MARKET HIGHLIGHT, JUNE 2006

SALT LAKE SHAKE: PLENTY OF MOVEMENT IN UTAH’S CAPITAL
Collin Perkins, Jeff Heaton, Greg Ratliff and Brett Palmer

There’s a lot of excitement in Utah’s commercial real estate circles. Keeping Salt Lake City all abuzz are some very healthy market fundamentals.

Office

The Salt Lake City office market continues to rebound, and many brokers and landlords believe it is fully recovered. Tenants argue, however, that the market is still relatively soft and not nearly as healthy as their counterparts are stating. As usual, the truth lies somewhere in the middle.

Comprising the central business district (CBD) and peripheral submarkets, the downtown submarket consists of approximately 10.25 million square feet or 37 percent of the total office market. The market’s total availability, which is the sum of vacant space and sublease space, at the end of first quarter 2006 was 11.68 percent, a shade higher than the vacancy downtown. Compared with the same period last year, total market availability was 15.95 percent with the downtown area at 14.83 percent. This clearly shows the strong recovery occurring in the market. When compared to the market during its strongest period in recent history — the late 1990s, when total availability was hovering between 6 and 8 percent — perspectives of both landlords and tenants can be argued effectively.

One of the tell-tale signs of a recovering market is the decrease of sublease space. Sublease availability has declined from 2 percent in first quarter 2005 to less than 1.2 percent in first quarter 2006. Comparing this level to the high-water mark of 5.4 percent in 2002 gives one an understanding of just how far the market and the economy in general have recovered.

Vacancy rates, including direct space vacancy, for Class A, B and C space in the CBD are currently at 2.05 percent, 8.23 percent and 24.22 percent, respectively. The overall vacancy for the Salt Lake City office market is 10.31 percent. As a result of Class A vacancy dropping close to 2 percent, developers are moving forward with new office developments to help fill the high demand. The two new projects scheduled for construction downtown are 222 South Main, a 400,000-square-foot high rise being developed through a joint venture between Hamilton Partners and Wasatch Development Associates, and Gateway Five, an 80,000-square-foot mid-rise being developed by The Boyer Company. Both projects are seeking final approval with groundbreaking scheduled for late summer. 

The Salt Lake City office market for the rest of the year should continue to be strong, healthy and active. With a strong economy, fast growing population, and a pro-active governor and economic development unit, Salt Lake City will likely experience a single-digit vacancy for the overall market in 2006. Lease rates will increase for Class A and B properties with Class C rates declining. Office sales will also continue, especially if interest rates do not increase too dramatically. It is a good time to invest in the Salt Lake City market.

— Collin Perkins is a partner and office/investment specialist with NAI Utah Commercial Real Estate in Salt Lake City.

Industrial

Industrial activity through first quarter 2006 has been nothing short of remarkable. Two words best describe the attitude in our market — act fast.

An overbuilt market dating back to 2001 created lower lease rates and well priced building values, which finally prompted market movement. Activity has been consistently strong in the last 2 years. The vacancy rate continues to slide and currently sits at 5.95 percent, which is the lowest rate Salt Lake City has seen in more than a decade. The vacancy rate is down 2.76 percent from a year ago (numbers based on first quarter 2005 to 2006). Lease rates have increased approximately 2 cents per square foot each quarter in the last three quarters and are projected to continue to rise at a faster rate. Land values and construction costs are on an upward trend, resulting in rising building sale prices; actual building sales prices have risen more than $13 per square foot in the last year alone. Because of the rising expenses, tenants and developers are wise to act now. Within a regional perspective, Salt Lake City still remains less expensive than other competing markets such as Las Vegas and Phoenix.

Natomas Meadows LLC, a company associated with A&K Railroad Materials, has made its mark on the bulk distribution market in Salt Lake City. After its acquisition last year of Ninigret Park and 1.35 million square feet of surrounding land, the company has continued to develop speculative buildings and will be a dominant player for years to come. Overstock.com’s 207,900-square-foot lease, Mrs. Fields Cookies’ 159,800-square-foot build-to-suit (both Natomas Meadows’ deals) and HK Systems’ 87,665-square-foot build-to-suit by First Industrial were some of the larger transactions in first quarter 2006.

Real estate along 5600 West in the west valley area of Salt Lake City is a notable hot spot from Interstate 80 to Highway 201. The buzz in this area is due to Union Pacific’s intermodal hub. Utah’s Department of Transportation has also begun widening the road to accommodate the increase in traffic and the new real estate developments in the area. Approximately, 100 acres of land have sold or gone under contract in this submarket so far this year.

Solid industrial investment deals, while still very hot, are increasingly difficult to find as cap rates continue to decrease. However, with the rising cost of debt, other asset classes will compete for dollars and bring equilibrium to the supply and demand of investment properties.

Industrial activity, as always, is expected to rise as temperatures begin to increase with the onset of summer. Look for 2006 to be a banner year in terms of overall market activity.

— Jeff Heaton is an industrial real estate specialist with NAI Utah Commercial Real Estate in Salt Lake City.

Multifamily

Both the present and near future are rosy for owners and investors in the greater Salt Lake area apartment market. According to a report by the Salt Lake Board of Realtors, home prices in the Salt Lake area rose 16.7 percent in first quarter 2006. The good news is that Salt Lake is seeing healthy increases in sales and prices, but not unrealistic increases that could lead to a housing bubble like in other states. According to Bankrate.com, Salt Lake City is one of the “10 Bubble Blowers,” where real estate appreciation should continue to grow. Bankrate reports that “nothing drives housing like a stable economy and job growth. Salt Lake has both.” Also, Money magazine ranks Salt Lake City 20th on its list of 100 markets for growth in the next 2 years.

As home appreciation soars along the Wasatch Front and as interest rates continue to rise, many renters will be forced to stay in apartments. The fifth fastest population growth in the nation and a healthy blend of low, moderate and high-paying job growth have helped to create the strongest apartment market in this area in more than 4 years. This year, rent growth will range from 3 to 4 percent, most rent concessions will burn off and occupancies at the 95-percent level should become commonplace among all multifamily property types.

Interest rates for commercial loans have risen well over 1 percent within the previous 9 months. However, investor interest for apartment communities in the greater Salt Lake Area remains strong, albeit cautionary. Total sales volume for multifamily investments along the Wasatch Front approximated $390 million last year as compared to $161 million in 2004. In some cases, “sticker shock” is occurring among buyers because rental rates, while increasing, have not yet caught up with lowered cap rates. That being said, prices in the greater Salt Lake Area are lower than in most metropolitan western markets, boosting the perceived value by investors. Cap rates for apartment properties — ranging from 5.5 to 6.5 percent along the Wasatch Front — still remain lower than any other category of investment real estate.

In an effort to meet minimum lender debt-coverage requirements, multifamily investors are investing more heavily and leveraging less. Investors wishing for 75-percent leverage now have to purchase apartment properties with loan-to-value ratios ranging from 55 to 70 percent in order to generate modest returns. Real estate investment capital in the market remains abundant. Uncertain stock market conditions, major global issues, high oil prices and the growing 1031-exchange segment are all fueling demand for investment properties.

— Greg Ratliff is a senior associate multifamily/investment specialist with NAI Utah Commercial Real Estate in Salt Lake City.

Retail

The Salt Lake retail market has the right recipe for continued healthy growth — robust population growth, rising incomes, job growth/low unemployment, a healthy economy, new shopping centers, stable single-digit vacancy, increasing lease rates, affordable real estate values, strong sales performance and continued expansion by existing and new retailers. All these factors point to strong and sustainable growth.

According to a recent Associated Press report, “Utah is projected to be one of the five fastest-growing states over the next three decades.” The U.S. Census Bureau ranks Utah 11th in the nation for highest median household income at $50,614, for a 3-year average between 2002 and 2004. Utah is also one of six AAA bond-rated states in the nation from Moody’s Investors Service, Standard & Poor’s and Fitch Ratings. All sectors of Utah’s economy performed strongly during 2005 and continue to do so in 2006. As the economy goes, so goes commercial real estate. Both continue to enjoy strong and sustainable growth.

As a result, many new shopping centers are being constructed and others redeveloped. Even with the addition of so many new shopping centers, the healthy absorption of space is keeping vacancy in the single digits in all property types. Consequently, lease rates and land values continue to notch up. Lease rates for shop space range from $12 to $35 per square foot per year NNN, with most of the new shop space in good centers ranging from $19 to $28 per square foot per year. Mid-size and small anchor space in quality centers range from $8 to $18 per square foot. Most land pad values range from $10 to $23 per square foot, with the majority in the mid- to high teens per square foot. Land for neighborhood and community centers is typically going for $4 to $8 per square foot. In most cases, the retailer’s volumes continue to support the increased lease rates and land values. The investment sector has experienced decreasing cap rates that will level off as interest rates start to creep up.

Existing mid-box and big box retailers in the marketplace continue to expand. Some of the notables are Costco, Wal-Mart, Target, Best Buy, Michaels, Roberts Crafts, The Home Depot, Lowe’s Home Improvement Warehouse, Walgreens, Big 5 Sporting Goods and the popular dollar stores. Retailers that have recently entered or are preparing to enter the market include Cabella’s, IKEA, Cost Plus World Market, Sears Grand, JC Penney, Hobby Lobby, Sport Chalet and Dollar General. FYE (Trans World Entertainment) is taking four out of the five former Media Play spaces.

Expect to see strong sustainable growth in Utah’s economy and retail real estate. Developers and retailers will make increasingly calculated decisions. Closings and casualties among the retailers will occur, but expect more openings and successes. Sustained residential growth will benefit the retail sector while competing against other commercial land users. Construction and land costs will continue to push lease rates up while the retailers continue to push against those increases. Finally, expect nearly all aspects of the retail sector in the Salt Lake market to be very warm, but not necessarily burning hot.

— Brett Palmer is a retail/investment property specialist with NAI Utah Commercial Real Estate in Salt Lake City.

Investment

Utah has shown a healthy increase in commercial sales volume since 2002. In 2005, Utah saw $1.5 billion in sales volume, an increase of nearly 130 percent over 2004’s record-breaking year of $670 million. This surge came from a combination of increased capital, low interest rates and a strong local economy — a recipe that carried over much optimism into 2006.

The increased capital looking for opportunities in Utah came from multiple sources, ranging from small 1031-exchange investors to major institutions. With overheated markets in the West and nationally, an increasing number of investors have added Utah to their target list of states, finding value in cap rates 150 to 200 basis points higher than in primary markets. It is not uncommon to find prices below or near replacement cost and low market rental rates with potential upside. This has fueled all sizes of deals — in 2005, Utah saw three transactions of more than $100 million, one between $50 and $100 million, 13 deals between $20 and $50 million, and 15 exceeding $10 million. The size and magnitude of these deals is unparalleled in the state’s history.

Increased interest rates have had little effect on Utah’s investment market through first quarter 2006. Even with the increased cost of capital, historically low cap rates are evident in all sectors of the market. This combination of compressed cap rates and increased cost of debt has resulted in a number of negative leveraged deals or one in which larger equity positions are taken. This is a sign of the disproportionate amount of investor demand in comparison with the amount of quality supply available. It also shows confidence in Utah’s real estate market and economic fundamentals with the majority of these buyers counting on upside in rents to meet their yield requirements.

Utah’s population grew 3.2 percent in 2005, which was three times the national rate. With healthy growth from in-migration and the nation’s highest fertility rate, Utah is the fifth fastest-growing state in the country. Population increases generally fuel employment, and there was no exception in 2005. Utah added 43,900 new jobs in the year ending February 28, which equated to a 4.4 percent job growth. Utah, Nevada and Arizona were the top three states in terms of highest job growth.

— Tucker White is an investment specialist with NAI Utah Commercial Real Estate in Salt Lake City.

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