MARKET HIGHLIGHT, FEBRUARY 2005

PORTLAND REAL ESTATE: COMING UP ROSES?
Lindsay Gordon and Skip Rotticci

Well known for its natural beauty, livability and cultural variety, Portland also boasts a relatively diverse and rapidly recovering economy. During the last decade, Portland moved measurably away from its economic reliance on timber and natural resources and focused heavily on the recruitment of high technology. Significant high-tech companies — Intel, IBM, Hewlett Packard, Sun Microsystems and Xerox — responded by acquiring, expanding or initiating operations in the metropolitan area. These industry leaders and small, local firms have caused the formation of a significant technology community, located primarily on Portland’s west side.

After the last few years, Portland’s high-tech sector is thankfully not the only influence on the city’s economic landscape. Through the economic downturn, the City of Roses faced many challenges, not the least of which was high unemployment. Nonetheless, Portland, in 2005, enjoys a relatively broad range of corporate citizenship, including the new, fast-growing regional banking and financial software arenas. Industry clustering by apparel, healthcare, aircraft parts and truck manufacturing, and home video companies is a distinct part of Portland’s business makeup. Nike, Columbia Sportswear, Adidas America and Reebok USA; Legacy Health System and Kaiser Permanente; Boeing, Gunderson, Precision Castparts, and Schnitzer Steel; and Hollywood Video and Rentrak all have their central or regional headquarters in Portland.

All signs point to a continued economic recovery for Portland in 2005. Despite a high unemployment rate, people continue to relocate to the area for its high quality of life and relatively low cost of living. Oregon economic experts are forecasting employment gains of 2.1 percent in 2005 and 1.8 percent in 2006. As employment picks up, so should demand for all types of commercial space in the Portland area.

Office

The Portland metro area comprises 60 million square feet of office space, 14 percent of which was vacant at year-end 2004. It appears that the bottom of the market was reached in the summer of 2003 when vacancy hit a high of 18 percent. Leasing activity throughout 2004 was strong with more than 1.4 million square feet of net absorption. The General Services Administration had the biggest impact on the market, signing four leases totaling more than 160,000 square feet of space. The two largest transactions in the Portland metro area were Nautilus’ 482,000-square-foot lease at The Columbia Tech Center in Vancouver, Washington, and Nike’s lease of 105,000 square feet at The Rogue Building, part of IBM’s campus, adjacent to its headquarters campus in Beaverton, Oregon.

Major office development activity in 2004 was limited to 19 smaller suburban properties, totaling a modest 600,000 square feet of space. The largest project was the 108,000-square-foot Vancouver Center, a building developed in the heart of downtown Vancouver. Cranes are currently in the air on the perimeter of Portland’s central business district (CBD) for the build-out of the South Waterfront development, a mixed-use project anchored by the expansion of Oregon Health and Sciences University. Overlooking the Willamette River, this development will feature residential condominium living just minutes from downtown, as well as retail and office space. A unique feature of this development will be a mile-long aerial tram connecting the property to the main Oregon Health and Sciences University campus in the west hills.

The Kruse Way Corridor, located just 10 miles south of downtown Portland, is the strongest office submarket. Consisting of more than 2 million square feet of office space, the corridor has a vacancy level of just 8 percent. Equity Office Properties dominates this submarket and has done site preparation for a 125,000-square-foot Class A building scheduled for construction this summer.

With Class A office rents averaging $18 to $24 per square foot in most submarkets, major new development will be slow. Rents exceeding $30 per square foot are required in most cases to kick off a new Class A development. With that being said, expect the CBD and major suburban submarkets to see rents climb substantially in the next 2 years as expanding businesses begin, once again, to compete for space in a tightening market.

Total office building sales activity increased in 2004 from the prior year. In the first 9 months of the year, 29 properties were sold for a total of $226 million. The average price was $153 per square foot. Cap rates were higher in 2004, averaging 8.38 percent. The largest transaction during the year was Melvin Mark’s sale of Robert Duncan Plaza in downtown Portland to National Government Properties. This 350,000-square-foot building exchanged hands for $69.75 million or $199 per square foot. The property sold at a 7.17 percent cap rate.

Retail

The Portland market continues to be a good place for retailers to do business. Unscathed compared to other sectors of the real estate market, retail has continued to see a rise in new construction with space being absorbed shortly after completion. The current trend in development favors specialty retail shopping environments and open-air lifestyle centers. Another trend of retailers is taking advantage of urban infill opportunities. Infill opportunities create unique challenges for developers. Finding tenants that serve the needs of the community, getting the architecture/look to fit into the existing feel of the trade area and overcoming the challenges of mixed-use requirements (mixing retail, office and multifamily housing into one project) in order to appease zoning requirements are typical hurdles to redevelopment opportunities.

Portland delivered its first two significant lifestyle centers in 2004: The Streets of Tanasbourne and Bridgeport Village. The Streets of Tanasbourne, a 386,000-square-foot open-air center located in the western suburb of Hillsboro, includes key retailers such as Meier & Frank, REI, Victoria’s Secret and P.F. Chang’s China Bistro. Bridgeport Village is a 465,000-square-foot open-air center situated on 30 acres off Interstate 5 in Tualatin, Oregon. Key tenants include Regal Cinemas, Wild Oats Supermarket, McCormick & Schmick’s Seafood Grill and Oregon’s first Crate & Barrel (which recently announced it recorded the highest store opening volumes in the company’s history). It is too early to know the overall impact this trend in development will have in the Portland market, but judging by Crate & Barrel’s success, it is likely we’ll see more retail development of this type.

Many national retailers, such as Wal-Mart and Kohl’s, are looking to expand within the Portland market. Other tenants absorbing space in Portland include Lowe’s Home Improvement Warehouse, Whole Foods Market, cellular providers such as Cingular and T-Mobile, and fast-casual restaurants such as Baja Fresh, Red Robin and Chipotle.

Vacancy has remained low and steady over the past 2 years with an overall vacancy rate of 7.6 percent at the end of 2004. Rental rates have remained relatively unchanged over the past year. The current asking rental rate for Class A retail space in Portland is running approximately $25 to $35 per square foot, depending on location and tenant improvement requirements.

Areas to keep an eye on this year include: The Pearl District, close-in Southeast and Tanasbourne. Over the past several years, the Pearl District has seen a transformation from its railroad and industrial roots to one of Portland’s hottest urban areas complete with high-end retail, restaurants, galleries and condominiums. The close-in Southeast submarket will be seeing a lot of small interior urban development projects as developers take advantage of urban infill opportunities. And following the early success of The Streets of Tanasbourne, the Tanasbourne area will continue to see retail development opportunities move forward.

Another area of interest is Airport Way. There is significant retailer interest surrounding the Cascade Station project. Economic limitations and municipal restrictions had this significant mixed-use office/retail development in a holding pattern. However, with economic conditions improving, national retailers are taking another look at the market and this project. If remaining city approvals can be secured, this will be a great opportunity for retailers to tap into the greater Portland and southwest Washington markets.

Multifamily

The multifamily market in Portland, like many other western markets, has felt the impact of stagnant job growth and low interest rates. Low interest rates give many would-be apartment dwellers the justification they need to buy homes instead of rent. High unemployment and slower-than-national average job growth have forced many younger Portlanders into less conventional housing — with their families or in some form of shared housing. Despite slow job growth, young people continue to move to Portland. Unlike many other markets, Portland has the nation’s fourth highest population growth rate among college-educated individuals ages 25 to 34 and eighth highest in the 23- to 34-year-old demographic. A high quality of life and a relatively low cost of living will continue to attract the “creative class” and population growth will remain strong. These individuals represent the core demographic of apartment renters. Jobs will follow this group, apartment markets will follow jobs and gradually rising interest rates will equalize the buy-vs.-rent equation. The Portland apartment market is poised for modest recovery in the second half of 2005. Across the Columbia River from Portland, Clark County remains one of the fastest growing counties in the country with an annualized growth rate of 5.6 percent.

At year-end 2004, the overall multifamily vacancy rate for the Portland area was 7.8 percent. In 2005, it is anticipated that vacancies will improve by 40 basis points to 7.4 percent. The suburban submarkets of Hillsboro, Gresham and Beaverton were slightly higher than the region at 9 percent, while the Pearl District and downtown Portland as well as the Tigard, Tualatin and Wilsonville submarkets have enjoyed significantly lower vacancy rates than the rest of the region at 5.8 percent. Approximately 2,000 new units were delivered in 2004, with roughly 800 of those in the Pearl District and downtown submarkets, areas that historically have achieved the highest rents. More than 1900 units were absorbed during 2004, 1000 more than in 2003, and demand remains strong.

Asking rents have remained stable throughout 2004 with a regional average of $689 per month. The downtown submarket continues to have the highest rents, averaging $849 per month, while northeast Portland remains on the low end at $635 per month. The Tigard, Tualatin and Wilsonville submarkets show a lot of promise, having both the highest rates of absorption and increased effective rents. While overall asking rents have fallen 200 basis points over the last 3 years, effective rents have fallen approximately 10 percent during the same period. As indicated by recent surveys, the majority of apartment investors agree that effective rents will increase by greater than 100 basis points in the next 12 months, and the gap between asking rents and effective rates will return to normal spreads of between 2 to 4 percent.

Investor interest has remained very strong, keeping apartment sales robust with more than 100 transactions in 2004, an increase of 3 percent from the prior year. The median price per unit has increased 2.5 percent in 2004 to an average of $54,000 per unit. In 2004, the average cap rate dropped 50 basis points to 7 percent at year’s end.

A number of the stronger submarkets benefit from public-private efforts focused on smart growth and transportation alternatives. In the downtown and Pearl District submarkets, public-private planning collaborations and an expanding streetcar line have contributed to the highest per-unit sales prices, averaging $108,000 per unit. Well-located, stable complexes are selling at premiums with large-scale properties averaging cap rates in the 5 percent range. Another city-supported project is the redevelopment of the South Waterfront/North Macadam District. It is anticipated that “SoWa” will incorporate a mix of approximately 700 affordable and student units, 700 market-rate apartments and as many as 1350 for-sale condominiums.

In Wilsonville, Oregon, local and regional jurisdictions are working with Costa Pacific Communities to redevelop 500 acres adjacent to a proposed commuter rail station. As one of the fastest growing employment centers, Wilsonville has long suffered a housing-to-jobs shortage. Villebois, the largest non-resort, master-planned community in the state, has been designed as a European-inspired, smart-growth, mixed-use village with 2400 dwellings including 1500 single-family homes and as many as 900 condominiums, townhomes and apartments.

In summary, the multifamily market in Portland has made significant progress since the end of 2003 and appears poised to continue its recovery, particularly in the second half of 2005. While job growth remains relatively weak, in-migration of the “creative class,” positive population growth and excessive amounts of available investment capital will continue to fuel the need for new, high-quality, multifamily complexes.

Industrial

New industrial development in Portland has essentially been limited to build-to-suits. Build-to-suit activity has been fed by: 1) Lower interest rates — many users have opted to purchase rather than lease the facilities they propose to occupy. Demand for smaller, unique occupancies has created an active build-to-suit market; 2) The need for larger facilities — space requirements are exceeding available space opportunities in the market. Recent examples in Portland include Georgia Pacific (604,000 square feet in the northeast submarket); 3) Specialized facilities — many companies have begun to reassess the way that they use space. The “extras” they now require are not typically found in speculative inventory. These features typically improve efficiencies and the utilization of properties, but can also consist of unique features for a specific business (e.g., extra trailer storage or oversized loading doors).

Speculative industrial development was down significantly in 2004, a trend that will most likely continue this year due to rising overall construction costs. Building expenses for a concrete tilt-up warehouse increased by an average of 15 to 18 percent in 2004. Until market rents move to a more commensurate level with costs, traditional speculative development will continue to be limited in Portland.

Some significant speculative completions that have taken place include a 250,000-square-foot warehouse in Wilsonville, which was developed by AMB and is currently 85 percent occupied; Rivergate Corporate Center II in northeast Portland, a 604,000 square-foot warehouse that is currently 100 percent leased; and the three-building, 150,000-square-foot Gateway Corporate Center in Gresham, Oregon.

The majority of recent development has been of the big box variety. Portland has become of interest to more and more companies as an alternative regional distribution location to Seattle and Northern California. This is particularly true in and around the Port of Portland’s Terminal 6 and Portland International Airport. Recent speculative development at the Rivergate Corporate Center in the T-6 submarket and buildings planned and under construction in the South Shore Corporate Park have and will continue to allow Portland to attract a meaningful share of these larger, big box regional distribution center interests.

There have been few, if any, new industrial developers to Portland. Many of the current developers have reinvented their approach to speculative development, choosing to pursue build-to-suit and redevelopment opportunities. Industrial users such as Nike, Columbia Sportswear and Intel continue to absorb space as their businesses expand. Third party logistics companies have also put demand on existing warehouse space inventory in Portland. The northeast corridor has been the most active area of the city due to land availability. The Port of Portland continues to control one of the largest industrial tracts of land and has allowed industrial development to support its maritime terminal services. All told, the Portland industrial market absorbed roughly 2.5 million square feet of space in 2004.

Recent significant leases in the Portland market include Georgia Pacific’s 204,550-square-foot expansion at Rivergate Corporate Center II and Dean Foods’ signing for 250,000 square feet at Kelly Point Distribution Center, both in northeast Portland; and Davis Tools’ 210,000 square feet at 3740 N.W. Aloclek Place and Intel’s lease of 383,042 square feet at Dawson Creek Corporate Park, both in Hillsboro. The largest industrial sale in the Portland market last year also occurred in Hillsboro — the 126,809-square-foot Sun Tech Corporate Park sold for $19.39 million ($152.91 per square foot), at a cap rate of 9.89 percent.

Asking rental rates for the Portland metro area are $3.60 to $3.95 per square foot NNN for warehouse shell facilities. The current vacancy rate for the market at year-end 2004 stood at around 12 percent, down 3 percentage points from a year earlier.

Lindsay Gordon is the area director for the Portland branch of Trammell Crow Company. Skip Rotticci is the director of acquisitions and research at Costa Pacific Communities.

Trammell Crow brokers Mark McFarland, Dave Ellis and Marc Strabic contributed to this article.

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