and was located in Seattle, Woodinville, Tukwila and Kent; the $29 million sale of the 413,800-square-foot Portside Industrial Building at a 6 percent cap rate; the $22.9 million sale of the 97,216-square-foot North Creek Center at a 6.25 percent cap rate; and the $20.6 million sale of the 184,707-square-foot Springbrook Business Park at a 5.75 percent cap rate.

Real estate experts expect Seattle to be the second best commercial real estate market in the nation in 2008, second only to New York City. PricewaterhouseCoopers and the Urban Land Institute surveyed more than 600 landowners, developers, lenders and other industry professionals for their annual forecast and reported that Seattle is developing into an exciting 24-hour city smack dab on key Asian shipping routes, and its brainpower economy diversifies. It also recognized the multifamily and industrial sectors as Seattle’s leading real estate markets. Together with a successful 2007 and predictions of a strong 2008, the Seattle/Puget Sound industrial market is thriving and prepared to handle any economic downturn.

— Jeff Crane is a principal at The Andover Company/CORFAC International in Seattle.

Retail

Bucking the trends of the national economy, the Puget Sound area expects to continue consistent growth of retail sales through 2008, though moderating from the unsustainable levels of the previous 3 years. The major factors for this growth are strong employment and a resilient housing market, at least when compared to the rest of the nation.

Seattle ranked 8th in the country for the highest-priced downtown retail space, with effective average rents of $48 per square foot, according to NAI Global’s 2008 Global Market report.

Not having experienced many substantial changes in the fourth quarter, the vacancy rate rose from 3.8 percent in the previous quarter to 4 percent in the current quarter, with positive net absorption exceeding 640,000 square feet, of which Wal-Mart accounted for 201,247 square feet. Rental rates continued to increase to an average of $23.17 per square foot, an increase of more than 7 percent from the previous year. The high end of the scale continues to be The Shops at the Bravern, anchored by Neiman Marcus, with asking rates of $40 to $100 per square foot.

Investors and users continue to look for opportunities in the area. Sales in the third and fourth quarters were highlighted by Touchstone KPP Development LLC’s purchase of the 260,432-square-foot Kirkland Parkplace for $60 million and Fred Meyer stores’ $49.795 million purchase of the 274,017-square-foot North Benson Center in Renton, where it is the anchor tenant. In the third quarter, there were 27 sales of projects exceeding 15,000 square feet at an average price of $194 per square foot. This compares to a total of 60 transactions for all of 2006 at an average price of $162.38, an increase of 16.2 percent.

More than 718,000 square feet of new retail space was delivered in the last quarter of 2007, bringing the total amount of new space delivered in 2007 to more than 2.44 million square feet in 65 buildings; this was highlighted by the new 537,820-square-foot Lexus dealership. Additionally, more than 5 million square feet is currently under construction, including the 554,000-square-foot Sunrise Village in Spanaway, which is one third pre-leased, and the much-publicized project in Renton called The Landing, which has pre-leased more than half of its 487,000 square feet.

The greater Seattle market continues to outpace the rest of the nation, but there does seem to be a quiet nervousness in the air as some fear the tightening of capital and the national slowdown could eventually have an effect on the Puget Sound area. However, the downtown Bellevue market seems to be shrugging off any fears as high-end retailers and restaurants such as El Gaucho, Wild Ginger, John Howie Steak and Allure Restaurant continue to flood into the Eastside. Not to be outdone, Seattle boasts the opening of the Capital Grill House, and the popular apparel retailer H&M which will open later this year.

Overall, look for Seattle to continue with solid growth in the retail sector but with a slightly more conservative approach.

— Barry Kelly is a senior associate at NAI Puget Sound Properties in Bellevue, Washington.

Multifamily

2007 was a strong year for multifamily sales in the greater Seattle area with more than $2.5 billion in transactions. Cap rates reached record lows, averaging 4.8 percent in the Puget Sound area with double-digit price increases on the sale of apartment properties for the third consecutive year. With cap rates falling, the price per unit has increased 14 percent from 2006, averaging $125,790 in 2007. The strong Seattle area economy and healthy job market is contributing to rent increases, which averaged 8.6 percent. Condo conversions and in-migration have also contributed to strong apartment rental demand, with a low 3.8 percent vacancy rate.

The recent trouble in the debt markets showed its effects in the third and fourth quarters as the average price per unit dropped to $120,000, and interest rates for commercial borrowing increased as lenders continue to price in-market risk. Condo conversions have slowed considerably, and in some cases reversions back to apartments are occurring. Expect some adjustments to pricing as a result of the current market conditions.

Rent growth continues and vacancy rates are remaining low. The Seattle area economy is strong, with low unemployment and projections for more than 40,000 new jobs added in the greater Seattle area in 2008. Due to some ripple effects of the debt markets, lenders will be more conservative on their loan underwritings, which will affect prices and cap rates lenders will be willing to finance. In-migration and a strong economy will keep rental rates increasing. Expect fewer condo conversions in 2008. Furthermore, less than 2,000 new apartment units are in the pipeline for 2008, which is a low level of new inventory, though significantly more will be added in 2009–2010.

In summary, the investment fundamentals should stay strong, maintaining Seattle’s title as a hot spot for apartment investors.

— Joe Levin works in the Private Capital Advisors | Multifamily part of Colliers International’s Seattle office.

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