COVER STORY, APRIL 2009

CBDs: RISE & FALL BUT STILL STANDING TALL
Who's moving on up and who's moving out in three key office sub-regions in the West?
compiled by Brian A. Lee

In the spirit of competition, Western Real Estate Business pitted the CBD office performance of the Pacific Northwest’s bellwether markets versus that of the Mountain West cities and their “Desert West” counterparts. Which sub-region’s downtown submarkets are still towering, which are cowering and which are showing signs of regaining momentum amidst trying economic times?

Phoenix

A view from the new Sheraton Hotel in downtown Phoenix shows construction of the One Central Park East project and the Valley of the Sun's tallest high-rise, Chase Tower.

With a brand new light-rail system, billions of dollars in private/public building projects under way and a recently unveiled marketing campaign christening it “Arizona’s urban heart,” Phoenix’s CBD is determined to shake its sleepy image.

And from all indications, the efforts appear to be working.

The submarket, traditionally home to government, financial and law offices, has rolled out the red carpet to a variety of new users during the past decade in an effort to breathe new life into an area, whose growth remained mysteriously stunted. As a result, the district is finally beginning to resemble a downtown commensurate with Phoenix’s status as the nation’s sixth largest city.

Most notable, from an office perspective, is the construction of two new high-rises, the submarket’s first since 2001. Mesiro Financial’s One Central Park East, a $175 million, 500,000-square-foot Class A office project at Central Avenue and Van Buren Street, appears on track for delivery in late fall. Meanwhile, RED Development is progressing with 600,000 square feet of Class A office space at CityScape, a mixed-use project under construction adjacent to U.S. Airways Center. Completion is scheduled for spring 2010.

The office towers join recently completed signature projects including: the Phoenix Convention Center’s 900,000-square-foot expansion; Arizona State University’s downtown campus, which presently infuses the area with 8,000 students, most of whom work, live and play nearby; a 1,000-room Sheraton hotel; a 28-acre city-owned biomedical campus; and thousands of urban residential units.

The area’s 16.7 million-square-foot base held up well relative to the rest of metro Phoenix’s office market in terms of vacancies, registering 13 percent at the end of 2008, compared to 19.1 percent overall. Asking rents, ranging from the low $20s to mid-$30s per square foot, are a bargain compared to other premier submarkets, where prices approach $40 per foot.

— Brad Anderson is senior vice president in the Phoenix office of CB Richard Ellis.

Albuquerque

The Albuquerque downtown office market continued to lag behind the rest of the city at the end of 2008, with little change appearing in the pipeline for 2009. Unlike many CBD markets, Albuquerque’s downtown seems to lack any stimulus or attraction to bring tenants downtown. Approximately 6 years ago, there was a strong effort to rebuild the city’s minor league baseball stadium in the downtown area in hopes of re-energizing the core. For many reasons, not the least of which was economics, the effort failed. Not too many years prior to that, the GSA removed its previously imposed incentives for federal buildings to go into the CBD. It appears that the downtown has never been able to recover from that change that allowed the IRS, the BIA and the FBI to spread out across the city, never to return.

At 2.7 million square feet, Albuquerque’s downtown office submarket is the second largest in the city. The fourth quarter experienced a little more than an 18 percent vacancy rate in the sector, which represents approximately 500,000 square feet. That rate might be expected to increase slightly this year due in part to Bank of America downsizing and giving back five floors of a eight-story office building that it has historically dominated.

Although downtown Class A space is reasonably available and competitively priced at $18 to $22 per square foot, full service, the perception and often times the reality of insufficient parking seems to also discourage strong tenant interest. Fortunately, most of the large banks that operate in the state, along with the two largest law firms, continue to find efficiencies in being downtown.

The city of Albuquerque is currently exploring the concept of building a $450 million multi-use performance venue, hotel and convention center to supplement the existing convention facilities. This project is currently being studied, and, if approved by the city council, it should go before the voters as early as next year. If this effort is successful, it could provide Albuquerque an economic stimulus of its very own.

— John M. Henderson, III is the chief operating officer and qualifying broker for Maestas & Ward Commercial Real Estate in Albuquerque.

Portland

At 7.6 percent at year-end 2008, Portland's overall CBD office vacancy ranked the third lowest of the top 54 metros in the nation.

Businessweek.com recently ranked Portland No. 1 in a list of 50 of “America’s Unhappiest Cities,” but last July CNNMoney.com rated Portland No. 6 for “Best Places to Live,” and, in 2006, Portland was proclaimed the most sustainable U.S. city by SustainLane.com, a green research and publishing group. What does all this mean for Portland’s CBD office submarket?

The downtown office submarket is highly desirable due to the meaningful restrictions on new supply combined with historically consistent demand growth from strong employment increases and a consolidation trend towards the CBD. Key companies locating in the downtown area, coupled with an outstanding transportation infrastructure, vibrant central core retail, and entertainment and hotel amenities, have created one of the healthiest central urban cores in the nation.

The overall CBD office vacancy was 7.6 percent at year-end 2008, ranking it the third lowest of the top 54 metros in the nation. The Class A market is even more impressive with its 5.3 percent vacancy. Given its relative limited supply, office rents have continued to rise in the CBD, even though the market is softening. At $27.07 per square foot at year’s end, rates have increased $5.15 since the low point in third quarter 2005. However, signs of the current recession are evidenced by the growing amount of sublease space — since fourth quarter 2007, its percentage of direct available space has doubled within Portland’s CBD from 19.9 to 38.7 percent in fourth quarter 2008.

Two significant office trends supporting Portland’s strong CBD is the suburban tenant influx and the lack of large available blocks of space. The migration back to the CBD was first noticed in third quarter 2008 with the renovation of the Pietro Belluschi- designed Commonwealth Building. Major tenants flocking to this building included Galois from “The Round” in Beaverton. This past quarter, State Accident and Insurance Fund relocated to 35,000 square feet at Crown Plaza. This was followed by the recent announcement of NW Evaluations’ 107,000-square-foot lease at the Port of Portland Building. The Pearl District’s 70,000-square-foot Machine Works, which opened this quarter, should see some leasing activity.

The lack of supply for large tenants coupled with the Portland CBD’s low Class A vacancy rates have driven the current construction of two new Class A office towers —the 320,000-square-foot, 23-story Park Avenue West, which captured the 157,000-square-foot pre-lease of law firm Stoel Rives, LLP; and First and Main, a 16-story, 346,000-square-foot Class A tower by Shorenstein Properties.

— Scott Madsen is a principal at Capacity Commercial Group in Portland.

Seattle

2008 saw the Seattle CBD office submarket start to reflect the national economic downturn. The vacancy rate at the end of 2008 stood at 11.01 percent (direct and sublease vacancy combined), up from 7.97 percent at the end of 2007, according to OfficeSpace.com.

During 2008, the 47 million-square-foot market suffered more than 1.177 million square feet of negative absorption. Looking ahead, expect the trend of negative absorption to continue as more than 2.6 million square feet of new space remains under construction and due for delivery in 2009-2010 with just more than 470,000 square feet pre-leased.

The Seattle market was impacted by the failure of Washington Mutual Bank, downsizing of Starbucks Coffee, and cancelled expansions by Amazon.com at the Columbia Center and by Microsoft at Vulcan Inc.’s brand new 326,000-square-foot building at 2201 Westlake. On the bright side, ING/Sharebuilder is relocating this spring from Bellevue to 130,000 square feet at the 83 King Building to backfill some of the former Starbucks space, Cisco renewed for 80,000 square feet at Martin Selig’s Third & Broad Building and Perkins Coie is in the market for roughly 300,000 square feet, while Publicis has a requirement for 60,000-70,000 square feet.

Tenants currently seeking market options are seeing lease rate proposals anywhere from 10 to 20 percent lower than 12 months ago, plus free rent being included in the proposals and significantly higher tenant-improvement allowances from landlords.

There have been no sales of any major office properties in downtown Seattle since the first half of 2008. Redwood City, California-based Legacy Partners is marketing the 101,000-square-foot Seattle PI Building and the historic/art-deco 167,000-square-foot Seattle Tower for sale without an asking price for either property.

— Rod Keefe is a first vice president and downtown Seattle office specialist with GVA Kidder Mathews.

Denver

In fourth quarter 2008, Denver’s CBD vacancy increased from 13 to 14.1 percent, but more than 1 million square feet of new space was delivered in that time period.

The unprecedented pace of change in today’s real estate industry has made tracking the state of our nation’s major CBD office submarkets a real-time exercise. Statistics and KPIs that were valid 30 days ago are significantly different today. Until recently the Denver CBD had been somewhat resistant to this trend. Now, however, the impact of the economic crisis appears to be catching up to the Mile High City.

The relative level of industry diversity in Denver’s CBD tenancy, combined with the second and third quarter 2008 strengthening of the energy sector, had insulated it from some the volatility other major CBDs experienced. In fourth quarter 2008, vacancy in Denver’s CBD increased from 13 to 14.1 percent. While certainly not a positive indicator, the change is relatively moderate, particularly when taking into account that more than 1 million square feet of new space was delivered in the same period.

A more concerning and less well-known statistic is the amount of sublease space that is or is about to become available. Businesses have now begun to face the realities of what the economic conditions mean for their space requirements, and have begun moving from a wait-and-see to a shed-cost-now mindset. This is evidenced by a jump of more than 25 percent in the amount of vacant sublease space that became available in the period.

While the statistics suggest landlords are only beginning to feel the effects of what will likely be a slow but steady erosion of face rates, the news is not all bad, particularly if you are a credit-worthy tenant. Businesses that are stable enough to commit to an additional term beyond their current one and have solid credit can be very aggressive in approaching their landlords with “blend-and-extend” scenarios. This is particularly effective in situations were the landlord has a near-term re-financing requirement, and reduced long-term cash flow is more valuable than higher short term.

Despite current conditions, Denver’s long-term outlook is relatively strong. The diversity of the tenant base, continuing investment in attracting businesses of tomorrow and Denver’s number one ranking as the city in which most Americans would want to live suggest that while not escaping the current downturn, it certainly won’t be hit as hard as most.

— Martin Woodrow and James Wachholz are executive vice president and senior vice president, respectively, for UGL Equis in Greenwood, Colorado.

Salt Lake City

During the next 4 years, more than $1.5 billion will be invested in a 10-block radius in Salt Lake City's CBD. The largest project, City Creek Center, is slated for completion in 2012.

The weakening economy has finally made some impact on the Salt Lake City CBD. In the third and fourth quarters of last year, an extra 134,750 square feet of office space became available in the downtown area, which represents a 1.2 percent increase in available space. This brings the overall vacancy rate for downtown office space up to 13.18 percent. Despite this increase, Salt Lake City’s CBD is fairing slightly better than the broader Salt Lake metro areas, with office vacancy roughly 2 percent lower than the broader market.

The CBD doing worse than it was several months ago is primarily due to the weakening economy, not a reflection of the popularity of downtown Salt Lake specifically. During the next 4 years, an investment of more than $1.5 billion will be poured into a 10-block radius in Salt Lake City’s CBD due to a handful of projects, the largest of which is the City Creek Center slated for completion sometime in 2012. The City Creek Center will primarily be made up of around 500,000 square feet of retail space in an open-air mall and around 750 planned residential units.

There is one significant Class A office building slated to hit the market in late 2009. The 450,000-square-foot project is located at 222 S. Main Street. Current asking lease rates for the property are $32 to $34 per square foot, full service, which is a substantial increase compared to the average asking Class A rate of $23.94. If the owners are able to achieve these rents, it would represent a new benchmark for office lease rates in Salt Lake’s CBD.

Because of the substantial investment being made in Salt Lake City’s CBD in the next few years, it will remain a popular place for business.

— Casey Mills is an office specialist at NAI Utah Commercial Real Estate Inc.

©2009 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.