MARKET HIGHLIGHT, JUNE 2007

SALT LAKE CITY MARKET HIGHLIGHT
Adam Christofferson and Craig Kaminski

While job growth in Salt Lake City may be tempered in 2007, it will still exceed the national average. What’s not above average when compared to other high-priced western cities are Salt Lake City’s property values and cost of living. These factors continue to attract developers, investors, tenants and residents to Utah.

Office

Salt Lake City’s office market will experience a period of expansion throughout the year, highlighted by continued job growth and completions in excess of recent historical averages. Tenant demand has been strong recently, driven by robust expansion in the office-using sectors. While job growth is expected to moderate during the year, gains will still exceed the national average, as estimates suggest nearly 4,800 office-using jobs will be added this year. In response to tightening market conditions, developers will deliver more space in 2007 than the metro received in the past 3 years combined. Despite a substantial increase in new construction, vacancy is only expected to rise 10 basis points by year’s end, due in part to strong absorption in the Southeast Valley.

Competition from new office product will make owners more cautious with regard to rent increases, however, asking rents are expected to rise moderately throughout the year.

Transaction velocity reached historically high levels last year, and, while it is not likely that the market will experience the same performance this year, fundamentals still exist to attract capital and keep the market extremely liquid. Compared to some overheated nearby coastal metros, office prices in Salt Lake City remain relatively affordable, attracting out-of-state investors seeking to upgrade their holdings in a higher-yielding market. Currently, cap rates are in the low 7-percent range, 100 basis points higher than some California markets, and 50 basis points above the national average. Lastly, investors should note that redevelopment of older, underutilized properties in the central business district (CBD) could add value as some lower-tier assets are selling for below replacement cost, presenting repositioning opportunities to capitalize on rent growth and price appreciation.

The forecast for Salt Lake City’s office market:

Job growth will cool this year. Salt Lake City employers are poised to add 9,400 jobs this year, a 1.5 percent increase. Total office-using employment will gain 2.8 percent, an increase of 4,800 new positions.

Developers have been averaging 250,000 square feet of new space during the past 5 years in Salt Lake City. Construction activity is forecast to increase considerably in the next 3 quarters as builders are estimated to add 1.2 million square feet of space to the metro area.

Completions will slightly exceed tenant demand in 2007, resulting in a 10-basis point uptick in vacancy to 11.7 percent, impressive considering developers will increase inventory by 4.3 percent.

Asking rents will increase 3.4 percent to $17.97 per square foot, while concession burn will push effective rents up 4.6 percent to $15.06 per square foot. Asking and effective rents increased 4.9 percent and 7.9 percent, respectively, last year.

As revitalization in the CBD continues in earnest, investors may want to target older industrial and flex assets that can be redeveloped to secure greater returns in this high-demand submarket.

— Adam Christofferson is the vice president and regional manager of Marcus & Millichap’s Salt Lake City office.

Industrial

Utah is the vibrant leader in the robust economy of the Intermountain West. This trend should continue all year, benefiting all sectors of the Salt Lake industrial market with low vacancy rates and higher values, but creating challenges as well.

Everything is up significantly this year — sales prices, lease rates and land values — compared with 2006. Basic economic factors are causing it — limited supply of existing inventory and zoned land, plus rising construction costs. Leasing and sales activity for all segments of the market jumped nearly 24 percent during the past 18 months, a trend most evident in mid-sized facilities (20,000 to 50,000 square feet), which had a rock-bottom 1.50 percent vacancy rate at mid-year 2006.

Overall vacancy in the industrial market experienced a significant decrease from fourth quarter 2006, dropping from 7.40 to 6.50 percent. This number would be even lower if it weren’t for 3.7 million square feet of new construction, which was built primarily to meet the backlog of big box users. If this absorption of space continues through 2007, as it did in 2006, developers will continue to be motivated to build new projects. However, there was very little new product available during first quarter 2007, which could be due to developers waiting to see if construction costs decline, lack of available improved industrial sites, and the brokerage community educating tenants and buyers about the impending rise in prices. Another factor affecting the market is primary landholders’ desire to hold their land and develop it vertically, which forces owners/users to accept build-to-suit situations, instead of buying property and building their own facilities.

Significant projects under construction include three speculative buildings by Freeport West, totaling 1.16 million square feet and divisible down to 50,000 square feet, as well as the Buzz Oates 410,000-square-foot big box facility.

The Salt Lake City industrial market will see new construction providing inventory for the 20,000- to 50,000-square-foot segment and second-generation space with increased sale and lease prices, as the upward pressure of land prices, continued absorption and construction costs push newer product even higher.

The forecast for the rest of 2007:

Rental rates and sale prices will continue to rise across all segments, with the under 50,000-square-foot market seeing the largest increase.

New or speculative big box projects will be split into 20,000- to 50,000-square foot increments.

Land prices will continue to escalate due to continued absorption and dwindling inventory.

All of these economic pressures create a challenge both for clients needing space and for agents, because what’s expected in the market today is, in effect, a vacancy rate near zero. The challenge: To educate tenants and buyers on how to deal with the new reality in Salt Lake City.

— Craig Kaminski is an industrial specialist for Commerce CRG – Cushman & Wakefield in Salt Lake City.

Multifamily

Household growth, along with moderate job creation and more limited housing affordability, will continue to support renter demand this year. Salt Lake City’s economy has been growing at a rapid pace and, though economic expansion is expected to slow somewhat this year, unemployment will remain in the 3 percent range. The region’s high employment gains in recent years have helped spur the current population boom. Furthermore, the state’s favorable business climate is generating additional population growth from both restructuring companies and California transplants seeking employment and a lower cost of living. Local home prices will also benefit apartment owners, as residents are increasingly priced out of homeownership.

Well aware of the area’s favorable demographic trends, developers are expected to ramp up apartment construction this year, which will cause vacancy to increase slightly in the near term.

Salt Lake City is one of the more stable multifamily markets in the western United States. The region offers above-average cap rates and has been one of the few markets where conversion activity did not drive appreciation beyond what could be supported by revenue fundamentals. Investors in search of lower-risk, revenue-generating investments are expected to continue to channel capital into Salt Lake City. With the traditional renter demographic — residents ages 20 to 34 years old — making up nearly 25 percent of the metro’s population, investors are expected to target local properties for longer-term investments. Opportunities are expected to arise in the eastern submarkets, where homes tend to be more expensive, and the gap between monthly asking rents and mortgage payments is the most significant.

The forecast for Salt Lake City’s multifamily market:

Salt Lake City employers are forecast to create nearly 9,000 jobs in the next three quarters, expanding payrolls by 1.4 percent. The leisure/hospitality and professional/business service sectors will account for about half of the new positions this year. In 2006, Salt Lake City payrolls grew by 4 percent.

Approximately 1,900 units are expected to come online by year’s end, nearly triple the total number of apartments brought online last year. Half of this year’s deliveries will be added in the central Salt Lake submarket.

After a 10-basis-point improvement in 2006, vacancy is forecast to increase 40 basis points by year’s end to 6 percent, as new inventory is slowly absorbed. South Salt Lake and Davis County, however, are expected to post occupancy gains.

Even with vacancy rising, rents are expected to grow in the next three quarters of 2007. Asking rents are forecast to increase 2.4 percent, while effective rents will gain 2.7 percent. The central and South Salt Lake submarkets are expected to outperform the metro this year.

With a few apartment markets in the western United States facing some level of uncertainty this year due to conversion exhaustion in 2006, Salt Lake City is expected to receive an inflow of out-of-state capital seeking stable cash-flow investments.

— Adam Christofferson is the regional manager and vice president of Marcus & Millichap’s Salt Lake City office.

Retail

Salt Lake City has experienced tremendous growth in the past several years, supporting strong improvements in its retail market. While job growth is expected to slow in 2007, retailers will continue to find the metro area attractive for expansion due to its relatively high household incomes and prospects for continue population growth.

While market occupancy and rents are expected to rise, the most dramatic improvements are forecast in the popular residential Midvale/Sandy submarket. Vacancy in the submarket is expected to decline 160 basis points to 8 percent this year, supporting above-average rent growth. Delivery of new space in the metro area will increase slightly this year, and there may be some risk of overdevelopment of big box centers. Salt Lake City is already home to 20 Wal-Marts, and the metro has a reputation for being receptive to big box development.

Salt Lake City’s urban core is in the early stages of a massive redevelopment, which is expected to fuel retail investment for several years to come. In late 2006, the city issued permits for Property Reserve Inc., the commercial real estate arm of the LDS Church, to move forward with its City Creek Center project. This 20-square-block, privately financed development is expected to break ground in early 2007 and will add millions of square feet of retail, office and residential space to downtown. City Creek, which will include a full-service grocery store, is expected to serve as a catalyst for downtown business and residential growth, and should boost demand for retail space throughout the submarket. Anticipating heightened demand in surrounding areas, out-of state buyers are expected to use City Creek to justify multi-tenant purchases at cap rates significantly lower than the current metro average of approximately 8.3 percent. Though revenue growth opportunities may be limited during redevelopment, prices for assets in the CBD are expected to increase in the coming year as buyers focus on long-term growth potential. Cap rates in the area are expected to dip below 7 percent by year’s end.

The forecast for Salt Lake City’s retail market:

Salt Lake City employers are expected to add 9,400 new jobs by year’s end, down from 25,700 positions created last year. The professional and business services sector will create the most positions.

An estimated 1.8 million square feet of retail space is expected to be delivered throughout the year, up from 1.6 million square feet brought online in 2006. Open-air lifestyle centers are gaining popularity and are expected to make up a larger portion of development projects in coming years.

After a 10-basis-point bump in 2006, vacancy is forecast to decline 20 basis points to 7.8 percent by year’s end.

Asking rents are forecast to reach $16.62 per square foot this year, while effective rents advance to $14.96 per square foot, both increases of 2.9 percent.

With out-of-area capital expected to target urban locations, local investors will likely focus on assets in suburban Tooele and Utah counties, where population growth is the strongest.

— Adam Christofferson is the vice president and regional manager of Marcus & Millichap’s Salt Lake City office.


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