MARKET HIGHLIGHT, NOVEMBER 2011

HAWAII 
Matthew Bittick, Wendell F. Brooks, Scott L. Mitchell and Brooks R. Borror

Many cities talk of being land locked, but none feel the pinch the way Honolulu and its surrounding neighbors do. The six islands of Hawaii are working with very limited land. Combine that with the state’s heavy preservation efforts and every square foot counts. Read on to hear how Hawaii tackles office, retail and industrial projects, and the ever-important topic of commercial land sales.

OFFICE
Honolulu — The Manhattan of the Pacific

Bittick

Some think of Honolulu as a paradise in the Pacific, but for real estate investors, it’s more like Manhattan on a compact scale. Honolulu is a classic island economy, with inefficiencies that savvy investors have exploited for decades.

Honolulu is currently experiencing an increase in its vacancy rate, due primarily to a few large tenants “rightsizing” and larger owner-users putting new space on the market after relocating employees to more efficiently designed space in other owned properties.

Today’s environment is generally viewed as a tenant’s market for the smaller user, but for larger users (more than 10,000 square feet), options are limited. The largest block currently available is a 45,000-square-foot space in Kapolei at the Hale O Kapolei. The second largest is 25,600 square feet at Downtown’s First Hawaiian Center. Needless to say, larger tenants are currently at a distinct disadvantage because they’re having to negotiate at a time when there are virtually no viable relocation options.

Rent for space, particularly in Honolulu’s Central Business District, becomes inelastic as vacancy drops below 11 percent. At the end of September 2011, the vacancy rate was 13.77 percent. As a result, low to high average combined Class A and B asking base rental rates are about $1.59 to $1.77 per square foot, per month.

Premium effective rents are expected to materialize as the market continues to tighten. The return of a landlord’s market is anticipated over the next 24 months. Many landlords, anticipating rents for larger tenants to increase significantly, have shifted their leasing position from short-term tactical goals to long-term strategic goals. 

Overall, Honolulu is a long-term growth market with a high barrier to entry for development of new office buildings. The city has a reputation for offering a high quality of life and a history of long-term job formation. It is also one of the most supply constrained markets in the world, however. The most recent new office building in Downtown Honolulu was completed in 1996, and there is no plan for additional development anytime soon. Based on current Class A market conditions, rates would need to increase by more than 10 percent, compounded annually for the next 11 years, before market rents would justify new construction — conservatively estimated today at $550 per square foot. Think Manhattan and San Francisco prices.

Six major islands constitute the state of Hawaii, but most of the activity is on Oahu in Honolulu, which is home to 70 percent of the state’s population. While the office market there is slow today, it is poised for a rapid recovery. With no new buildings planned, high barriers to entry, and considerable distance between the islands, the West Coast and the countries of the Pacific Rim, the Honolulu market is unlike any other. During the last recovery, triple net rents peaked at $1.75 per square foot, nearly an 80 percent increase from their preceding economic low. Honolulu is set for a similar increase, but this time starting from a more elevated low.

— Matthew Bittick, president and senior managing director, Bishop Street Commercial in Honolulu

RETAIL
Flagships, Food Stores and Pharmacies — A Look into the Hawaii Retail Scene

Brooks

How often do you see Ross Dress for Less and Victoria’s Secret mentioned in the same sentence? Well, not often, but certainly you do when they both open massive flagship stores in the same week, literally around the corner from each other. Both companies “went all in” and opened their doors in one of world’s most popular resort destinations, Waikiki Beach.

Long known for its luxury sales, sushi bars and surf shops, Waikiki is now home to a 40,000-square-foot Ross and a towering bright and shiny Victoria’s Secret. Both of these commitments took guts. Ross was the first discount retailer to open in Waikiki, and Victoria’s Secret leased what has to be the most expensive location west of the Mississippi. Meanwhile, construction has started on three flagship TJ Maxx stores on the island of Oahu, and Armani Exchange is opening an impressive store on Kalakaua Avenue in Waikiki.

Across town in Honolulu’s urban core, Safeway is about to open one of its largest, most elaborate stores in the country. Slated to be the first Hawaii “Podium Store,” billed as a massive “grocery store in the sky,” this Safeway boasts an impressive architectural design that has already become a Honolulu icon. It will open its doors in December with the expectation of being a top-performing store, chain-wide.

The battle for pharmaceutical supremacy continues, with Walmart, Safeway, Walgreens, Target, Longs CVS and Foodland all opening multiple locations. No less than 15 new major pharmacy locations are planned in the next 18 months.

So overall, the retail news is pretty good in paradise. Our vacancy rate remains one of the lowest in the country, with a statewide average of about 5.6 percent. Our unemployment continues to drop, and is far below the national average at just less than 6 percent. Our projected retail construction spending also tops $1 billion. The main island of Oahu will see the bulk of the activity but major projects on Maui, Kauai and the Big Island are also moving forward. There is definitely a sense of optimism in the air. Visitor arrivals remain strong, people are working and spending money and the sun shines everyday.

— Wendell F. Brooks, III, senior vice president, CB Richard Ellis in Honolulu

INDUSTRIAL
Bouncing Along the Bottom

Mitchell

For the moment, vacancy rates have stabilized at 4.7 percent for the third quarter, down slightly from the 4.74 percent recorded at mid-year 2011. Volatility exists beneath the flat vacancy rate trends. Over the past four quarters, Hawaii’s industrial market has bounced between a negative 106,000 square feet of net absorption and a positive 77,000 square feet of absorption, and appears to be trying to establish the foundation for the bottom of the market. The future trajectory still remains questionable with more optimism than solid economic fact on whether a near term recovery will germinate.

Two industrial sectors dictate the majority of the tenant base in Hawaii. They include contracting and wholesale/distribution firms. These industries had mixed performances in 2011. Similar to other U.S. mainland markets, construction activity declines corresponded to the recessionary conditions and the difficult financial markets. Year-to-date July, building permit volume is down 37.4 percent, or more than $391 million from the 2007 peak. Industrial sector employment still remains depressed, having lost more than 11,000 jobs over the past four years.

Despite the slowdown in construction activity and the overall loss of industrial sector jobs, year-to-date June 2011 industrial business revenue is ahead of last year’s levels by a healthy 12.6 percent. In fact, the first half of 2011 set a record for the highest level of industrial sales revenue. Of the industrial business sectors, wholesale sales posted the majority of the gains by generating a $927.4-million increase, or 16.7 percent over last year’s levels, and appears to be benefiting from the tourism sector’s recovery.

The economic uncertainty that permeates through the business marketplace is influencing the pace in which relocation or expansion decisions are made. Industrial businesses are typically low margin and very price sensitive to rental rate changes. With the recent declines to rent, many businesses have considered relocating back to the urban core to be closer to their clientele and to reduce their transport/commuting costs that are due to rising gas prices. The migration from outlying markets to the central Honolulu locations contributed to vacancies rising in West Oahu’s Campbell/Kapolei industrial parks, which now exceed 9 percent. Average asking rents have consistently declined over the past four years, falling 30.6 percent from $1.30 per square foot, per month to $0.91 per square foot.

In addition to falling rents, West Oahu land prices are being affected by foreclosure activity. More than 250 acres of undeveloped industrial zoned land have already changed hands. New owners are recapitalizing these potential industrial park developments at lower cost basis, and although pricing for finished lots have not been announced, many believe 30 percent discounts from peak land prices is a strong likelihood. With no large undeveloped parcels available in other parts of the island, the future of industrial expansion on Oahu rests solely in West Oahu. Therefore, progress in bringing these projects to market is being closely watched by buyers and users.

Very little change is anticipated that will reverse the outlook for the industrial marketplace for the remainder of 2011. Although vacancy rates are projected to continue their moderate rise into 2012, the hope is that the residential housing market and associated construction activity will begin to reappear in 2012 and help to stabilize the market.

— Scott L. Mitchell, executive vice president/manager, industrial division, senior member, Colliers investment sales division

COMMERCIAL LAND SALES
What’s Hot and What’s Not…Land in Hawaii

Borror

It has often been said that Hawaii real estate is expensive because there is only so much developable land. Affordable, well located, fee-simple land is usually a scarcity.

Oahu absorption of residential housing units is rising, although the prices are lower than previous years. So far the market is still not warranting new housing starts. The prices of residential units in West Oahu, or the Ewa Plain, have been the hardest hit due to the high number of foreclosures. Neighbor islands are seeing record highs of foreclosed residential properties that are being purchased well below replacement cost. As a result, new neighbor island housing starts are at a record low.

Once the economy plateaus and there is confidence that a true economic recovery has begun, lenders and home buyers will remobilize. The lenders will need to clear their books of the bad loans and become willing to lend money to the average consumer. Once the excess supply of homes is absorbed, there will be a market for new housing starts, and there will be a market for residentially zoned land.

Naturally, Hawaii is no exception to the adage of “commercial follows residential.” With the uncertain economy, retailers are much more selective about the locations and economics of new store openings. Rents have regressed some 15 percent to 20 percent on Oahu, and even more in the neighbor island markets like Hilo, Kona, Kahului, Lihue and Kapa’a. In Hawaii, new commercial construction currently is not generally economically viable. Hence, the value of commercial zoned land has been hard hit. Investors and developers alike are finding it increasingly difficult to underwrite land acquisitions due to their inability to forecast the holding period/carry costs or projected rents.

For the first time in a long time, shopping centers are beginning to be offered below replacement cost. These properties are generally bank-owned (or controlled) and require some investment and time to turn them around. Lower rents and higher cap rates required by the market seem to be the driving forces behind these offerings at lower prices. Commercial rents, occupancy and new construction starts should recommence once the residential construction starts again. The demand for commercial land will follow instead.

It is actually a great time for neighbor island home buyers, shopping center buyers and land speculators to find “deals” in Hawaii, provided they have patience and staying power.

— Brooks R. Borror, senior managing director, retail division, Grubb & Ellis|CBI in Honolulu

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