MARKET HIGHLIGHT, NOVEMBER 2004

SEATTLE CLEARED FOR TAKEOFF
Gregory Wendelken and Chris Vay

Seattle is recognized as a leader in the aerospace and technology industries and is home to major employers Microsoft, Starbucks Coffee and Washington Mutual. Education, cultural attractions, recreational opportunities and quality of life are reasons Seattle remains such a desirable place to live. The decline of the technology market, combined with layoffs in aerospace and related sectors, has taken its toll on the Seattle market during the last 3 years. However, Boeing has recently been adding jobs in the state of Washington. In July, Boeing announced plans to add 2,000 to 3,000 new jobs in the state by the end of the year. Microsoft also announced plans to hire 3,000 new workers during the coming year.

Retail

Puget Sound’s retail sector has been resilient while other commercial real estate sectors in the Seattle area have struggled through tough economic times. Factors including reduced unemployment, increased capital and consumer spending, and low inflation continue to have a positive impact on the retail market in the region. Strong demographics, stable retail fundamentals and rising property values will continue to attract retail investors to the Seattle area.

The Seattle MSA will experience household growth of more than 5 percent during the next 5 years, with population increasing by 4.8 percent. During the same period, the median household income is expected to rise by nearly 15 percent. High-technology salaries are forecast to increase 3.3 percent in 2004, with disposable income forecast to grow by 10.3 percent in the next 5 years. In the same period, total retail expenditures will grow by 9.3 percent in the Seattle MSA, compared to 8.1 percent nationally. These demographic trends will support a strong local retail market.

Retail completions totaling 844,000 square feet are expected in 2004, an increase from the 765,000 square feet completed in 2003. The two largest projects include a Sam’s Club in Renton and phase four of the Alderwood Mall, which added 172,000 square feet to the Lynnwood retail market when it came online this summer. The largest project currently under construction is Lincoln Square in Bellevue. This multi-use project is scheduled to come online in 2005 and will total 1.4 million square feet at a cost of $360 million.

The overall vacancy rate will dip 50 basis points in 2004 to reach 5.2 percent by the end of the year. All submarkets are forecast to post a decline in vacancy. The Central and North Seattle submarkets are expected to show the most significant improvement, with vacancies falling 200 and 290 basis points, respectively. Regionwide, the use of concessions to attract businesses will subside as vacancy dips, pushing up returns for owners. This year the improving economy will allow for rent growth of 4.4 percent, pushing the average asking rent to $19.83 per square foot per year by close of 2004.

Unlike the majority of commercial real estate investors, those interested in single-tenant properties are typically willing to buy and sell properties nationwide as long as the expected returns on their investments are met. The Puget Sound market offers investors strong retail fundamentals and the potential for growth. A well-located single-tenant property in the Seattle region that is occupied by a credit tenant, and has a minimum of 10 years left on the lease, will usually receive multiple offers.

Retail property sales prices across the Puget Sound region are forecast to rise by an average of 3 percent in 2004. Overall sales velocity is expected to remain stable, but multi-tenant property sales are likely to rise, while the limited availability of single-tenant assets hinders activity in the sector. Well-located neighborhood and power centers will be in the highest demand among multi-tenant properties as they will offer the most stable returns.

Multifamily

The Puget Sound apartment market has embarked on the road to recovery. Job growth has arrived, and investors are taking note. Investor interest in Puget Sound apartments is expected to continue at a near-record pace through the end of 2004 as rents begin to climb and occupancies improve. Once-cautious developers have also heeded signs of improvement and are again planning new projects.

Employment is on track to increase 2.2 percent by year’s end as employers add 29,500 jobs. Improvement for the manufacturing sector could be on the horizon as companies such as Boeing appear to have stabilized, hopefully putting an end to layoffs. The information technology sector has begun to rebound nicely with almost 4,300 jobs added in the past 12 months. The unemployment rate has declined almost 100 basis points to date in 2004 to less than 6 percent.

Apartment construction has remained slow this year, with 2,100 units expected to come online by year’s end. However, the restraint exhibited during the past 18 months is expected to give way to renewed building in early 2005. Currently, there are more than 7,000 units in the planning phase of development, the majority of which are located in the downtown areas. Approximately 60 percent of the units planned have listed a start date, and many are scheduled to break ground later this year.

Vacancy is on track to dip 20 basis points by the end of 2004 to 7.6 percent. The upscale Eastside and Queen Anne submarkets of Seattle have begun to tighten as high-paying information services jobs have resurfaced in the region. The predominantly working class Pierce County remains the most stable submarket in the region, with vacancies fluctuating less than 1 percent during the recent downturn. Occupancies will improve in this submarket through the end of 2004 and into early 2005, with vacancies falling below 6.5 percent for the first time since 2000.

Strong employment prospects have spurred positive net in-migration to the area. With the firming of occupancies, concessions are becoming less prevalent, and rents have stabilized. Some areas, however, are still struggling. Asking rents in the Snohomish County submarket dropped 10 percent from a high of $810 per month in 2001 to the current $729 per month. In the small but expensive Central submarket, rents dropped almost 7 percent in the first part of 2004. Rents in this area and the equally affluent Eastside submarket, however, are expected to increase slightly by year’s end. The desirable Downtown/Hills submarket will post strong gains. Pierce County rents are on track to gain 4 percent by 2005 as residents migrate to the area’s comparatively low-priced housing.

Transaction velocity is up from last year and is forecast to remain high in the near term as out-of-state investors target the Puget Sound region due to its relative affordability and higher yields. Unfazed by falling rents and climbing vacancies, apartment investment sales are up more than 40 percent when compared to the same period last year. Additionally, the median price per unit is up significantly to $89,600.

Office

Demand for office space remains in the black with 148,120 square feet of positive net absorption in third quarter 2004. The vacancy rate for the Puget Sound office market was unchanged at 16.3 percent in the third quarter, slightly below the national rate of 17.6 percent. Leasing activity has slowed as decision makers appear to be waiting until after the November elections to see how the economy will react. Until then, businesses will be conservative about capital investment and hiring. All of this has slowed job growth.

Although vacancy has declined over the past few quarters, tenants are still in the driver’s seat. Tenants have multiple space options and can negotiate very favorable lease terms in most buildings. Concessions like free rent, parking, moving allowances and tenant improvement allowances are common. The east side is beginning to tighten with concessions on the decline. Symetra Financial signed a lease for 290,000 square feet in downtown Bellevue. The firm will vacate its current space in Redmond next July. Drugstore.com leased 53,256 square feet at One Bellevue Center and will vacate space at Sunset Corporate Campus in the I-90 Corridor. These two deals alone will bring the vacancy rate in downtown Bellevue to 15.1 percent, down from the current rate of 21.1 percent. In response to a tightening of the Bellevue market, Class A asking rents in the Bellevue CBD submarket rose to $24.83 per square foot per year in the third quarter, up from $24.17 per square foot in the second quarter of 2004. Overall, in the Puget Sound market, Class A asking rents were $25.39 per square foot per year in the third quarter, down from $25.85 per square foot in the second quarter. Class B asking rents were $18.77 per square foot per year in the third quarter, marking an 11 cent increase from the second quarter.

Several large firms including NBBJ, Tommy Bahama and Washington Mutual are moving to build-to-suit office space, despite the glut of speculative space on the market. The Bill and Melinda Gates Foundation is considering construction of a 200,000 to 600,000-square-foot office complex in the South Lake Union area, while King County is deciding whether to build an $89 million, 261,000-square-foot office building in downtown Seattle. All of the above would put additional office space on the market over the next 3 years and could slow the rate of recovery.

Cingular Wireless announced plans to acquire Redmond-based AT&T Wireless. AT&T Wireless occupies about 1 million square feet of office space, mostly in Redmond and Bothell, Washington. The company employs 5,700 workers in the state, many of whom may lose their jobs or be relocated to Cingular’s Atlanta headquarters. A sale will slow the economic recovery, impacting the east side suburban market.

Demand continues to outstrip supply in the investment market. We are seeing a high water mark in investment sales and the prices that sellers can achieve. RREEF recently purchased 1000 and 1100 Dexter Avenue in Seattle for $63.98 million or $300 per square foot, one of the highest prices ever paid for a non-CBD office property in Seattle. Balance will come as interest rates rise. Until then, suitable investment opportunities will remain in short supply.

Industrial

The vacancy rate for the Puget Sound industrial market was 8.4 percent in the third quarter of 2004, down from 8.8 percent in the second quarter. There were 567,558 square feet of positive net absorption.

To accommodate new demand, developers are active, building 4.2 million square feet of industrial product, mostly in the south end market. Segale Properties, Knapp Development, Tarragon Development, Opus Northwest and Northwest Building LLC all have speculative projects underway, totaling 1.7 million square feet. Panattoni Development Company and Davis Properties & Investments have projects planned for the market. There are a few large tenants looking for space but it appears developers are competing for the same tenants. If this is the case, vacancy will increase as product hits the market during the next 9 months. If tenants and owner-users emerge to occupy these projects, more buildings will go up and development opportunities will move further south.

Geographic constraints have limited land availability. As developers begin to run out of land, more development opportunities will be found in Thurston County, Dupont and southern Washington. In the south end, parts of Sumner and Frederickson make up the last major pieces of developable land.

A Florida–based racetrack developer just announced future plans to build a NASCAR racetrack north of Marysville. This could take up to 850 acres of developable land in the north end market.

Rents and concessions still favor tenants, but, over the next couple of years, landlords will regain their negotiating strength. Effective rents have increased but concessions are still available. The average lease rates are $0.42 per square foot per month NNN for warehouse/distribution space and $0.86 per square foot per month NNN for R&D/flex space. Tenants are still seeing 3 to 5 months free rent on 5-year deals. Expect vacancy to decline as job growth improves.

Gregory Wendelken is a vice president and serves as regional manager of Marcus & Millichap’s Seattle office. Chris Vay is a research analyst for Grubb & Ellis in Seattle.


©2004 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.