MARKET HIGHLIGHT, JULY 2009

PORTLAND, OREGON
Michael Heerman, Buzz Ellis, Kristin Hammond, Paige Morgan, Nick Klein and Tyler Sheils

In Portland, tenants are calling the shots, and investment activity has slowed to a trot.

Retail

Although Portland has been a rather insulated market from the effects of the economy, it’s starting to experience much of what the rest of the country has with national and regional tenant bankruptcies in the market, especially in the big box realm. With such national big box tenants as Circuit City, Joe’s Sporting Goods and Linens ‘N Things falling out, it’s time to look at these vacancies as opportunity for tenants who may not have gotten into the market in the past. Aggressive landlords looking to fill vacancies are looking at such discounters as Dollar Tree, Grocery Outlet and Big Lots to get the vacancies filled. Landlords are getting creative with their deal structures and providing more concessions to deals than what they may have in the past.

Vacancy is up to approximately 5.11 percent. Downtown lease rates are around $60 to $65 per square foot, with the suburban market shop rents dropping to $20 to $30 per square foot, followed by box rates being anywhere from $12 to $14 per square foot.

Fortunately, active developers such as CenterCal and Gramor are seeing large success in leasing activity with their most recent projects, Nyberg Woods and Cascade Station. CenterCal developed the 203,000-square-foot Nyberg Woods, a 99 percent leased project that is anchored by PetSmart, Best Buy and Old Navy. Its other prominent project — Cascade Station, which comprises 745,000 square feet of retail space — brought the first IKEA to the market and is seeing strong interest with the project being 94 percent leased. Target plans to open their only new store development in October 2009 in the parcel adjacent to this project. Gramor is still moving ahead with its 200,000-square-foot Progress Ridge project, which will be anchored by New Seasons and Cinetopia.

Weak sales coupled with challenging financial markets will result in a slow upturn to development and new stores for Portland. With rates coming below asking, tenants are moving upward in relocation opportunities and upgrading or getting a better rate on renewal out of their current landlord. This is an opportunistic time for tenants that may now be able to afford space in a Class A center, which was previously too expensive. Activity is still strong and the market is gaining momentum as more tenants are looking at potential deals and expansion.

— Michael Heerman is president of  HSM Pacific Realty in Portland.

Office

Portland is feeling the effects of being a secondary market. The downsizing of corporate America, combined with the deflation of the residential bubble, has increased office vacancy 11 percent in the last 3 quarters. Leasing transaction volume is down in 2009, and investment sales are nearly non-existent. Central City’s office vacancy is around 9.5 percent with average asking rates barely exceeding $19 per square foot. Some premium Class A spaces are going for as little as $24 per square foot.

New construction has slowed with the completion of Unico Properties’ The LoveJoy (80 percent of the 80,200 square feet leased) and 69,000-square-foot Machine Works (0 percent leased), both mixed-use developments in the Pearl District. The 346,000-square foot First & Main (0 percent pre-leased) is nearly 100 percent enclosed and set to deliver in 2010. Construction on Tom Moyer’s Park Avenue West is halted while architects return to the drawing board to alter the design, removing the residential component and adding  two floors of office space for a total of 24 stories and about 350,000 square feet.

In the suburban markets, vacancy is around 16 percent with average asking rates of $15 to $21 per square foot depending on class type. The west side submarkets took a big hit due to the residential collapse and loss of businesses, including Washington Mutual, Lime Financial and Meritage Mortgage. Consequently, negative absorption is 62,164 square feet year to date. And finally, the Sunset Corridor continues to struggle as vacancy increased to 23 percent while rents have remained flat for 7 to 8 years.

Completed in April, Shorenstein Properties’ 108,000-square-foot Kruse Oaks III (0 percent pre-leased) is garnering some interest, but faces challenges as tenants shy away from premium rents. Cascade Station I (0 percent leased), a four-story, 92,000-square-foot building, is close to completion and will be the last major office project in the Airport Way submarket for a while.

Since fourth quarter 2007, investment sales volume in Portland has declined by approximately 80 percent. The main reason for decreased transaction volume is the difference between buyer and seller expectations. Until recently, seller expectations had not adjusted to the new market reality; of the 17 investment transactions exceeding $10 million brought to market since the start of 2008, only five closed. As such, activity will remain light well into 2010.

— Buzz Ellis is a principal and Kristin Hammond and Paige Morgan are associates at Pacific Real Estate Partners in Portland.

Multifamily

Even in the face of high unemployment, Portland remains a viable option for multifamily investing. Its apartment market is certainly not immune to current economic conditions but seems to be holding its own compared to larger metro areas. The first half of 2009 has been slow with transaction volume down, mainly due to the lack of buyer confidence and the uncertainty in the lending market. Vacancy rates are slowly increasing as unemployment numbers rise, prompting some landlords to consider rent concessions on properties located outside of core locations. Current market conditions have forced apartment owners to focus significant attention on tenant retention and customer service.

The Portland apartment market is in a better position than many because of its barriers to entry. All Oregon cities have Urban Growth Boundaries (UGBs), and Portland’s is serving to prevent urban sprawl by forcing infill. This restricts the development of new apartment units due to relatively high construction costs, high cost of land and the fact that lenders are shying away from construction loans. Portland has seen sustained healthy increases in population growth for many years now, and experts project that trend will continue, despite above average unemployment levels.

Investors in the Portland area have been waiting for cap rates to increase, hoping to get a favorable interest rate and a better return on their investment. Now that interest rates appear to be on an upward trend, buyers are realizing that they should act while the rates are still at historic lows. The market is in a correction phase right now as lending institutions and their underwriters face scrutiny from governing authorities.

The outlook: Portland’s apartment owners and investors are showing more interest in market participation, and things are expected to pick up in the second half of 2009.

— Nick Klein is an associate broker at HFO Investment Real Estate in Portland.

Industrial

It is a great time to be an industrial tenant in Portland. Availability jumped significantly in the early part of 2009 as more than 1.2 million square feet of industrial space was returned to the market. With vacancy hitting 8 percent, tenants have more options today in highly functional, newer product than they have had for several years. Owners are reaching to make every deal and ground-level market intelligence suggests that although published market asking rental rates have not dropped significantly, standing at $0.42 per square foot NNN on the shell, actual deals are being done in the low $0.30s. With almost 6 million square feet of new product delivered to the Portland market since early 2007, some owners have been sitting on new vacant space for more than 24 months and are now looking for a way to simply cover their net charges.

Exacerbating this situation is the large amount of highly functional sublease space that has hit the market in the past 2 quarters. The sublease market is now offering both large and smaller spaces, and much of this space still has significant term left on the lease. These companies are, in many cases, highly motivated to find a tenant to backfill, even at a loss, simply to slow the bleeding. This sublease space has hollowed out the industrial market, forcing owners of new developments to compete on rate not only with sublease space but also with second and third generation space.

Continuing a trend that started several years ago, major companies are beginning to decentralize their wholesale/distribution functions, and Portland seems to be the beneficiary of the trend. Spurred on by very congested ports in California and unpredictable fuel prices, companies have begun setting up smaller distribution centers in secondary locations, such as Portland, rather than shipping all their products through a centralized distribution center. Colgate Palmolive recently leased 151,000 square feet at Rivergate for its new northwest distribution facility.

Speculative development has come to a virtual standstill and will not resume until the economy has regained its footing. Only two major industrial buildings, both owner-built projects, are under construction in the Portland metro area. Federal Express is building a $100 million, 415,000-square-foot regional distribution hub in the Troutdale Reynolds Industrial Park, which is expected to deliver in second quarter 2010. SolarWorld has recently begun construction of a 210,000-square-foot production plant adjacent to their existing facility, which is scheduled to open in November.

Investment volume has dropped precipitously. There have been just three industrial investment sales in the first part of 2009, totaling less than $10 million. The lack of credit and significant uncertainty about values have put the brakes on almost all investment sales activity. There are very few properties on the market and fear is prevalent among investors. Debt remains scarce, selective and conservative, and there remains a large spread between bid and ask pricing. Sales activity will return when a new market reality is established, and motivated sellers should begin to surface towards the end of 2009 and early 2010.

— Tyler Sheils is a broker in the Industrial Services division of Grubb & Ellis Company’s Portland office.

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