MARKET HIGHLIGHT, AUGUST 2006

NO SETTLE TO SEATTLE MARKET
Leigh Callahan, Wilma Warshak, Joe Levin and Paul Sleeth

Seattle’s commercial real estate market is on the move. Office development is on the rise, the industrial market is stretching south into Pierce County and the Kent Valley, multifamily property values continue to escalate, and vacancy rates are maintaining their downward trend.

Office

The vacancy rate for downtown Seattle office space continues to fall, reflecting a well-performing economy. The city’s overall vacancy rate dropped 94 basis points to 10.29 percent in second quarter. The vacancy rate for the central business district (CBD) submarket, which represents nearly half of the market’s total space, is below the 10 percent mark at 9.84 percent.

Seattle’s net absorption was 327,500 square feet, bringing the year-to-date total to 992,725 square feet, well above the city’s average yearly absorption of 500,000 square feet. More significantly, the record net absorption ever recorded in the Seattle market is 1.5 million square feet (1999-2000). If the current trend continues, the previous record will be surpassed by as much as 500,000 to 1 million square feet. These are real companies making real profits under sustainable business plans, unlike the dot-com companies that contributed to the record absorption of the late 1990s. This 2-year turnaround is quickly gaining pace and will rapidly shift the market in favor of landlords in the coming year.

The majority of second-quarter absorption came from mid-size tenants (20,000 to 40,000 square feet) expanding and absorbing space in the CBD and Lake Union submarkets. With Washington Mutual Bank relinquishing so much space to move into its new downtown tower, many larger tenants took swift action to lease that available high-quality space before it was snatched up. This rising momentum continued through all class levels, spurring on a high degree of leasing activity.

At least three large local companies are seeking up to 1 million square feet apiece, combining with other office tenants looking to move or renew to comprise more than 9 million square feet of present demand. The Safeco Corporation leased 282,000 square feet at 1001 4th Avenue Plaza, which will be renamed Safeco Plaza. Safeco will take occupancy next year. In addition, Safeco leased 200,000 square feet at Second & Seneca and will take occupancy by the end of this year. These two deals combined make for one of the largest lease transactions downtown Seattle has ever seen. Safeco is vacating and selling their current tower in the University District.

Rental rates have already started to climb and will continue to do so now that the vacancy rate has reached 10 percent. The average Class A CBD rental rate is now at $27.25 per square foot, with rates in this category ranging from $20 to $35 fully serviced.

Sales activity is comparable to first quarter 2006: 13 sales with four of them exceeding $250 per square foot. The most notable was Tishman Speyer’s purchase of Market Place One & Two for $470 per square foot. These buildings, while Class A, are not mid-rise or in the CBD.

New construction in the Seattle office market includes Martin Selig’s 133,000-square-foot office building at 333 Elliott Avenue West, which is slated for completion in late 2007, and the University of Washington’s 96,000-square-foot office building on the Blue Flame – Phase II site.

— Leigh Callaghan is a senior vice president for Colliers International in Seattle.

Industrial

With the Seattle metro area continuing to move south, the Kent Valley and Pierce County have merged to create one large industrial market.

At the end of the second quarter, the Kent Valley’s vacancy rate was 5.45 percent, a number not seen since the “glory” years of 1999 to 2000. With year-to-date net absorption at more than 1.3 million square feet, it is anticipated that rental rates will rise as supply declines. Development in the Kent Valley submarket is and will be limited due to land constraints. Only two major projects are now under construction: Segale’s 440,000-square-foot Pacific Gateway in Kent and AMB’s Valley Distribution Center of 766,000 square feet in Auburn. Rental rates for these parks will be at an all-time high — close to a 10 percent increase for similar buildings in recent years.

The impending supply constraint has encouraged investors to continue paying a low cap rate for institutional-grade property, as reflected in RREEF’s sale of the Oakesdale Commerce Center West for $36.4 million ($118 per square foot).

Interestingly, the Pierce County submarket, where most of the new development is occurring, has maintained only a slightly higher vacancy rate at 5.83 percent. Net absorption is also only slightly higher at 1.37 million square feet through the first half of 2006. This indicates that the strong demand is comfortably absorbing new development, thereby encouraging developers to continue their hunt for land sites. Land prices in Sumner, Puyallup and Fife have risen with the average rate in the range of $8 to $10 per square foot. Given these rising land prices and increasing construction costs, rental rates will need to increase, otherwise development will slow. Fortunately, this appears to be occurring.

A representative sampling of projects now under construction are the following: Opus’ 505,000-square-foot Pacific Coast Corporate Park in Fife; AMB’s planned 770,000-square-foot park in Puyallup that is already almost 40 percent pre-leased; Schnitzer’s 206,000-square-foot Valley Avenue Business Park in Puyallup; Panattoni’s 411,000-square-foot Portside Industrial Park at the Port of Tacoma; and Panattoni Development’s 750,000-square-foot Rainier Park of Industry in Sumner. There is general optimism that all of this space will be absorbed within a reasonable time. In fact, more than 70 percent of the newly completed projects in first quarter 2006 were pre-leased.

With success evident in Pierce County, development is migrating even farther south along the Interstate 5 corridor. Developers are positioning themselves with sites in both Thurston and Lewis counties in hopes of catching the next wave of demand. It is anticipated that within the next 10 years, the south Puget Sound industrial market will extend as far south as Clark County.

— Wilma Warshak is a senior vice president for Colliers International in Seattle.

Multifamily

Record prices for multifamily properties continue to be posted in the Seattle area. In first half 2006, prices for the tri-county area exceeded $100,000 per unit, an increase of approximately 8 percent so far this year, on top of a 15 percent increase in 2005 and a 13 percent increase in 2004. Price increases continue to be driven by a reduced supply of apartment rental units due to condo conversions, improvements in job growth and an improving local economy. Furthermore, housing price increases in the past 2 years have made apartment rentals more attractive, with the average price for a single-family home in King County exceeding $400,000.

Condo conversions are occurring at record levels. Effectively, there is a reduced supply of apartment rentals in the market, and new construction is down. In 2005, there were more than 4,000 apartment units converted to condos, but only about 2,300 new apartment units added. This has not happened in a long time. So far this year there have been more than 2,200 units converted setting up another net loss of rental units. Recent sales of apartment properties to condo conversions are indicative of increased demand in core locations such as the Carillon Heights in Kirkland, Washington, and the Mosaic, the Jeffrey and the Oliver apartments in Seattle’s Capitol Hill area. These properties traded at record levels for apartment sales. Furthermore, condo conversion activity is prevalent throughout the area including to the north in Everett, to the south in Tacoma and Federal Way, and throughout the metro’s east side.

Apartment rents are on the rise, and rent increases are projected to continue. Vacancy rates dropped to an average of 4.6 percent in the area, down from 6.5 percent a year ago.  Seattle is experiencing an economic recovery, a trend supported by the fact that Boeing is increasing its workforce. Washington added 77,000 jobs in 2005 and is on track to produce another 95,000 this year, according to the Office of Financial Management.

Downtown Seattle is experiencing growth in residential development and increased height limits on high-rise developments. New condo development is in full swing with 5,000 units projected to be built in the next 5 years. The trend in urban living with “echo boomers” looking for affordable, close-in locations with amenities is likely to continue for some time. Investors are bullish about Seattle’s economy and its continued growth.

— Joe Levin works in Colliers International’s Multifamily Investments/Private Capital Advisors division in Seattle.

Retail

The Puget Sound’s retail investment market has remained strong through the first half of 2006, producing more than $390 million in sales in the past 6 months. The volume was driven by Opus’s $70 million sale of Federal Way Crossings, Newman Development Group’s $37.7 million sale of Burlington Crossings and Regency’s $30 million sale of South Point Plaza. Cap rates have remained at historically low levels due to low interest rates, low spreads and an unprecedented demand for retail investments.

Institutional, grocery-anchored assets and high-quality, single-tenant assets are producing cap rates in the low- to mid-6 percent range, with three assets trading below a 6 percent cap rate in the past 18 months. Roosevelt Square is the only stabilized, grocery-anchored asset to trade below a 6 percent cap rate. The center is anchored by Whole Foods and is located in a dense, infill location in north Seattle. Factoria Mall traded at a 5 percent cap rate. Located in Bellevue, Washington, the shopping center is anchored by Target, Safeway, Mervyn’s and Nordstrom Rack. The low cap rate was driven by the asset’s unbeatable location and potential upside through redevelopment. Meridian Center also traded below a 6 percent cap rate. Meridian Center is a very unique asset located in downtown Seattle and anchored by Niketown, Gameworks and Cineplex.

Cap rates have begun to level off after 5 straight years of compression due to the recent rise in interest rates. Despite the upward pressure on cap rates, the large sums of capital and high level of demand will help maintain low cap rates for top quality, institutional assets, although we may see a slight upward adjustment in cap rates for single-tenant assets and assets attracting leveraged buyers.

Multiple retail projects are currently under construction or proposed throughout the Puget Sound area. Simon Property Group is redeveloping Northgate Mall (North Seattle) and Tacoma Mall to incorporate lifestyle center additions. Tarragon Development is under construction on Phase II of the 470,000-square-foot Kent Station, south of Seattle. Westfield has begun the expansion of Southcenter Mall, and Developers Diversified Realty is planning a major redevelopment of Totem Lake Malls in Kirkland. Opus is finishing up the 225,000-square-foot Federal Way Crossings. Wesbild has completed the redevelopment of Westwood Village in west Seattle, and Kemper Freeman opened up the mixed-use project Lincoln Square in Bellevue. Harvest Partners has continued plans to develop The Landing, a $390 million urban village in Renton, which will include 800,000 square feet of retail space. Also, Pope Resources is planning a 25-acre, Costco-anchored shopping center in Gig Harbor.

— Paul Sleeth is a senior vice president for Colliers international in Seattle.

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