MARKET HIGHLIGHT, AUGUST 2007

SEATTLE’S SLEW
Leigh Callaghan, Eric Davis, Scott Alan and Rolland Jones

Riding strong job and economic growth, Seattle and the Puget Sound market in general are in very high demand. Vacancies are going down and rental rates up as developers, investors and tenants search for their own jewel in the Emerald City.

Office

The Puget Sound office market remained vibrant in all aspects as the halfway mark for 2007 came and went. Seattle’s overall vacancy rate at the end of the first quarter stood at 8.54 percent and the central business district (CBD), which comprises nearly 50 percent of the market’s office space, saw a vacancy rate of 8.68 percent, down from 10.22 percent 1 year ago.

The east side’s overall vacancy rate ended the first quarter at 6.54 percent, and absorption was 191,000 square feet. Bellevue’s CBD vacancy rate was very low at 4.5 percent and is anticipated to continue downward even as new construction becomes available. Despite negative office absorption in Seattle during the first quarter (-26,000 square feet), the flurry of tenant activity in the market during the second quarter will more than compensate.

Two events stand out that will have a significant and potentially long-lasting impact on the office market. First, Microsoft announced that it will lease 1.3 million square feet of office space in Schnitzer West’s The Bravern and Advanta projects, currently under construction on the east side. While Microsoft’s commitment will not affect the current vacancy in the area, it will influence the direction of future rents and development.

Secondly, in one of the biggest and most complicated portfolio sales in history, Equity Office Properties, the largest holder of office properties in the country and the Puget Sound, was purchased by Blackstone Group LP. Blackstone immediately flipped the local portfolio to Beacon Capital Partners, which in turn sold a majority of the properties to other parties. Some of the properties changed hands as many as five times in the 4 months following the Blackstone acquisition, with each buyer paying more than the previous. Requiring a higher pro forma rent to meet their targeted returns, the new landlords raised asking rates. Virtually overnight, the Bellevue and Seattle CBDs saw rental rates skyrocket as much as 30 percent to more $45 per square foot in some instances. This new market reality is still working its way through the area, leaving in its wake many disgruntled tenants.

With rental rates continuing to increase and vacancy rates remaining low, development has continued and new buildings are in the works. Two new office buildings in Seattle came under construction this quarter with no pre-leasing: the Touchstone Corporation’s 480,000-square-foot West 8th project and Schnitzer West’s 230,000-square-foot 818 Stewart project. These projects, along with 12 others that are already under construction, will come online in the next 18 to 24 months. Bellevue currently has 3.9 million square feet of office space under construction, 2 million square feet of which is set to deliver in 2007.

As a result, the look forward to 2008 is bright. The combination of Microsoft’s enormous lease, the record-breaking Equity portfolio sale and the area’s overall bustling real estate activity means the prospect of a softening market has all but been eliminated, putting landlords in the driver’s seat.

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

Multifamily

The greater Seattle/Puget Sound market is considered one of the premier and dynamic multifamily markets in the nation. According to a recent national poll by PriceWaterhouseCoopers, which surveyed national executives and investors on the most desirable investment market, Seattle/Everett/Tacoma ranked 4th. There is a positive outlook on all factors affecting the multifamily market that has many investors buying at low cap rates and looking forward on rents and returns.

The local economy is extremely strong with corporate headquarters of international companies nestled amidst the beauty of the Pacific Northwest. Amazon, Boeing, Costco, Microsoft, Nordstrom, Paccar, Starbucks Coffee and Washington Mutual all call the area home. It is anticipated in 2007 that the market’s employment growth rate will be three times the national average. In 2006, the area added 60,000 new jobs, and it is anticipated that 47,000 new jobs will be created this year. Washington state’s unemployment rate hit an all-time low in March 2007 at 4.6 percent. Seattle currently ranks Number 7 nationally for absolute job production and Number 8 for job production percentage growth rate.

The Seattle/Everett/Tacoma area is still experiencing a limited supply of multifamily units similar to 2006. In 2007, the market will open 2,543 new apartment units, and conversions already total 1,849 units this year. The reduction in supply is for two reasons, condominium conversions and rising construction costs leading to fewer opportunities. Land values and construction costs have risen 30 percent in the last 12 months.  Developers are finding it difficult to make the numbers work on new construction with rents in most cases having to exceed $2.25 per square foot. Condo conversions in the market are still prominent unlike the rest of the nation.

Recent sale transactions have surpassed previous records in the Seattle/Bellevue market and are up 12 percent from last year. In May, United Dominion Realty closed on the 71-unit Borgata Apartments in downtown Bellevue for $31 million, a state record of $436,619 per unit. In downtown Seattle, the 199-unit Amli 535 sold for $61.05 million ($306,784 per unit). Core Seattle products average 4.41 percent cap rates while core Bellevue deals average 4.51 percent cap rates. Currently being marketed is a three-building portfolio of 293 units of core University District properties in Seattle for $73 million ($249,147 per unit). Cap rates are at historic lows because investors are bullish on Seattle’s economy and predict rents to climb faster than expenses.

According to local apartment rent and vacancy expert Dupre+Scott, the Puget Sound multifamly vacancy rate is 4.3 percent. Bellevue, the second largest city in the area, is booming with multifamily and office development and has an average vacancy rate of 3.2 percent, and no concessions are being offered. These low vacancy rates are a result of continued job growth, rising home prices making renting more attractive and units lost to condo conversions.

The Puget Sound area and the city of Seattle are in midst of a never-before-seen multifamily market. Low vacancies, rent growth and a dynamic, growing local economy creating thousands of new jobs have created a powerful performer in the Pacific Northwest. This leads to record-selling prices and unprecedented low cap rates.

— Eric Davis is an investment associate with GVA Kidder Mathews in Bellevue, Washington.

Industrial

For the first half of 2007, the Puget Sound’s industrial market reflects similar trends as the area’s office market: vacancy continues to decrease and rental rates are climbing. Overall, the market vacancy rate ended first quarter at 6.36 percent and net absorption was 1.7 million square feet. Rental rates are likely to rise as demand outstrips supply for spaces less than 100,000 square feet. For larger spaces — those exceeding 150,000 square feet — downward pressure on rental rates is evident. This trend is the result of most activity occurring in the 20,000- to 50,000-square-foot range instead of the larger users seen in recent years.

The Seattle industrial leasing market has been very active, and vacancy is at its lowest in more than 3 years. Boeing Corp. gobbled up 149,115 square feet of space at Harbour Pointe Tech Center in Mukilteo. In the Kent Valley, activity and absorption remain above average with increased rental rates up as high as 10 percent in the 20,000- to 50,000-square-foot range, the largest spike ever seen. Currently, the largest vacancy in the Kent Valley submarket is Segale Properties’ 434,000-square-foot Pacific Gateway Business Park, Building 2, with a 250,000-square-foot lease pending with The Home Depot.

Seattle’s east side had another strong first quarter as well. Total vacancy dropped, there was positive absorption and leasing activity was strong. The stable strength of the local economy has fueled this increased demand for space, while at the same time few new buildings have been built to increase inventory. Warehouse space with office is being leased quickly.

On the investment side, available product is in high demand as the number of sales throughout the market remains strong. Finding enough product for the amount of interest has been difficult. Notable transactions for the first half of the year include the purchase of Oakesdale Business Campus in Renton by Principal Real Estate Investors for $56 million ($94 per square foot), which included four buildings totaling 594,032 square feet. Also, Associated Grocers sold its 55-acre property in South Seattle for $91 million ($88 per square foot).

Smaller users were also active in the investment market, especially in South Seattle and the Kent Valley. In May, the 79,229-square-foot Amway Building in Kent went to the local partnership Medina Fund LLC for $5.75 million ($72.57 per square foot). The Dempsey Family Trust sold its 5.23-acre MacMillan Pipe site in SODO, south Seattle, for $13.5 million ($59 per square foot land). The Georgetown neighborhood, also in south Seattle, saw rising prices — a 35,000-square-foot piece of land with a 10,400-square-foot building sold for $2.1 million or $60 per square foot.

New construction in the Seattle market is minimal, and the lack of new supply could drop the overall vacancy rate even further over the course of the year. If that happens, look for rental rates to continue upwards until space is built to relieve the pressure.

— Scott Alan is a senior vice president for Colliers International in Seattle.

Retail

Current retail trends vary in the Seattle market. In stark contrast to the previous de-malling trend, all of the malls in the area have either recently added exterior space or are under construction or planning exterior expansion with lifestyle tenants and restaurants. Elsewhere, many local governmental design standards are dictating that retail development have a village-style, vertical or mixed-use format.

Having one of the lowest retail square footage ratios in the nation has resulted in a low vacancy of 3.8 percent in the Puget Sound market. Rental rates in Seattle’s CBD are $35 to $75 per square foot and $20 to $40 per square foot in suburban, grocery-anchored centers.

Well-located, available neighborhood centers are in limited supply and highly desired by both local and national investors. As a result, first half 2007 is comparable to 2006 with properties in excess of $5 million being sold at cap rates from 5.8 to 7.2 percent.

The Puget Sound market is bounded by mountain ranges and bodies of water running north and south. This has caused growth of both residential and large box retail to primarily follow the freeways to such areas as Marysville, to the north, and Puyallup, to the south.

The high-income residents of the east side have driven new and expanded projects focused on a more upscale lifestyle. Downtown Bellevue’s The Shops at The Bravern project with a 125,000-square-foot Neiman Marcus, luxury retail and restaurants is under construction. The greatest concentration of high-volume restaurants and retail is the Bellevue Collection owned by Kemper Development, which is being further expanded to include luxury retail, a spa and a boutique hotel.

The Renton Lakeshore Landing featuring Target, Regal Cinemas, LA Fitness and Staples is under construction by Harvest Partners. Nearby, the largest concentration of retail in the market is being expanded with Southcenter Parkway’s project by Mon Wig under construction, adding Kohl’s, Nordstrom Rack and DSW Shore Warehouse. In addition, Westfield’s Southcenter expansion is underway adding 400,000 square feet of restaurants and shops on the first floor, Borders Books & Music and a food court on the second floor and AMC Theatres on the third level. Northgate Mall has removed a hospital and theater and is now under construction with an 116,000-square-foot addition featuring a very prominent Barnes & Noble and several restaurants.

Other active developers in the Puget Sound market include TRF Pacific, Powell Development, Opus Northwest, Westbild Shopping Centers and P.O’ B. Montgomery. Some of the most active tenants making deals recently are Wal-Mart, Kohl’s, Target, Whole Foods Market, L.A. Fitness and Ace Hardware. Recent purchases of retail investment properties have been made by Kimco Realty, Inland Real Estate, Passco Companies, Barclays and Phillips Edison & Co.

The future of Seattle’s retail market does not indicate any slowdown, only steady continued activity as the Puget Sound area has a strong employment base with many promising years of growth ahead.

— Rolland Jones is a vice president for GVA Kidder Mathews in Seattle.


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