MARKET HIGHLIGHT, JULY 2007

PORTLAND’S PUSH
Robert Black, Joe Vaughan, Jennifer Medak, Scott MacLean and J.J. Unger

Large institutional investors are getting more involved in Portland, Oregon’s office sector, the city’s multifamily sector is coming off its best year in recent memory and major retailers are noticing the market as well. Big things are afoot in the City of Roses.

Multifamily

The Portland metropolitan multifamily market comprises approximately 250,000 units in just less than 5,000 properties. Although the market has been healthy for several years, 2006 was the best year in recent memory. There are a number of factors contributing to the strength of this market segment: Portland’s rebounding economy; population growth, particularly in the 20- to 35-year-old sector; a lack of new apartment construction; the conversion of existing apartments to condominiums further reducing rent inventory; continuing significant price appreciation in the single-family housing market.

The prospects for 2007 and beyond look bright as the above factors will continue to come into play. Vacancy continues to be extremely low, with first quarter 2007’s rate dropping slightly to 3.57 percent overall. Rental rates are also rising, with every single submarket reporting an increase in rates. This is likely to continue throughout the year.

Portland is experiencing flat or net loss growth in unit inventory, and one should anticipate that new construction will continue to fall well short of demand. 2006 saw 5,000 units permitted, however, half of these were condominiums. The lack of available multifamily-zoned land and the rising cost of the few available sites will prevent any large scale construction.

Development in the pipeline will occur in areas with highest demand. Currently under construction are two projects in the downtown core totaling roughly 450 units and an additional 250 units in the recently created South Waterfront neighborhood. Other infill development is occurring in the east side of north Portland, where three projects total approximately 400 units. Suburban development of significance includes 422 units at Orenco Station and 300 units in Wilsonville, as well as 500 units close-in on the west side at Peter Court.

The positive factors affecting the overall multifamily market are magnified in the downtown submarket. Downtown Portland, including the Pearl District and South Waterfront, has become the most attractive and expensive address for the Portland urbanite. With more than 1,500 units of existing apartment properties converted to condominiums in the past 2 years and the lack of replacement properties coming online, downtown rental rates have seen the greatest escalations and vacancy has all but been eliminated. Downtown vacancy for first quarter 2007 is 2.28 percent.

As the popularity of South Waterfront and the Pearl District grows, these urban developments will see rental rate growth outstripping the market average of 2 to 3 percent per year, and this growth gap will likely widen in 2008.

Investor demand for institutional-grade multifamily projects has been driving prices upwards and will continue to do so through second quarter 2007. Non-institutional demand is also high, though not as aggressive as the institutional arena.

— Robert Black is an associate vice president at NAI Norris, Beggs & Simpson in Portland.

Office

The Central City office market encompasses more than 19 million square feet throughout 180 properties located in three distinct submarkets. The central business district (CBD) is largest, representing more than 75 percent of the total. Overall market conditions are improving, continuing the general trend started in 2003.

Office vacancy is decreasing; the current rate of less than 12 percent includes a nominal supply of sublease space. Class A space, however, is in single digits in all three submarkets and only about 7 percent in the CBD.

Absorption is trending upward, exceeding historic averages in each of the past 2 years. 2006 was particularly outstanding with more than 500,000 square feet absorbed, an increase of 35 percent over recent years and the highest since 2000. Inventory is limited, especially for larger blocks of contiguous space in well-located, quality properties. There are currently only 15 full floors of Class A space available in the Central City, which compares to 28 at the start of 2005 and 58 at the beginning of 2003.

Rental rates are increasing, but not yet to levels supporting abundant new construction. Rental rates for available space in Class A properties have increased 7 percent during the past year, with projected increases of 6 to10 percent in 2007. Initial rates are now approaching $30 per square foot annually on a full-service basis in select, top-tier properties. New construction is expected to command rents starting in the range of $33 to more than $35 per square foot.

New construction is minimal, however, with only one project of 82,000 square feet to be delivered by the end of 2008. New supply is expected to follow in other proposed developments. Most notable is First & Main, a more than 350,000-square-foot Shorenstein Properties project slated for delivery in 2009 as Portland’s first new LEED-certified office tower. In addition, Park Avenue West, a mixed-use project with a 280,000-square-foot office component to be developed by TMT Development, is scheduled for delivery in 2010.

The landscape of ownership entities has changed, now significantly more institutional in character. Ashforth Pacific with GE Capital as its partner, JP Morgan teamed with Unico Properties and RREEF have all recently completed major acquisitions. Other landmark properties, such as KOIN Center and the Brewery Blocks, are anticipated to trade in 2007.

In summary, the Central City marketplace exhibits classic traits of a late-stage recovery, with the cycle set to transition into an expansion mode in the next several years.

— Joe Vaughan is a vice president at NAI Norris, Beggs & Simpson in Portland.

In suburban Portland, office activity kept the status quo.

The steep rise in construction costs — some estimate a 40 percent rise since late spring 2006 — have caused developers and owners to pause for a deep breath before moving ahead. Leasing processes lengthened as players adopted a wait-and-see attitude in the wake of Shorenstein’s acquisition of Equity Office Properties’ Portland holdings.

Interstate 5 South and the 217 submarkets are red-hot, as is the Tigard Triangle. Kruse Way’s activity is momentarily static, but the presence of subleases complicates the picture. Clackamas is an up-and-comer with forceful development trends.

Beaverton and the Sunset Corridor are slower. However, there has been more activity in the past 6 months there than there has been in the last 5 years. The 25 percent vacancy in the Sunset Corridor is down from the 40 percent it has shown historically. Activity on the Beaverton-Hillsdale highway posted a 16.89 percent vacancy, and central Beaverton came in at 13.5 percent in first quarter 2007.

Development remains strong, most notably with Opus Development’s Fanno Creek Place project. The three-building, 125,000-square-foot, Class A Tigard office complex is scheduled to deliver in November of this year. The recent completion of Sunnybrook Ridge in the I-5/217 area brings 20,000 square feet to the area, and an additional Sunnybrook Ridge building is under construction. The two-building Tigard Triangle Commons are being developed by Pacific Northwest Properties. Last year’s completion of Durham Plaza comes to fruition as the last spaces fill.

— Jennifer Medak is an associate vice president at NAI Norris, Beggs & Simpson in Portland.

Industrial

After a marked rise in Portland’s industrial activity in first quarter 2007, lease rates and development have stabilized during the second quarter and look to be firm throughout second half 2007. Sales have been steady, though not increasing. The velocity of the market slowed in the second quarter and could continue to drop slightly more before the year is out.

Portland industrial properties saw a 10 to 20 percent increase in lease rates during the last few quarters and continue to hover around $0.36 to $0.40 per square foot on warehouse shells. Office surcharges rose to $0.75 per square foot on most warehouse space. Interestingly, Seattle’s industrial lease rates still remain comparable to those in Portland.

First quarter 2007 saw less than 10 percent vacancy rates in all submarkets with the exception of Hillsboro/southwest 217. The northwest submarket has the lowest vacancy in the Portland metropolitan area at 5 percent. Another notable submarket, north/northeast, has seen a slight rise in vacancy since first quarter to 10.49 percent.

New development is on the horizon, but not yet under construction. In 2006, owners snapped up land but await stronger pre-leasing before breaking ground on building construction. However, the rapid expansions not just of local companies but the desirability of the city itself — having been a landing pad for a recent outcropping of Google, Genentech and Vestas — ensures that tenants are on the way.

United Natural is one new user who is ready to build, having purchased 25 acres in Ridgefield, Washington. Another buyer, Pacific Coast Fruit, is purchasing 10 acres from the Portland Development Commission to relocate from its inner southeast neighborhood to the Portland Airport area.

Birtcher Development, Opus (with an ongoing development opportunity in Woodburn) and Prologis Corp. continue to make themselves known as key developer players. Capstone Development was recently awarded the development rights to Mill Creek Industrial Park in Salem, Oregon, where it will construct a spec building. The good news is offset by Wal-Mart announcing that it was not going to purchase the adjacent site.

Overall, the strong wave of Portland’s building sales in the past 3 to 4 years seems to have crested. Tenants who had been looking to purchase either couldn’t find a building to buy or decided to invest elsewhere. 2007’s second quarter slowdown may signal a “hunkering down” period in which potential owners of past years will instead look to lease.

— Scott MacLean is a vice president at NAI Norris, Beggs & Simpson in Portland.

Retail

Portland is starting to get noticed by major-market retailers as an expansion destination with proven retail performance. The City of Roses’ appeal lies partially in the fact that it is relatively under-retailed in comparison to other western markets. Contributing factors include the absence of sales tax and the local government’s reluctance to foster retail growth.

With vacancy rates currently as low as 2 percent in the Clackamas and Sunset Corridor submarkets, retailers are having a tough time finding locations in the Portland metro area that meet their expansion goals. Without question, this lack of supply has driven retail asking rates up to previously unthinkable heights — $60 per square foot, triple net, on ultra-hip Northwest 23rd Avenue and comparable rates at Bridgeport Village. With this kind of market activity, developers are justified in moving forward with construction projects such as Nyberg Woods, The Point at Bridgeport, Cascade Station and Tanasbourne Market.

Private equity firms have effectively overtaken the retail sector in recent years, which has pressured retailers throughout the country into a mode of aggressive expansion. Companies such as Golden Gate Capital, KKR, Blackstone, Texas Pacific and Bain have been major private equity players. In March, Dollar General announced that the discount chain would be acquired by private equity firm Kohlberg Kravis Roberts & Co. LLP in a deal valued at $7.3 billion, including approximately $380 million of debt.

Brisk development and high rates are spurring absorption into slower submarkets like Gresham, which has in recent history experienced a vacancy rate hovering around 7.5 percent. As a result, watch for Gresham Station and Wood Village Town Center to get a lot of attention from regional and national retailers.

In addition to Center Cal Properties’ development of shopping centers such as Cascade Station, Nyberg Woods and Gresham Station North, it has proposed plans to develop the Oregon City landfill. Plans for the Janzten Beach Super Center Complex made a splash and are slated to include a lifestyle component.

Other Portland mall renovations percolate under the city’s radar with two unnamed major malls currently for sale. Industry insiders predict that those who pull off the acquisition — backed once again by powerful private equity firms — will be focusing on major renovations.

The retail sector stands to see a healthy second half of 2007. Many retailers experienced a slower expansion in first quarter 2007, but were arguably still recovering from a record-breaking 2006.

— J.J. Unger is a real estate broker at NAI Norris, Beggs & Simpson in Portland.


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