FEATURE ARTICLE, MAY 2004

MIDDLE MARKET BROKER OUTLOOK
The western region’s secondary markets receive brokers’ primary attention.
Jennifer Orr

Affected less by the slow economy, most of the West’s mid-sized cites enjoy a steady commercial real estate market. Brokers expect this trend to continue throughout 2004.

Reno, Nevada

Though the population in the Reno-Sparks metropolitan area is only 375,000, the area draws from a trade region that totals 500,000 people. Adding to that number are the more than 5 million tourists who flock to the Reno-Lake Tahoe area each year. These promising figures have finally caught the attention of retailers, who have exploded on to the Reno scene in the last 5 years.

Blonsley

“All of a sudden, we are on the radar,” says Todd Blonsley, a managing broker for Marcus & Millichap’s Reno office. “A few years ago we didn’t have a Walgreens or a Rite Aid. The national retailers have woken up to a market that wasn’t being served with the retail dollar.”

Reno’s office sector is also healthy, with a vacancy rate — as of December 2003 — of 9.9 percent. This is the first time it has dipped into the single digits in 5 years, says Blonsley. Developers added 300,000 square feet of office space to the market in 2003 and are planning another 350,000 square feet for 2004.

Reno’s industrial market is holding steady, ending 2003 with a 10.3 percent vacancy rate, up a percentage point from 2002. Developers are active in the industrial sector with about 1 million square feet of new space planned for 2004, according to Grubb & Ellis.

Blonsley says Reno is an ideal location for industrial-type uses: “The Reno-Sparks market is within 12 hours by truck of all the major markets west of the Rocky Mountains. Geographically, we’ve become a fantastic hub to handle distribution. We have no corporate income tax, no personal income tax and no inventory flooring tax. So there are all sorts of incentives to do business here for a company who wants to access California and other major markets on the West Coast.”

Reno’s multifamily market is also unshakable. Traditionally, the multifamily sector averages a vacancy rate of 5 percent, and 2003’s rate came in at 5.9 percent. Rents average $792 per month, and 1,015 units came on line in 2003.

Blonsley sums up Reno’s market by describing it as the “passbook savings of growth.” He adds, “Our market has had slow, steady growth for 30 straight years. We keep going and clicking along with 2.5 percent to 3 percent long-term population growth.”

Tucson, Arizona

The retail sector leads the charge in Tucson. Late last year, Westcor opened La Encantada, a 258,000-square-foot development that includes lifestyle tenants such as Crate & Barrel, Williams-Sonoma, The Apple Store and Tommy Bahama. “Tucson is starving for this kind of retail,” says John Buette, a senior advisor with Sperry Van Ness Commercial Real Estate Partners. The market will absorb at least 850,000 square feet in 2004, and the vacancy rate is projected to finish the year at 9.4 percent.

Buette

Multifamily is also a hot spot and has the most potential for growth in 2004, says Buette. Though the low interest rates over the last few years have kept Tucson’s single-family market robust and have drawn people out of apartments, that trend is expected to change in 2004. “In 2003, our multifamily vacancy rate averaged 9.1 percent,” says Buette. “I’m predicting that will decrease to 8.2 percent because an up-tick in interest rates will knock people back to apartments.”

The low interest rates of previous years have also affected the office market, as more and more businesses opt for buying instead of leasing space. Tenants are abandoning their leases for new office-condo projects. This trend is one of the reasons that Buette expects Tucson’s office vacancy rate to reach 14 percent in 2004.

Tucson’s industrial market is the weakest sector, with 2004’s vacancy rate projected to climb to 18 percent. As of third quarter 2003, Tucson had more than 3 million square feet of vacant leasable industrial space. In 2004, more space will flood the market, when two major tenants, Bombardier and Weiser Lock, leave the area.

Tucson’s chilly industrial sector aside, the market as a whole has a bright future ahead. “We’re slated to have 13,000 new jobs in Tucson in 2004 and 17,000 in 2005,” says Buette. “And we just heard that Citigroup is bringing in a call center here and employing another 1,300 people. Employment is definitely on the upswing. [Our population] is growing at 22,000 people per year, and we’re slated to be at 1 million people by mid-2007. Once we hit that mark, we’ll start getting more attention from major retailers and companies.”

Spokane, Washington

The weakest link in Spokane’s commercial real estate market is the office sector in the downtown central business district, where two rehabilitated buildings and one new development are opening this year. SDS Realty has already opened the American Legion Building, a redevelopment of a 70-plus-year-old building. Also open is the rehabilitated Morgan Building developed by Ron Wells. The American West Bank building, developed by Mick McDowell, will open in June. This development will be anchored by American West Bank and will feature five stories and 60,000 square feet. Together these three developments bring roughly 165,000 square feet of office space to the downtown market.

Quigley

Furthermore, Metropolitan Mortgage, one of Spokane’s major employers, is suffering financial difficulties, which will most likely affect the 180,000-square-foot building the company owns and occupies downtown, says Thomas Quigley, president and CEO of Kiemle & Hagood Company. “We’ve got some interesting challenges and opportunities ahead of us in the office sector,” he acknowledges.

On a more positive note, retail continues to shine, with leasing still active at River Park Square, a 5-year-old, 300,000-square-foot multi-story mall anchored by AMC Theatres and Nordstrom.

More good news: The industrial market seems to have bounced back after the sector lost more than 1 million square feet in 2001. Last year, the market absorbed 536,000 square feet of industrial space and posted a vacancy rate of 7.9 percent, down from 8.2 percent in 2002. “We’re a little above where we’d like to be, there’s no question about that,” says Quigley. “But we’re beginning to see some activity. We tend to look at our industrial market as the bellwether. If the industrial-type tenants are hiring, they’re going to need additional services — whether that be retail, accounting, legal, whatever the case may be — and they tend to drive our market here.”

The multifamily market is also performing well in Spokane. As of December 2003, the vacancy rate was 7.4 percent; though an increase from 2002’s 5.9 percent, the rate shows the sign of a healthy, steady market, according to Quigley.

Overall, Spokane commercial real estate remains consistent with previous years. “We tend to think of our market as active, but thin,” says Quigley. “There is not an overabundance of transactions that are going to occur, but there is always activity.”

Colorado Springs, Colorado

This year is a transition year for Colorado Springs, says Gary Winegar, CFO of Griffus-Blessing. “We are probably surfing at the bottom, with some cautious optimism about what’s out there in the future. Some properties have been hobbled by some declining cash flows, and recovery has seemed painfully slow. But there are signs that things are going to get better.”

Winegar

One sign is that little development is occurring in Colorado Springs’ commercial real estate market. Brokers are hoping the basic rules of supply and demand will kick in and some extra space will be absorbed.

In addition, with the U.S. Department of Homeland Security setting up shop in the city last year, more defense contractors are expected to be drawn to the area, bringing jobs with them.

And thirdly, 11,000 U.S. troops will be returning home to Colorado Springs this year, which could give the multifamily sector a much-needed boost — last year’s vacancy rate reached 13 percent, says Winegar.

Apartment owners are not the only ones looking forward to the troops’ return. “A lot of retailers are salivating because they think the troops might have some pent-up spending,” says Winegar. The retail sector has remained the strongest in Colorado Springs, with increased development and a relatively low vacancy rate — about 9 percent. Last year, Poag & McEwen opened The Shops at Briargate, a 225,000-square-foot lifestyle center with tenants — many new to the area — including Pottery Barn, Ann Taylor and P.F. Chang’s China Bistro.

Smaller retail developments are also planned, many for the Powers Boulevard corridor on the east side of town, which is also active with residential development. “I think a lot of national retailers are scouting out this whole market,” says Winegar, “but a lot of them seem to be fighting over space on Powers.”

A few years ago, office developers were equally enthusiastic about the north section of Colorado Springs, an area that ended up taking a big hit when the economy turned sour. “It got to the point where rents decreased 20 percent,” says Winegar. “When you added in sublease space, the market was probably more than 20 percent vacant. But some of that has started to heal a little bit.”

Luckily Colorado Springs real estate developers kept all of their construction in check. “We never got to the bleeding point,” continues Winegar. “If we get some absorption, overall, we’ll be fine. We think by 2005 we’ll definitely be on sustained recovery.”

Fresno, California

Unlike most California cities, Fresno’s office market is thriving, practically booming. Last year, the vacancy rate dropped to 8.6 percent, down 2 percent from 2002. Another sign of a healthy market: the amount of sublease space available in Fresno is minimal — about 57,000 square feet, according to Grubb & Ellis/Pearson Commercial research — even with developers adding new space to the market. At the end of 2003, more than 450,000 square feet of office space was under construction.

One of Fresno’s new office developments is M.L. Street Properties’ Tower at Convention Center Court, which opened downtown last year. With 11 stories and 269,000 square feet, it is one of Fresno’s largest office buildings. In late February, the Fresno Bee reported that the office project was almost sold out, with just 20,000 square feet of space available. Grubb & Ellis expects office leasing to remain steady throughout 2004 and end the year with positive net absorption.

Fresno’s industrial sector is also strong, with a vacancy rate of just 6.1 percent at the end of 2003. Grubb & Ellis reports that the northwest and northeast submarkets are the tightest, with vacancy rates of 3.1 percent and 4.4 percent, respectively. With such little supply, rents can run as high as $5.38 per square foot, according to Grubb & Ellis/Pearson Commercial research. The southern part of Fresno has a wider selection of inventory, with more than 350,000 square feet of space either under construction or currently available and rental rates just around $3 per square foot.

Developers are also active in the multifamily market. More than 3,000 multifamily units will come on line in 2004. The occupancy rates in this sector have been high, causing rents to soar by 20 percent in some submarkets. Overall, rents have increased by 8 percent, according to Grubb & Ellis.

In the retail sector, increased residential growth is fueling new development. Grubb & Ellis reports that upscale shopping centers are especially popular with developers. One such project, Piazza del Fiorre, will open in north Fresno in 2004. The 75,000-square-foot shopping center, developed by Granum Partners, will feature a mix of high-end specialty shops.

Santa Fe, New Mexico

With a population of 65,000, Santa Fe doesn’t usually have an overabundance of commercial real estate activity, says Leon Mellow, a managing director in Grubb & Ellis’s Santa Fe office. “There is always commercial development going on here, but it’s always on a very small scale,” he says.

Mellow

The retail and office sectors dominate most of the activity occurring in Santa Fe. The retail market is divided into two parts — the downtown sector, which caters to tourists, and the peripheral areas, which cater to local shoppers. The latter sector is doing quite well, reports Mellow, but the downtown market is flat. “The lodging and restaurant industry have also had flat sales, and that’s due to the [continued] impact of September 11, 2001,” says Mellow.

Office leasing has picked up after two slow quarters, as companies have begun to move ahead with plans that they had originally put on hold, says Mellow.

The city’s multifamily market has traditionally boasted a low vacancy rate. But with more and more apartments turning into condos, the market has become even tighter. Mellow predicts that the apartment market will continue to stay tight throughout 2004.

The future of Santa Fe’s commercial real estate market heavily depends on the re-emergence of tourism in the area. “Once the tourist market turns around, it will turn around all parts of Santa Fe’s commercial real estate, too,” says Mellow. “Tourism brings in a large group of affluent folks, who fall in love with Santa Fe. Many decide they can run their businesses here. They’ll buy second homes and then they’ll need office facilities or small commercial space.”

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