MARKET HIGHLIGHT, JUNE 2009

SACRAMENTO
Fred Springer, John Gallagher, Bob Kuhl, Rick Phillips and Rob Mora

The economic shockwave has reached the greater Sacramento area commercial real estate market. In all sectors, activity has dwindled as investors continue to wait for financial markets to thaw, those with cash wait for signs that this is truly “the bottom,” and owners and tenants battle over the size of concessions.

Retail

The prominent trend in retail development thus far in 2009 has been its absence. Developers are either completing projects already underway or remodeling existing properties to maximize marketability. Only 15 new buildings were delivered in first quarter, totaling approximately 156,000 square feet (another 856,000 is slated for delivery later in the year).

The overall vacancy rate for retail space in the first quarter was 9.2 percent, with negative net absorption of nearly 850,000 square feet. Rental rates climbed to $21.06 per square foot per year (approximately $1.75 per month). That represents a 1.9 percent increase in rental rates in the current quarter, and a 6.13 percent decrease from first quarter 2008. Asking rents do not reflect market activity, which is being affected by tenants demanding and owners making major concessions in order to close transactions.

As for hot spots, everyone is watching Sacramento’s K Street redevelopment with a hopeful eye toward an emerging downtown entertainment district. The city has redevelopment funds to draw the attention of potential tenants, and it could be successful, even if it means buying the tenants.

Newly delivered retail projects include 5065 Quinn Rd., a 37,914-square-foot general freestanding building occupied by Camping World; a 20,000-square-foot building at 6985 65th St. developed by Stonehenge Property Group and now occupied by FAMSA, a Mexican retail chain selling home furnishings; and the largest project (also from Stonehenge Property Group) is at 6117 Florin Rd., a 213,316-square-foot building in Florin Towne Centre with 100 percent of its space pre-leased by Wal-Mart. In one other big move for 2009, upscale retailer William Glen took 35,000 square feet in The Collection at Town & Country Village.

— Fred Springer is a retail and investment specialist at TRI Commercial/CORFAC International in Roseville, California.

Multifamily

New construction is at a standstill, although apartment vacancy rates have not significantly dropped in the Sacramento area. At present, supply is adequate for market demand. Average vacancy is up slightly to 9 percent with rental rates holding. Incentives such as 1 month free for a 12-month lease are common. The economy and, more specifically, job losses have caused tenants to double up or move back home to save money and cut living expenses.

The demand generated from families who have lost their homes due to foreclosure is offset by the increased affordability of single-family homes and attractive financing for those who qualify. Many apartment residents who could not afford a home from 2003 to 2007 can now purchase one.

The positive news for apartment developers is that land prices have come down roughly 50 percent, and construction costs are down in both materials and labor. Construction financing, however, is non-existent.

There have been very few investment sales of apartment properties to report for 2009. Of 30 listed properties in Sacramento, only two are under contract. Twenty-seven of those listings have been on the market for more than 6 months, and 17 listings show a price reduction. Essentially, the investment sales market is at a standstill, too. Clients are expressing interest in investing in bank REOs and other financially distressed properties.

— John Gallagher is a senior vice president at TRI Commercial/CORFAC International in Roseville. 

Office

The overall vacancy rate in Sacramento’s central business district decreased to 7.9 percent, compared to 8.4 percent at the end of fourth quarter 2008. However, the vacancy rate in the suburban markets increased to 16.9 percent, up from 16 percent in fourth quarter 2008.

Some recent departures: UPS is moving out of 24,000 square feet at 8455 Jackson Rd.; Fandango’s restaurant is leaving 12,586 square feet at 10910 Olson Dr.; and Telomolecular Corporation is moving out of 8,949 square feet at 10933 Trade Center Dr.

On the positive side, new leases include California Court of Appeal, 3rd Appellate District, moving into 55,000 square feet at 621 Capitol Mall; County of Sacramento moving into 54,677 square feet at 3075 Prospect Park Dr.; and Waste Connections Inc. moving into 54,000 square feet at 2295 Iron Point Dr. The largest lease signings so far in 2009 were a 75,626-square-foot renewal by Volcano Corporation at 2870 Kilgore Rd. on the Highway 50 Corridor; a 56,400-square-foot deal signed by Numonyx Inc. at 2235 Iron Point Rd.; and the 36,626-square-foot lease by Allstate Insurance at 10877 White Rock Rd. along Highway 50.

The average quoted rental rate for all available office space in the Sacramento area was $23.45 per square foot per year ($1.95 per month), a 1 percent decrease from the end of 2008. Class A space averaged $27.61 per square foot, while Class B rates averaged $23.72 and Class C stood at $17.90.

Despite market indicators, 1.7 million square feet of office space was under construction at the end of first quarter 2009. The largest projects underway were Five Hundred Capitol Mall, a 433,500-square-foot building developed by Tsakapoulous Investments with 27 percent of its space pre-leased; and CalSTRS’ new headquarters on 3rd Street, a 400,000-square-foot facility that is 100 percent pre-leased.

Developments recently completed include Opus West Corp.’s 160 Promenade Circle, a 115,134-square-foot facility that is now 42 percent occupied, and 2295 Iron Point Dr., a 96,000-square-foot building developed by the Evergreen Company that is 56 percent occupied.

Heading toward the summer months, brokers are seeing a lot of fact-finding on the part of tenants who just want to know what’s out there, but little in the way of qualified prospects. As one agent put it, “tenants are out shopping around and kicking the tires. We’re doing a lot of tours but not seeing many offers.” There’s no sign that this is going to change in the foreseeable future.

— Bob Kuhl is a principal at TRI Commercial in Roseville. 

Industrial

Sacramento area industrial vacancy rose to 10.4 percent with flex space vacancy up to 20 percent. Tenants are bold about requesting below-market rates along with concessions, and more and more owners are willing to take deals just to offset expenses. As these deals hit the market, it further strengthens tenants’ perceptions of market value. Though asking rates are at $6.25 per square foot per year on a NNN basis, vacancy rates are rising. Owners are unable to backfill the spaces as quickly as they did in the past. Many tenants are pursuing rate reductions with their existing landlords, and this year, landlords are forced to listen.

Activity has slowed dramatically since fourth quarter 2008. Users are no longer looking to purchase space, as business slows and cash flow tightens. In spite of the strain on landlords, investors have yet to come forward in the industrial sector as they wait to see blood in the water.

The largest lease signings occurring in first quarter included the 44,740-square-foot lease renewal by EDS at 3078 Prospect Park Dr. in Sacramento; the 35,500-square-foot lease renewal by Continental Supply Company at 700 Santa Anita Dr. in Yolo County; and the 24,120-square-foot renewal by Hands On Sign Languages at 595 Menlo Dr. in Placer County.

Absent the owner-users looking to build warehouses, land prices are still too high for investors. As existing land and building prices continue to fall and the banks tighten their underwriting on speculative projects, it’s clear that developers are waiting it out. Zero new projects were delivered in first quarter 2009, although a few remain under construction for later delivery.

As the recession deepens, cap rates will rise and rents continue to decline. Match this with rising vacancy rates, and it’s the perfect storm for lender underwriting.

Without enough comp data to establish market pricing and decreasing trends in rates for those deals that are getting done, there is little confidence that the market has hit bottom. Anyone that can wait will wait. Those that cannot wait will grind deals down to the bone — if there is any financing left to get them done. This will be the tone for the rest of 2009 as the industrial market continues its downward cycle.

— Rick Phillips and Rob Mora are senior vice president and industrial specialist, respectively, at TRI Commercial in Roseville.

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