WESTERN SNAPSHOT , AUGUST 2005

Portland, Oregon Office Market

Medak

The national unemployment rate has decreased from 5.6 percent in May 2004 to 5.1 percent in May 2005. Likewise, Oregon has also seen significant decreases in unemployment according to the Oregon Labor Market Information System (OLMIS). The reported 6.5 percent unemployment rate in May 2005 constitutes a major improvement from the 7.4 percent rate in 2004. In fact, according to the most recent Blue Chip Job Growth rankings, Oregon placed third in the nation for year-over-year job growth, a vast improvement from its 26th ranking last year.

People from the Northwest are resilient as is the region’s real estate market. Portland’s central business district (CBD) continues to diminish its store of sublease space and is seeing positive absorption of direct space in the first half of 2005. The suburban market is experiencing significant decreases in vacancy, going from 19.9 percent in first quarter 2005 to 15.8 percent at the end of the second quarter. Class A office leasing improved greatly overall, but there are still some sore spots in the suburban market. The Sunset Corridor market on Portland’s west side hovers around 30 percent vacancy and has seen little, if any, absorption of late. Fortunately, the pressure from neighboring markets and dwindling Class A product should increase demand and may even force some entities to look to the Sunset Corridor for more economically structured leases.

Unique and dynamic are the buzzwords surrounding the Class A office leasing market today. The majority of Class A suburban office product is now controlled by one of a few national REITs. In the past, ownership of Class A office product has been more diverse. Monopoly may be too strong a term, but Equity Office Properties (EOP) owns and operates approximately 3 million square feet of suburban Class A office space in the John’s Landing, Kruseway and Washington Square submarkets. The bulk of Class A suburban office product resides in these submarkets. EOP controls nearly 65 percent of this supply, putting the landlord in a very good position to dictate price and availability of space.

Portland’s unique environment, coupled with the high quality of life residents enjoy, a well-educated work force and relatively low cost of living, continues to spur growth and demand for Oregon’s commercial real estate. The state’s July 2004 estimated population increased 1.16 percent over the 2003 estimated population. The cost of capital remains low and so does the number of bona fide, qualified investment opportunities. Cap rates still hover around 6.75 to 7 percent for well-located NNN leased investments. Likewise, the seller’s market continues even as players venture closer and closer to financing prospective properties with negative leverage. The renewed leasing strength only adds to the frenzy of buyers chasing too little space for sale.

Though there has been little to no new construction in 2005, firming lease rates and the scarcity of large, contiguous office space has set developers’ sights on future construction in 2006 and 2007. The challenge to developers right now is the increase in already high construction costs, as well as the just-recovering lease rates. Current average rental rates for Portland’s CBD and suburban markets are around $23 to $28 per square foot and $20 to $22 per square foot, respectively. Developers are looking for rates near $30 to $35 per square foot and vacancy rates below 12 percent before new construction becomes a viable option.

Nevertheless, many landlords have not fully recovered from the wave of concessions and lack of absorption in the past 9 months. Fortunately, the end is in sight, and the storm has finally receded. Tenants are again seeking additional space. Companies are taking advantage of record-low interest rates to acquire new facilities. Tenants that would otherwise not choose to relocate due to favorable renewal lease terms are being wooed by several landlords, receiving unsolicited proposals and reshaping the available supply of office space. Older, more antiquated buildings are being vacated for newer, more efficient facilities at the same or comparable rent. Recovery is in sight, but office leasing is still quite competitive. Landlords will breathe a bit easier when overall vacancy drops below 12 percent and absorption occurs at an aggressive rate.

Jennifer Medak is an associate vice president at NAI | Norris, Beggs & Simpson in Portland.

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