MARKET HIGHLIGHT, APRIL 2009

SEATTLE
Greg Laycock, Craig Hill, Brian Dennehy and Jane Lanford

The recession that many hoped Seattle could deftly sidestep has struck — and it isn’t pretty. Unemployment is rising, home prices are falling and blue-chip employers are tightening their belts. All commercial property types in the Puget Sound area are getting hit to one degree or another, and the shakeout will likely continue through 2009 and into the beginning of 2010. Although Seattle is still better positioned than most to weather this downturn, it will be a difficult year for the commercial real estate industry nonetheless.

Multifamily

Multifamily outperformed all other commercial property sectors in the Seattle metropolitan area during 2008. Due to the housing downturn, healthy population growth and a limited supply of new product, vacancies were kept near historic lows across the Puget Sound area, and rents notched significant increases from 2007. The market, however, began to soften in fall 2008 due to significant layoffs by key local employers such as Boeing, Microsoft, Washington Mutual and Starbucks Coffee.

For the past 6 months, vacancy has been increasing as tenants pushed back against rent increases and the housing market became more affordable. Seattle home prices are now back to levels last seen in October 2005, according the S&P Case/Shiller Index. Prices have now fallen 16.7 percent since the peak in July 2007, and most economists predict further declines before the market stabilizes. As home and condominium prices decline, sellers of these properties are forced to rent out their properties to receive some cash flow.

Other signs of softening abound. More owners are offering rent incentives, rents are flattening and capitalization rates are rising.  During the past 8 years, cap rates were pushed down from 8 to 4.4 percent by low interest rates and significant projected rent increases. Now, with financing tight and rent increases largely out of the picture, cap rates are naturally feeling upward pressure. Cap rates averaged an historic low of 5.1 percent during 2008, but in the past several months they have begun a steep ascent and now average above 6 percent.

All the news is not negative, however. According to the Emerging Trends in Real Estate 2009 report by PricewaterhouseCoopers and the Urban Land institute, the Seattle multifamily market is the best in the nation. Despite the downturn in the local market, it is still outperforming most other major metro areas in the country. Although sales volume will be depressed this year, look for private capital to cherry-pick distressed assets and re-priced properties being brought back to market as building owners continue to feel the squeeze of the economic downturn.

— Greg Laycock is a senior vice president with Grubb & Ellis.

Office

Vacancy increased markedly during fourth quarter 2008, driven upwards by a spate of new building completions amidst flagging business demand for office space. Climbing 110 basis points to 11.6 percent, vacancy rates posted their sharpest quarterly jump in 6 years and have now reached levels not seen since the beginning of 2006. The office sector entered the new year buffeted by a strong headwind of negative economic developments and daunting supply-and-demand dynamics.

Naturally, the softening market has depressed asking rates: downtown Seattle rates have now been declining since the beginning of 2008, creating opportunities for tenants and headaches for owners. Asking rates in Bellevue, meanwhile, have remained essentially static, halting a 4-year trend of hefty quarterly increases.

With the Puget Sound Economic Forecaster predicting a 2.4 percent decline in regional employment during 2009, these trends will continue — and possibly accelerate. Seattle will almost certainly experience annual negative net absorption for the first time since 2002, significant increases in vacancy and further drops in lease rates. Class A asking rates in downtown Seattle will sink down to nearly $30 per square foot on average by the end of the upcoming year, while vacancy should surpass 15 percent.

A wave of speculative office space will hit the market this year, most with little or no pre-leasing activity. Still with no signed tenants, 1918 Eighth, a 660,000-square-foot downtown office building being developed by Schnitzer West, was due for completion later this year. Forced to compete for a limited supply of cautious tenants, these new projects will have to compromise on lease rates and offer generous concessions in order to fully lease up the space. Free rent and tenant-improvement allowances may reach their highest levels since the dot-com bust.

— Craig Hill is a senior vice president with Grubb & Ellis.

Industrial

Vacancy crept up during fourth quarter 2008, increasing 10 basis points to 6.5 percent. The availability rate, however, which often leads the vacancy rate, jumped 120 basis points to 9.9 percent. Effective rates (average lease rates after deducting concessions such as free rent, etc.) have been declining for several months due to increased owner concessions. Sales have remained relatively flat, although a spate of transactions in December pushed the fourth quarter total to 16 deals worth $174.2 million. Although the national industrial market continues to deteriorate, the local Seattle market seems to be holding up better than most.

The development pipeline has thinned considerably — a sign that developers anticipate weaker demand during 2009.  Seven new buildings totaling 662,647 square feet were completed during fourth quarter 2008. Benaroya Business Park Building A, an owner-occupied warehouse in Sumner, was the largest completion of the quarter at 264,282 square feet.

Several encouraging signs emerged during 2008 for the Seattle industrial sector. In its Emerging Trends in Real Estate 2009 report, PricewaterhouseCoopers and the Urban Land Institute ranked Seattle the best investment market for industrial properties due to its status as a premier “gateway city” — a large metropolis inextricably embedded within global trade routes. As such, trade volumes, the life-blood of warehouse/distribution properties, have declined less than most other regions. As of January, year-over-year trade volumes are down 15.9 percent at the Port of Tacoma and 5.7 percent at the Port of Seattle — hardly encouraging figures, but far from disastrous.

Vacancy will likely continue with a measured increase during the next several quarters accompanied by a plateau in asking rates. R&D/flex space, sensitive to trends in Seattle’s biotech industry, will feel the softening more acutely, as will suburban areas away from the major transportation corridors.

— Brian Dennehy is a senior advisor with Grubb & Ellis.

Retail

The local retail market has been hampered in the past six months by the dramatic drops in consumer confidence and spending seen nationwide. This trend is epitomized by Nordstrom, the local high-end clothing retailer, which significantly scaled back expansion plans for the upcoming year and shifted its focus towards Nordstrom Rack stores, which are typically more discount oriented.

Relationships between tenants and landlords — and the leasing environment more generally —have become more contentious as both parties are squeezed by the economic downturn. A recent dispute between Whole Foods Marketplace and the developer TRF Pacific over a lease in the Interbay neighborhood of Seattle highlighted the risks both tenants and landlords face in the current environment (and the willingness of landlords to wield the power of the lawsuit).

The uphill battle continues for the retail investment sector. Property sales totaled only $30 million in fourth quarter 2008, the lowest dollar volume since third quarter 2001. However, retail properties have begun trading hands more briskly in 2009, with $60 million in transactions through the first 2 months. Investors are looking closely at grocery-anchored retail as a good bet to ride out the recession, as evidenced by the January purchase of a single-tenant H-mart grocery store in Lynnwood by a developer for $14.9 million.

Several retail developments are still proceeding through the pipeline in the hopes of being completed in time for the rebound. The Kirkland Parkplace mixed-use project recently had its plans, which include 600,000 square feet of retail, approved by the Kirkland city council. The developer, Touchstone Corp., believes that construction could begin by early 2010. The Bravern mixed-use project, being developed by Schnitzer West, should be completed by late summer and will feature the first Neiman Marcus, Jimmy Choo and Hermes stores in the Pacific Northwest.

— Jane Lanford is a senior vice president with Grubb & Ellis.

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