WESTERN SNAPSHOT, FEBRUARY 2006
Honolulu Office Market
The Honolulu office market has rebounded, experiencing very strong positive absorption in 2005. This performance demonstrates that the strong economy has reached the office leasing market, with increasing rental rates and diminishing inventory making it now a landlord's market. The Honolulu office market has had positive absorption in 11 out of 16 quarters and totaled up some 300,000 square feet of positive absorption since 2001.
Not since 1992 has the office market vacancy moved below 10 percent. There is every expectation of it continuing to decrease from its current 9.9 percent level. That equals approximately 1.1 million vacant square feet, and with over 500 spaces on the market, the average vacant space is less than 2,500 square feet. This creates a significant challenge for larger tenants with little or no option for relocation or expansion. Large, full floors in Honolulu range from 10,000 to 20,000 square feet, and currently there are less than eight vacant. Those tenants needing to make the move into larger spaces are finding that it takes more than a year, sometimes two, to find satisfactory accommodations. The Hawaii State Department of Business, Economic Development and Tourism estimates an increase in office sector employment of more than 22,000 employees since 1995. Considering historical occupancy, this would equate to a 15 percent reduction in average office space available per worker. For many of Honolulu's prospering tenants, the period of “maximizing efficiencies” has reached its peak, and searching for suitable expansion or relocation space has become overwhelming.
Gross asking rents in the Honolulu metropolitan office market have now increased for nine straight quarters, after remaining relatively flat for over 6 years. Whereas some of the increase can be attributed to the expected increases in operating expenses, the net rents are clearly on the rise. In 2005, the average monthly gross asking rents increased to more than $2.35 per square foot, a rate not seen in more than 10 years. After vacancy levels hit bottom in 1990, the gross asking rents continued to rise until they peaked in 1993 at about $2.75 per square foot. We are seeing a similar pattern now.
While negotiated lease rates in the past have remained fixed for the 3- to 5-year term, more leases are being written with annual rate increases, from nickel bumps to a 3 or 4 percent annual step-up. For some, the initial rate may be lower than market, however, at the end of the term, the rates are higher than market. The incremental adjustments depend on the lease term.
The last expansion of the Honolulu office market ended in 1996 with the completion of First Hawaiian Center. Between 1990 and 1996, nearly 2.5 million square feet of office space was added to the market with the construction of 21 buildings. Nearly 1.8 million square feet of that was added to the urban market consisting of the central business district (CBD), Kapiolani/Kakaako and Waikiki, which encompass nearly 80 percent of the entire Honolulu office market. Vacancy had bottomed out below 4 percent before the construction period was in full swing. There has been no significant space added since then.
Office rents have been on the rise, but they are still a long way from being able to support any new construction. Construction costs are currently estimated to be more than $400 per square foot. This would require the net rents to more than double, pushing the gross rents over $3.80 per square foot. At the current rate of growth, new construction for an office building is not foreseeable. The problem is that by the time rents are sufficient to support the construction of new office buildings the market will have almost no availability. And with a 5-year horizon on new construction, inception to completion, it will be an extremely long time before the market has any expansion space.
There have been discussions of putting office and other commercial spaces in a few of the residential mixed-use projects. However, these projects are outside the CBD, are limited in size and use, and will push the rates higher. Projects such as these are already commanding rental rates above the norm. A couple of new projects have been announced in the Kakaako area, near the John A. Burns School of Medicine. Estimates are for buildings that are 150,000 square feet or more. The target market is for biotech-related users, since the projects are scheduled to accommodate research and laboratory spaces. Some existing high-tech and R&D tenants are likely to relocate to these buildings, creating vacancies in the traditional office market. These new projects will not be completed until 2008 or 2009, however.
Along with the medical school, the whole Kapiolani/Kakaako submarket is experiencing a significant revival. Retail centers are repositioning and expanding. Residential construction is on the rise, literally. In previous office market cycles, this area has seen the initial construction of office product, and has the added advantage of more flexible site selection.
Jeffrey Hall is CIO and senior director of research, information resources, for CB Richard Ellis Hawaii in Honolulu.
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