MARKET HIGHLIGHT, AUGUST 2008

SEATTLE
Chris Moe, Rolland Jones, Eric Davis, Marty Leith and Jim Kidder

Caution seems to be the buzzword in Seattle’s commercial real estate circles as the fundamentally strong bellwether of the Pacific Northwest adjusts to a new playing field. Well-planned projects though are still finding quite fertile soil in the Emerald City.

Office

While Seattle’s office market began the year singled out as the strongest in the nation in terms of supply and demand stability, there is an uneasy feeling among leaders in the business community.

On the surface, Seattle appears to be the model of success for large institutional investors that have come in droves to invest their capital in the Puget Sound area during the past 3 years. More than half of Seattle’s Class A office inventory has changed hands in that time. Average office rents have climbed by nearly 50 percent in that same period. But economically, this is a curious time. Demand/absorption is still positive, but there is a big psychological cloud hanging low over this market. People are spooked, mostly by the headlines (including news that insurance giant Safeco has been sold to Boston-based Liberty Mutual Group), a little by their neighbor’s house that won’t sell, some by the fact that our unemployment rate in Washington has exceeded 5 percent for the first time in 20 months, and by comparing their income against housing prices and wondering “where is the correlation?” The answer is: don’t bother to look for one because there isn’t one.

Based on the number of Class A office projects currently under development with expected delivery dates in 2009-2010, inventory will grow by an additional 3.6 million square feet, which would increase the overall market size by almost 6 percent to approximately 64.6 million square feet. Couple that with another 1.25 million square feet of second-generation space that will be vacated by some of the region’s largest companies and it is no wonder that confidence in the Seattle office market is in question.

Annual absorption has averaged approximately 1.4 million square feet during the past 3 years. The relentless reminders that Starbucks Coffee, Washington Mutual and likely Safeco will continue to shed more space fuel additional speculation that office vacancy may begin to creep upward from the current 6.7 percent level.

The silver lining on this low-hanging cloud is that the institutional ownership groups that control the majority of the downtown market have a conservative global perspective. During the last up-cycle in the market, developers built large buildings and entered into leases with some very high-risk, venture-backed companies that, in the end, simply dried-up and left those landlords holding the bag. This new cartel of institutional owners has not only raised rates but has carefully scrutinized the credit of tenants and heavily securitized higher risk leases. As a result they are well positioned to weather a downturn in the market.

— Chris Moe is a senior vice president with GVA Kidder Mathews, specializing in downtown Seattle office properties.

Retail

The Pacific Northwest’s regional economy remains strong even after being impacted by the national and global economic trends. Unemployment is up to 5.3 percent in the region. Housing sales have also slowed, however, sales prices have increased slightly. Most retailers’ sales have increased although across-the-board sales have been flat, since auto and furniture sales are down, due to rising fuel prices and fewer home sales, respectively.

Questionable shopping center projects are now being placed on hold or have become staged developments, while well located, designed and tenanted centers are going forward. Well-placed neighborhood centers continue to be planned and developed, though some neighborhood centers have been impacted by Wal-Mart Supercenters and Winco Foods, causing nearby grocers to close or reposition. This has resulted in large vacancies in a few neighborhood centers.

Regional and community centers have also seen a few more vacancies, which has caused some retailers previously suffering from poor sales to close stores, while others are taking a more cautious approach to expansion. National retail apparel chains have slowed, bypassing most community center opportunities.

Regional malls continue adding lifestyle components. At Southcenter in Tukwila, Washington, a second lifestyle component could be added to the north side of the mall after one was just added to its south side. Neiman Marcus has inked a deal to open its first Pacific Northwest location in The Bravern across Lake Washington in Bellevue. Restaurant and luxury retail leasing is making progress at Schnitzer West’s The Shops at The Bravern. Kemper Development Company is remodeling Bellevue Square, and is planning on increasing the already successful Bellevue Collection with a luxury addition.

Successful retailers continuing to expand in the Seattle area are Ace Hardware, Barnes & Noble, Bed Bath & Beyond, Best Buy, Costco, Fred Meyer, Kohl’s, L.A. Fitness, Staples, Target, The Sports Authority, Wal-Mart, Whole Foods Marketplace and Winco Foods. Active developers in the region are Schnitzer, Kemper, Powell Development Company, TRF Pacific, Simon Property Group, Tarragon Development, Urban Retail Properties, Wesbild, Westfield Development and White-Leasure.

The area’s hot submarket is Covington, southeast of Seattle, with a new Kohl’s, The Home Depot, Costco and a proposed Target. Bellingham, Washington, retailers are doing well with shoppers from Vancouver coming south for value purchases. The difficult submarkets, such as Federal Way, Washington, are where the retail has been divided into two distinct areas.

Investment sales have slowed —higher cap rates are being dictated by the national economic conditions, while sellers still think that their properties are worth more given the lack of local retail space. Asking rents have not yet declined in the Seattle area with small shop space going anywhere from $20 per square foot in economically depressed areas to $35 for first generation space to $50 per square foot in secondary locations of downtown Seattle. Larger retailers are in the $12 to $30 per square foot range, depending on location and whether it’s first- or second-generation space.

— Rolland Jones is a senior vice president and head of the Retail Specialty Group with GVA Kidder Mathews.

Multifamily

The Seattle multifamily market continues to post high prices and low cap rates in 2008. Many of the leaders in the multifamily industry consider Seattle to be one of the nation’s best cities for development. However, not all is green in Seattle with sales volume 70 percent below the peak of summer 2005. Currently, the market is averaging 20 sales a month, a decade low.

The average price for existing product for in-city Seattle is $189,021 per unit and $265 per square foot. Cap rates are the lowest in the region, averaging 4.1 percent for 2008. Deals are more difficult to put together with what seems to be a disconnect between the buyers’ and sellers’ pricing expectations.

Seattle’s market fundamentals remain extremely strong in one of the nation’s dynamic regions. According to the Bureau of Labor Statistics, the Seattle metro area ranked fourth nationally among large cities for job growth in the past year, equating to 33,800 jobs in that timeframe. The region’s corporate headquarters of international headliner companies continue to do well; Amazon, Boeing, Costco, Microsoft, Nordstrom, Paccar and Starbucks Coffee all reside in the area.

The Seattle area is rapidly expanding with a limited supply of apartments, resulting in vacancies below 4 percent. In 2008, developers will begin renting 1,700 new units. 2008 will be the first year since 2003 that developers added more apartments to the market than converters took out. It is expected that 10,900 units will be added between 2008 and 2010. New construction will continue to push rents, with some developers needing $2.50 per square foot for their new projects to financially pencil.

Centrally locating in city land has been very expensive for developing mid-rise construction. Developments are taking place outside the city’s central business district. Legacy Partners is developing a 247-unit apartment project called Legacy at Pratt Park in the city’s central district. The majority of the multifamily development activity in Seattle is around the South Lake Union and Denny Triangle areas. One of the more notable projects in the area is 27-story, 216-apartment The Olivian, scheduled to be completed in 2009. Many new in-city developments are designed to appeal to the Generation Y, who are now entering the rental market.

The Seattle multifamily sector has been very resilient while other areas of the country have struggled through the credit crisis and tough economic times.

— Eric Davis and Marty Leith are senior associate and associate vice president, respectively, for GVA Kidder Mathews in Seattle.

Industrial

New warehouse/distribution buildings are moving south. Other than a few exceptions in the Kent Valley, most new construction will be happening in Pierce, Thurston and Lewis counties. Due to higher real estate prices and a lack of available zoned land, industrial development will continue to move south and, on a smaller scale, north of Everett, Washington.

Vacancy close to Seattle remains low at 3.25 percent. The Kent Valley’s vacancy is lower than it has been for a long time at 4.54 percent, East King County 6.23 percent, Snohomish County 6.02 percent and Pierce County 7.14 percent. The higher vacancy in Pierce County is reflective of approximately 2.5 million square feet of new construction.

Opus Northwest, First Industrial Realty Trust and Panattoni are the prominent developers in this southward expansion. In Fife, Washington, Opus has just completed Pacific Coast Corporate Park I & II with 886,000 square feet spread across three buildings. Panattoni has been successful with its development of the Rainier Park of Industry in Sumner, Washington — 11 buildings on 85 acres for a planned total of 1.5 million square feet of distribution space. First Industrial has two significant developments — the 45-acre First Park Meridian Campus in Lacey offering build-to-suit lease or for-sale properties and First Park Northwest Landing in DuPont consisting of 248 acres that can accommodate uses from retail to warehouse distribution.

Panattoni recently sold 204,458-square-foot Auburn Park 44 to Black Rock Realty Advisors; going for nearly $18 million at a 6 percent cap rate, the distribution building was occupied by Belshaw Brothers, Goodyear Tire and Pacific Cascade. AMB completed a 500,000-suare-foot lease deal at Valley Distribution Center to Excel Logistics.

Big tenants will continue to look further south to keep their warehouse rates low. Vacancy should remain low through the end of 2008; absorption may slow until after the fall election.

— Jim Kidder is senior vice president with GVA Kidder Mathews.

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