MARKET HIGHLIGHT, JUNE 2008

SALT LAKE CITY
Chad Moore, Ben Brown, Kip Paul, Dana Baird, Randy Atkin and John G. Taylor

Salt Lake City continues to post strong real estate numbers thanks to sturdy fundamentals.

Retail

Salt Lake City’s retail market continues to exhibit extraordinary strength and stability. Overall vacancy has continued to trend downward to 6.39 percent during the past 12 months, a time in which close to 1.5 million square feet of new space was added to the retail base. This marks the second straight year that vacancy declined in spite of historically high levels of new construction.

Lease rates in top-tier retail centers continue to rise. Average asking rates reached $21.32 per square foot during the past 12 months, led by the increases commanded by powerful regional centers. Rents in community centers rose slightly, while neighborhood and anchorless strip centers remain stable. While data reflect activity across 12 months, rents for high-quality space actually began to stabilize in the past 6 months.

The overall strength of Utah’s economy should outshine the “doom-and-gloom” atmosphere created by the sharp downturn in residential construction. A slowdown in home building does not translate directly into a decline in the retail arena. While statewide retail sales have moved down from the historic highs of recent years, the market reflected a healthy 5 percent increase in 2007 that outpaced the U.S. average.

The market experienced an influx of high-profile retail chains in 2007 and early 2008. Well-known names, such as IKEA, The Cheesecake Factory, Chipotle Mexican Grill, Urban Outfitters, American Apparel, Ashley Furniture and Steve & Barry’s, made their Utah debuts last year. Others, such as Whole Foods Market, Sunflower Market, El Pollo Loco, ULTA and Corner Bakery, will enter the market in coming months.

Retail construction should begin to slow in the coming year. Although new space has been absorbed almost as quickly as it is built, it is unlikely the market can sustain the breakneck pace of new construction of the past 2 years. The anticipated deceleration reflects the natural trend of development cycles.

The slowdown in residential construction could pave the way to more realistic prices for retail land. While land values have stabilized, they remain at a historic high for the Wasatch Front. As the slowdown in home building eases demand for land, the steep increases in values of the past few years are likely to subside.

All these factors, along with the relative stability of the Intermountain region, provided an opportunity for developers, investors and tenants to find opportunities in this market that are more stable than in other parts of the country.

— Chad Moore and Ben Brown are retail specialists at Commerce CRG in Salt Lake City.

Multifamily

Last year was a good time to invest in Salt Lake City apartments, and 2008 looks equally compelling. Expect the current strong fundamentals to hold up, even as the economy weakens. In fact, one of the primary factors causing the downturn — the decline in the housing market precipitated by subprime lending — is a positive for the rental market. First, because mortgages are now harder to obtain, many potential first-time buyers can’t become owners. Second, other homeowners have been forced to rent again, because they couldn’t afford to keep their homes when their adjustable rate mortgages reset.

When you add these factors to an already tight apartment market — 3 percent vacancy, 10 percent overall rent increases and fewer than 1,000 new units to be added this year (a 1 percent increase) — the forecast is that owners will be raising rents for the next few years. The escalating cost of new construction is another factor supporting the market, as the higher rents for new units pull up existing apartment rates.

The bottom line for investors: With interest rates of 6 percent or less, we think cap rates between 6 and 6.5 percent are a safe and reasonable return investors can count on for the foreseeable future.

Salt Lake County’s apartment vacancy rate in summer 2007 was 3.2 percent, which represents the fourth consecutive year of vacancy rate declines. In 2006, the vacancy rate was 4 percent; in 2005, it was 6.1 percent and in 2004, 7.2 percent. In general, larger apartment communities have lower vacancy rates and higher rental rates, but with the improved market conditions, all types of apartment communities are experiencing low vacancy rates.

The Salt Lake County apartment market, with more than 95,000 rental units, has added only a modest number of new units in recent years. The number of new units receiving building permits since 1997 has averaged approximately 1,000, about 10 percent of the inventory annually. Severe supply constraints will continue to limit the number of new rental units added to the market; they include rapidly rising building and land costs and intense local opposition to high-density rental housing.

— Kip Paul is an investment specialist based in Commerce CRG’s Salt Lake City office.

Office

Although the national economy has experienced a slowdown during the past several months, the Utah office market continues to perform well, with the underlying fundamentals, such as unemployment, job and population growth, ranking in the top 10 in the country.

The Salt Lake area office vacancy has increased slightly to 11.4 percent from 10.6 percent at year-end 2007, primarily due to significant second-generation suburban space added to the leasing market.

Class A vacancy in the central business district (CBD) and periphery remains low at 5.14 percent. With virtually no new construction being completed in the CBD, tenants looking for space in the downtown area have few options. Class A tenants have demonstrated an unwillingness to consider a downgrade to Class B facilities to accommodate their needs. Although Gateway 5 and 6, totaling 160,000 square feet, will be completed within 12 to 18 months, the shortage will continue until the end of 2009, when Hamilton Partners’ 420,000-square-foot tower at 222 S. Main St. will be completed. New office construction of 14 buildings totaling 1.1 million square feet is underway and slated for completion by year’s end, and all but one will be in the suburban market.

Lease rates are rising slightly following a 2-year run of significant increases, with an average rental rate of $19.94 per square foot at the end of first quarter 2008, compared to $19.82 at year-end 2007.

Development of medical-related office buildings is a rapidly emerging segment of the market. Health care services, research and development, bioscience, and new medical technology are among the fastest growing segments of the Utah economy. The University of Utah Research Park, which has long been a haven for companies involved in R&D, is nearly out of space, forcing tenants to look elsewhere to expand. The needs of these sectors offer opportunities for office development in the Salt Lake Valley.

New campus-style parks will emerge to meet the future demands of the robust office market. With limited land available for eastside development, Daybreak in South Jordan and the 2 million-square-foot office park planned in Midvale City will become examples of new master-planned Class A developments. Smaller infill sites near mixed-use transit-oriented developments will provide alternatives for office tenants throughout the Valley.

— Dana Baird is a commercial real estate broker with Commerce CRG.

Industrial

Despite the general economic decline in the country, activity in the Salt Lake industrial sector remains relatively brisk. In the past several years, manufacturing has been the most significant force in the market. Now it’s experiencing a gradual move to distribution. As fuel prices increase and companies look for central locations, Salt Lake City has become a good choice as demonstrated by the 355,000-square-foot Sephora distribution center.

The overall vacancy rate remains low at 6.11 percent, with available square feet — for sale and lease — declining from 6.42 percent in first quarter 2007. This low vacancy rate and lack of available space will continue because little new product will be ready in coming months.

The entire industrial sector is experiencing considerable increases, both in selling prices and lease rates. The combined overall weighted lease rate has risen 20 percent year over year, with 20,000 to 50,000 and 100,000-square-foot spaces increasing even more. Sales rates have also risen significantly, caused by such factors as little new construction, increases in building costs, low vacancy rates and the high cost of choice land. With the exception of older buildings and product that’s obsolete, sales and lease prices will continue to rise.

Combined sales and lease activity declined a modest 7 percent from first quarter 2007. Although down, this indicates a positive outlook for the market. Total lease activity, excluding sales, increased approximately 30 percent, and the number of lease transactions remained level compared with first quarter 2007, indicating more larger-space deals.

Due to the lack of available product, sales activity dropped significantly from first quarter of 2007. Companies cannot buy industrial space; they must lease or build, putting additional pressure on land costs and making it even harder to acquire quality locations. Affordable land is so difficult to find that previously undesirable parcels are now acceptable.

Despite the increase in land and construction costs, several developers remain active, including First Industrial Trust, Freeport West, Buzz Oates, LNR and IDI. They’ll build primarily in the northwest quadrant of the Valley, with a moderate amount in the southwest.

— Randy Atkin is an industrial specialist for Commerce CRG.

Investment

On a relative basis Utah is still strong. The Salt Lake area investment market continued its long-running streak of strength and vitality in 2007. For the third consecutive year, total investment sales volume topped the $1 billion mark, finishing out at an impressive $1.25 billion for all property types. Although overall volume and the number of transactions were down slightly from the previous year, the market remains robust, impeded only by limitations in the supply of available product. Projections for first half 2008 support this trend.

The Salt Lake area is still experiencing a boom in commercial construction. While residential construction has slowed its breakneck pace, the commercial arena is moving full speed ahead. There are numerous large projects in the pipeline, and 2008 is projected to be a record year for non-residential projects. Construction costs, which increased dramatically over the past 2 years, appear to have stabilized and in some cases to have decreased.

Lenders are becoming more cautious. Although financing is still available at favorable interest rates for quality transactions, lenders are tightening underwriting standards. Some sectors of the market are no longer active, and many of those that remain are demanding stiffer requirements for both properties and borrowers, including higher down payments and larger reserves.

Utah’s strong economic indicators continue to attract out-of-state investors. Population growth, low unemployment, economic strength, continued in-migration, personal income growth and burgeoning sales tax revenues are all factors that draw interest from institutional investors, private investors and individuals. Buyers are also attentive to the state’s major investments in infrastructure and mass transit, improvements that provide a firm foundation for years to come.

Investment activity is likely to decline modestly in 2008. The extended run of extraordinarily high activity levels has depleted the pool of available product. This coupled with tightening financing requirements will moderate investment in the local market.

Collateral damage associated with the subprime lending calamity and serious downturns in residential and commercial real estate in other markets have contributed to an atmosphere of caution and concern. Although Utah is by no means a declining market, investors and property owners will still face a ripple effect.

Utah will remain one of the best investment markets in the West. The diversity of Utah’s economic base will help shield the state from problems affecting our regional peers and other parts of the country.

— John G. Taylor is an investment specialist and real estate agent at Commerce CRG.

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