COVER STORY, OCTOBER 2005

BUILDING & BUYING
The office and industrial sectors across the West are attracting more and more attention.
Brian A. Lee

Job growth is slowly reviving those office sectors in markets like San Francisco and Seattle that were hit hard by the dot-com bust, and investors are rushing there in hopes of getting in on the ground floor. Southern California developers — office and industrial alike — are hunting for the few remaining parcels of developable land. Partnerships and joint ventures are quite common in big buys all across the high-growth West.

Northern California

Alaska Permanent Fund purchased 100 Pine Street for $149 million in San Francisco's financial district.

Unico will retain a stake in 100 Pine Street and will act as third-party manager of the property. Erick Paulson, senior vice president, acquisitions, of LaSalle Investment Management, which represented the buyer, and Michel Seifer, managing director of Jones Lang LaSalle, the sellers' representative, used terms such as “recovery” and “resiliency” in describing the City by the Bay's office market that yielded this large transaction.

Across the bay, the industrial owner-user for-sale market has been the strongest aspect of the Interstate 880 corridor, says Craig Hagglund, principal at Lee & Associates' East Bay office. “Although the leasing market is growing stronger every month, it is much like the economy, slowly jugging along and gaining strength,” he says. “But with sale values being as high as they are, it's hard not to focus on the owner-user for-sale market.”

Hagglund references ProLogis' impending purchase of Catellus Development as the biggest play in terms of industrial market share in the Fremont, Union City, Hayward, San Leandro and Oakland markets. Of course, that deal will reverberate across most of the country. “In an effort to grow, it seems the prudent move is through acquisition of a competitor and not necessarily through development and acquisition of buildings, [since] there is a ton of pressure in the market from developers and investors for individual buildings or business parks,” says Hagglund.

In the Sacramento submarket of Rancho Cordova, JPMorgan Asset Management and Lowe Enterprises teamed up in the acquisition of 641,710 square feet of office space along the Highway 50 Corridor — the Prospect Green office campus and One Capital Center office building. Prospect Green is a five-building, 517,969-square-foot low-rise office campus situated on 34 acres, 2.5 of which are dedicated to an attractive interior park. One block west is the six-story, 123,741-square-foot One Capital Center.

In September, First Industrial Realty Trust acquired an 11-building portfolio in Santa Clara County on behalf of FirstCal, the $950 million joint venture between First Industrial and the California State Teachers Retirement System (CalSTRS). This marked the first major purchase in Northern California by FirstCal, which invests in the development and repositioning of industrial real estate. The 737,000-square-foot portfolio comprises four R&D projects located in San Jose, Sunnyvale and Milpitas.

Laguna Hills, California-based Foremost Business Parks bought a seven-building, 884,845-square-foot industrial park in Modesto, California, for $20.5 million. The property is 100 percent leased to lone tenant, Stanislaus Food Products Company.

Southern California

According to Chris Runyen, senior managing director at Charles Dunn Company's downtown Los Angeles office, the biggest trend in downtown L.A. is the surge in residential development aided by the conversion of office buildings to residential uses. “This trend has generated a significant amount of retail activity and residential infill,” he says. “The conversion of existing office buildings is reducing the overall office inventory by approximately 10 percent, and the absorption of vacant office for housing will reduce the vacant office space inventory by an astounding 30 percent in the next 24 months.”

In late July in Hawthorne, California, MS Kearny Northrop Avenue LLC, a partnership led by Los Angeles-based Kearny Real Estate Company and Morgan Stanley Real Estate Fund V, purchased a 92-acre, 2.68 million square-foot manufacturing facility from Vought Aircraft Industries. The property is located near the intersection of the 405 and 105 freeways and Los Angeles International Airport, and immediately south of the Hawthorne Municipal Airport, also known as Jack Northrop Field.

The $65 million sale comprises 28 industrial and manufacturing buildings, two office buildings, a wind tunnel and one hangar currently leased to Northrop. Vought will lease back the entire property for 6 months as it consolidates its operations. After that, Vought will continue to lease 1.38 million square feet, including a 1 million-square-foot building used to manufacture Boeing 747 fuselages and 767 aft-body panels. The $15 million lease expires in 2010.

The partnership is currently upgrading or demolishing the existing 157,000 square feet of hangars and other aviation-related buildings at Hawthorne, and plans to develop an additional 190,000 square feet of new hangars to meet the demand at the airport. There is currently a 3-year waiting list for the existing hangars, according to Kearny Managing Director Jeff Dritley.  

Ryan Companies US will build the 1.9 million-square-foot RiverView at Santee office-and-industrial complex just 20 minutes from downtown San Diego.

“RiverView at Santee is a Class A project in an office market that doesn't exist yet,” says Matthew Reid, vice president of development, west division, of Ryan Companies US in San Diego. “However, if you look at the development's location and existing infrastructure that offers retail, recreation, residential, a solid transportation network and easy freeway access, office is the only missing component.”

RiverView at Santee will be built for technology, R&D and professional office uses. Beside offering a reverse commute opportunity, the property will be integrated with the Santee Transit Center, which links Santee to downtown San Diego via the Green Line on the San Diego Trolley.

“The San Diego market is experiencing a substantial amount of growth and demand in the office and industrial sectors,” says Reid. “Santee has been an untapped commercial market until now, and is able to meet the needs of both large and smaller users.”

Kearny Real Estate Company is busy in the San Diego market as well. In a joint venture with Pacific Coast Capital and Keeton Construction, the company has acquired 90 acres in the city's Otay Mesa submarket with plans to build a $90 million, 1 million-square-foot industrial development.

“Our conviction in the Otay Mesa submarket stems from the inexpensive land prices relative to other infill Southern California markets,” says Kearny's Jason Rosin. “The growth of residential and business communities to the north and the scheduled highway improvements, including State Route 125 and Highway 905, make Otay Mesa, and in particular our sites, well positioned to benefit as the last bastion for true industrial property in San Diego County.”

The property will offer small lots (2 to 5 acres) that will enable flexible development options, ranging from business park condominiums from 2,000 to 15,000 square feet to stand-alone buildings starting at 20,000 square feet.

“In the past 12 to 18 months, there has been an emergence of small (3,000 to 5,000 square feet) industrial owner-user buildings being developed, which are selling for approximately $185 per square foot compared to $100 to $125 per square foot a year ago,” says Shane Strickland, principal in Lee & Associates' San Diego office. “With land availability disappearing, land prices are being forced upward dramatically.”

On the land availability theme, Strickland references Pacific Coast Business Park Partners' approximately 1.75 million-square-foot industrial development in Oceanside, California, which, he says, constitutes the last large development opportunity in that city and one of the last in all of north San Diego County. Scheduled to break ground this month, the $250 million Pacific Coast Business Park is a joint venture among The Monarch Group, DWO Enterprises and Guthrie Development.

The years of stout demand for industrial space in the Inland Empire have produced a lack of developable parcels for larger buildings in the western part of the region, according to Scott Ostlund, principal in Lee & Associates' Ontario, California, office. This has pushed the sizable developments to the east while the west remains active with more than 100 small buildings now planned or under construction. “The lack of land has pushed up both sales and lease rates as this, coupled with higher construction costs, has created a 20 percent increases in sale prices,” says Ostlund. Market conditions dictate that most small industrial buildings are for sale only as opposed to the larger projects that are also offered for lease, he adds.

Denver

In January 2006, Denver-based Aardex Corporation will break ground on a $40 million, 185,000-square-foot Class A office building, the first new project of its kind on the west side of the Mile High City since the 1990s. The Signature Centre is master planned by internationally known architect Binh Vinh, Aardex's principal and vice president of design. To be built with efficiency and environmental compatibility in mind, the property will offer suites ranging in size from 2,000 to 165,000 square feet when it's completed in September 2006.

“The amount of interest has changed this from a spec project to a build-to-suit,” says Ben Weeks, Aardex Corporation's president and executive principal in charge of the Signature Centre. “We could easily fill two buildings if we had the dirt. Signature Centre is responding to an unmet need for large floor plate Class A space on the west side [of Denver].”

According to Jones Lang LaSalle's mid-2005 market report, downtown Denver's office absorption is at 334,000 square feet, a big improvement over the negative absorption posted each of the last 2 years. Suburban Denver's office absorption (469,000 square feet) is on pace to pass 2004's total of 855,000 square feet.      

Phoenix

Western Devcon and Carefree Partners broke ground in August on the first Class A office building in Surprise, Arizona. The 160,000-square-foot Surprise Office Center will be ready for occupancy in February 2006. Scottsdale, Arizona-based A.R. Mays is the general contractor for the project. Phase I of Surprise Office Center consists of two stories and 57,000 square feet.

Stephen McKendry, executive vice president for GVA DAUM, reported that the Phoenix office market vacancy reached a 3-year low (16.7 percent) in mid-2005 while 4-year highs were attained in total activity and absorption. After declining for three consecutive quarters, new construction activity increased during the second quarter, with a total of 2.6 million square feet currently underway.

Las Vegas

According to Charles Witters, senior vice president at Lee & Associates' Las Vegas office, the Las Vegas Valley office market is on pace to top its 2004 numbers in terms of net absorption and delivery of new space. “The vacancy of approximately 10.8 percent at June 30, 2005 shows a fairly strong office market for the Las Vegas Valley,” he says. “Major tenant activity has taken place at The Beltway Business Park, The Green Valley Corporate Center and Centra Point, all of which front the Interstate 215 Beltway.” 

Slated for completion this month, the first phase of The Beltway Business Park will consist of six office buildings totaling 470,000 square feet at a cost of approximately $60 million. Thomas & Mack Development Group is developing the office segment of the 400-acre business park while Majestic Realty handles the industrial component. 

Speaking of industrial, “The influx of luxury high-rise condo development [in Las Vegas] has absorbed what would have been industrial redevelopment property and pushed the value of land through the roof,” says Stephen Spelman, senior vice president at Lee & Associates. “Industrial dirt that might have sold for $300,000 per acre a few years ago now can capture 10 times that if properly located. As a domino effect, all land in the valley has become very expensive.” Spelman singles out Portland, Oregon-based Harsch Properties as an active industrial developer in the market with sizable projects ongoing in North Las Vegas and Henderson, Nevada.

Seattle

Leigh Callaghan, senior vice president of Colliers International in Seattle, says that the most notable trend in the downtown Seattle office market is the flurry of sales activity. For instance, in December 2004, TIAA-CREF purchased the IDX Tower for $368.6 million or more than $400 per square foot. “It was only 2 years ago that people thought the $290-per-square-foot price paid for One Convention Place and the $324-per-square-foot price paid for Millennium Tower were remarkable,” says Callaghan. “Buyers are stepping over themselves at a near frenzied pace to find that key office property that has yet to go to market.”

These investors have certainly noticed that Class A office space in Seattle has seen its vacancy dip to 13.12 percent. Amazon.com recently leased approximately 180,000 square feet in what will now be called Columbia Center. Callaghan, who likens the Seattle's office market performance and conditions to San Francisco's, points to local developer Vulcan Inc. as the most active player in the market. “Vulcan is basically reinventing the entire South Lake Union submarket with nearly 2 million square feet of office and life science space planned or under development in addition to their extensive residential and retail development,” he says.

Kemper Development and Schnitzer Northwest are active developers on the east side of Seattle, says Jeff Jochums, senior vice president at Colliers International's Bellevue, Washington, office. On top of its mid-2006 development plans for approximately 660,000 square feet across two office towers in downtown Seattle, Schnitzer has a project on the drawing board for downtown Bellevue as well as more than 500,000 square feet on the north side of Interstate 90 on the land once occupied by the old Eastgate Airport. Kemper recently announced the signing of Eddie Bauer to a 200,000-square-foot pre-lease in its Lincoln Square project, located across the street from Bellevue Square. The 525,000-square-foot development will break ground soon with a completion date set for first half 2007.

“The most active tenants have been Eddie Bauer, Symetra Financial and T-Mobile,” Jochums says. “Collectively, these three tenants have helped change the face of the eastside office market by absorbing more than 650,000 square feet in the past 2 years.”

Record-level absorption of warehouse space is the most prominent characteristic in the Seattle industrial market, reports Scott Alan, a senior vice president at Colliers International. Mid-2005 numbers included 2.4 million square feet leased in the Kent Valley and 1.8 million in Pierce County. “The bulk of the users taking this space are big box users such as American Port Services, Pacific Distribution Services and Coca-Cola,” he says. “These three alone have leased 1 million square feet. Out-of-state investors seem to be more willing to pay the price to enter our market than local ownerships.” Panattoni Development recently completed and leased a 435,000-square-foot facility to American Port Services at Rainier Park of Industry in Sumner, Washington, located south of Seattle and east of Tacoma.

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