WESTERN SNAPSHOT, FEBRUARY 2008

Portland, Oregon Office Market

Haskins

2007 was a solid year for the Portland office market despite the slowing housing market and worries about a possible economic recession. Office market fundamentals remain in good balance with 5 consecutive years of vacancy declines where demand has outpaced supply and rental rates have seen solid advances for the past 18 months. These market fundamentals and Portland’s urban growth boundary (UGB), which constrains development and keeps a lid on overbuilding, have put the area solidly atop the list of second-tier markets for investors.

Portland’s central business district has fared exceptionally well in the past year, with vacancy approaching a 6-year low and Class A vacancy ending the year under 5 percent. The CBD Class A office market has benefited greatly from a lack of new construction and recent acquisitions, which have pushed rental rates up substantially in the past year. Premium Class A space now averages $27 per square foot per year full-service, up 15 percent from the end of 2006. Low vacancy and rapidly increasing rental rates have finally made new construction viable in the CBD for the first time in 5 years, and there are several projects under construction, including the first speculative office tower to break ground since Fox Tower delivered in 2000.

Raicht

Shorenstein Properties has broken ground on First and Main, a 346,000-square-foot tower. The Lovejoy is under development by Unico Properties in the Pearl District and is expected to deliver in third quarter 2008. Machine Works, also under construction in the Pearl District, is a project of Portland real estate veterans Al Solheim and Rich Ford. Finally, preeminent developers Gerding/Edlen have broken ground on their 85,000-square-foot project at 12th & Washington, which will be the headquarters for ZGF Architects.

Many of these projects exemplify several market trends — development in the central city is increasingly dominated by mixed-use projects, downtown development continues its migration north into the Pearl District and LEED certification is the price of admission for any new Class A office project in downtown Portland. All of these new projects will have, at a minimum, basic LEED certification. Finally, as rental rates for Class A space have increased and availability has waned, owners of Class B and C properties with vacancy are taking this opportunity to reposition their buildings to capture tenants and increase asking rates.

Portland’s suburban market is a mixed-bag. The Washington Square/Kruse Way corridor recovered from the previous down cycle before the CBD and was the first market to see dropping vacancies and rapidly rising rental rates. The area has a high concentration of financial services firms and consequently has been harder hit by the slowdown in the housing market and the struggles of the mortgage industry. The subprime mortgage crisis has led to some increased sublease space being put back on the market in the area, but the impact has not been catastrophic. The submarket’s Class A vacancy rate is back in double digits, ending 2007 at more than 11 percent. However, average rental rates remain the highest in the marketplace for existing space with premium buildings exceeding $30 per square foot per year full-service.

Construction activity is picking up along Kruse Way and the immediate surroundings. Opus Northwest is preparing to deliver Fanno Creek Place, a two-building project totaling 119,000 square feet, and Shorenstein Properties is scheduled to break ground on Kruse Oaks III, a 110,000-square-foot Class A project, which should open in 2009. Tenants in this submarket are facing steep increases in their occupancy costs when they renew, but they will have more choices to consider.

The Sunset Corridor submarket, which has a high concentration of technology companies, has not recovered as rapidly as the Kruse Way market and still suffers from high vacancy rates and stagnant rental rates. Activity in the market has picked up though, driven by expansions by Nike, Farmers Insurance, Yahoo and market newcomers SolarWorld and Genentech. While there is not likely to be any major new construction in the area during 2008, both vacancy and rental rates are trending in the right direction.

Portland’s investment market set a record in 2007 with more than $3.4 billion trading hands. Fueled by the unprecedented sale of the Equity Office Properties portfolio to Blackstone and its subsequent flip to Shorenstein Properties, the volume of property sold in 2007 is not likely to be matched in the next several years. This sale set a $300 price per-square-foot-record for Class A office property early in the year, but the record was short-lived when JP Morgan purchased The Brewery Blocks at a market-high $380 per square foot.

In addition to the Blackstone portfolio, many CBD assets have recently traded hands and aggressive underwriting and pricing have pushed up asking rental rates in these properties. Some of these trades include RREEF’s acquisition of One Main Place, CommonWealth Partner’s purchase of KOIN Tower and JP Morgan’s purchase of The Brewery Blocks and interest in the US Bancorp Tower.

Portland’s office market dynamic should continue to push vacancy rates to 20-year lows in the CBD during 2008, and the suburban markets will hold their own. The economy is expected to slow but pent-up demand and limited construction will keep the market healthy through 2008. The construction pipeline will put more space on the market in 2009 and beyond, which will offer tenants some relief from tightening market conditions.

Eric Haskins is vice president and Patricia Raicht is client services manager and senior research manager, West Coast, in Grubb & Ellis’ Portland office.

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