WESTERN SNAPSHOT, DECEMBER 2006

Honolulu Office Market

Brown

The city and county of Honolulu encompass Oahu, Hawaii’s most populated island, and is home to 75 percent of Hawaii’s population of 1.2 million. Honolulu’s Class A and B, multi-tenant office market comprises 68 buildings that total approximately 10.9 million square feet.

Honolulu has three main industries: tourism, construction and government (city, state and federal including Army, Navy, Air Force and Marine bases). The city’s office market is very concentrated with the 3-mile corridor between downtown and Waikiki accounting for 82 percent of the island’s inventory; the central business district’s inventory represents nearly half of the island’s inventory.

Supply & Demand

Honolulu’s multi-tenant office market has seen no new inventory since First Hawaiian Center was completed in 1996. In the urban core where any new construction would be high rise, current rental rates are far below those necessary to justify new office construction. As a result, many potential office-building sites are under construction as high-rise residential condominiums. Office developers need full-service rental rates somewhere in excess of $6 per square foot per month to justify new construction in the urban core and closer to $4.50 per square foot for the suburban markets. In other words, rents will need to more than double in the urban core before the submarket sees new supply. One potential exception is in an urban submarket called Kakaako where a 300,000-square-foot life sciences building is planned for biotech companies.

Other potential new office building supply is in the suburban markets of Kapolei in the southwest corner of the island and Mililani Tech Park in the center of the island. With much lower land prices than the urban core and lower construction costs due to lower-rise structures, four developers — Maryl Group, Avalon Development, Kahl & Goveia and Davenport Partners — are planning about 700,000 square feet of spec office space, which, if all built, will more than double that submarket’s inventory. In hopes of securing an anchor tenant, they are courting several large tenants currently occupying significant blocks of space in Honolulu’s urban core.

Honolulu’s office users support the city’s three main industries. Given that tourism, construction and government have been growing since 2004 and there’s been no new supply of space, office vacancy has been steadily declining. Office growth has been coming mostly from existing tenants such as Hawaiian Electric and American Sav- ings Bank as well as several smaller technology companies such as Oceanit and Nanopoint, which were spurred by Hawaii’s technology tax credits.

The vacancy decline has been most pronounced in the larger space segment. As of late October 2006, there were 340 distinct office vacancies in the market, and only 14 of them were 10,000 square feet or larger. However, while large tenants have a difficult time finding alternatives, there are still plenty of alternatives for the typical-sized tenant of 3,000 square feet and smaller.

Rental rates bottomed out in 2002 but have seen a steady increase since the island’s tourism, construction and government industries have expanded. Annual rental rate increases are now the norm, free base rental periods are virtually gone and tenant-improvement allowances have been reduced. The average asking, full-service gross rental rate for upper-floor Class A space in the CBD has increased 50 cents since 2002 to $2.88 per square foot, with 5 percent annual increases on the base rent portion.

New Owners

Two large office players have made large bets on the Honolulu market since 2004. The Shidler Group had owned several small Class B office buildings before purchasing two of the market’s 13 Class A office buildings, Davies Pacific Center and Waterfront Plaza, for $131 million and two Class B office buildings, Pan Am Building and First Insurance Center, for $78 million. With these acquisitions, The Shidler Group became Hawaii’s largest office building owner with 16 percent of the Class A market and 13 percent of the island-wide market.

Douglas Emmett Group, a Southern California-based office building owner, entered the market in 2004 with the purchase of two Class A office buildings, Harbor Court and Bishop Place, for $167 million. The acquisitions gave the company 13 percent of the Class A inventory and a much larger share of the vacancy, most of which has been leased.

Looking Forward

With no new supply in the urban core, suburban supply in the planning stages, continued job growth and rents nowhere near urban replacement costs, Honolulu’s office market is poised for an interesting next several years. On the one hand, some landlords expect rents to increase dramatically, while others point to extremely low unemployment — the lowest in the country at less than 3 percent — and the national economic slowdown as limiting demand.

Jamie Brown is president of Hawaii Commercial Real Estate LLC.

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