MARKET HIGHLIGHT, OCTOBER 2009

SEATTLE
Eric Davis, Thad Mallory, Jeffrey Rosen, Elizabeth Best and Jason Smith

Seattle has weathered much of the economic storm of the 2009 recession. Business downsizing or bankruptcy (e.g., Washington Mutual) has hurt the area, no different than the rest of the nation. However, with the worst behind us, Seattle’s fundamentals remain strong as one of the nation’s dynamic markets. Its international headliner companies continue to move forward as seen with Amazon, Boeing, Costco, Microsoft, Nordstrom, Paccar and Starbucks Coffee. The resilience of these corporations will allow Seattle to rebound faster than other markets.

Multifamily

Historically, the multifamily industry has been less volatile in economic downturns because tenants always need a place to live. In the greater Seattle area, vacancy is expected to reach 9 percent heading into 2010. Based on managers’ views, this appears to be due to renters downsizing. Many are sharing a 2-bedroom apartment versus living separately in a 1-bedroom unit. A number of single-family owners are renting their homes, adding more inventory and competition to the market. Concessions are back in the area, with 30 percent of properties offering at least 1-month rent concession. In the current economy, the job stability of tenants is uncertain resulting in less interest in touring and changing residences.

The sales volume for the greater Seattle area is at a decade-low 12 deals per month. In the 100-unit or larger apartment category, there has been little to no activity, with only four properties selling since January 2009. Most transactions are smaller, and sellers are offering attractive financing. Deals are being done in the 6 percent cap rate range depending on area and product type. The multifamily market continues to see a wait-and-see attitude that fuels the considerable disconnect between buyers and sellers pricing expectations.

— Eric Davis is a senior associate for GVA Kidder Mathews in Seattle.

Industrial

The effects of the economic downturn on the Greater Puget Sound industrial market have been significant, however the market was fortunate to not experience the impact to the degree the rest of the nation has.  Year to year, through second quarter 2009, the area’s vacancy rate increased from 5.28 to 6.89 percent, chiefly from weakness in manufacturing, primarily stemming from Boeing’s 787 woes and the lingering effects from the machinists’ strike in fall 2008, along with lack of demand for third-party logistics firms and retail distributors.

While this vacancy increase may seem striking, it is nominal when one considers the market’s scope.  The industrial market, especially the core of the South Seattle and Kent Valley submarkets, is essentially maxed out from a development standpoint, which has helped the region avert oversupply issues, although the Pierce County vacancy rate increased to 11.91 percent since year-end 2008 due to the completion of spec big box distribution centers and the downturn’s timing.

Rents have declined 10 to 20 percent from the highs achieved at the peak in early 2008.  Concessions are on the rise, with increases in free rent, declines in rent escalators and aggressive tenant-improvement allowances, all primarily designed to help landlords maintain as high a blended rate as possible.

Without many investment sales to evaluate cap rates, it is difficult to determine where rates should range.  In June, local investor Hill-Raaum-Pietromonaco paid $11 million for the 217,131-square-foot Tharco facility in Algona (8.5 percent cap rate), and in August local investor Bob Bertch purchased the 124,816-square-foot Renton Commerce Center for $11.35 million (9.3 percent cap rate).  With the looming commercial refinance crisis, the possibility exists for cap rates to skyrocket and for investors to purchase distressed properties at a deep discount and turn massive profits in coming years.

With all of the challenges the market has faced, the future remains bright as the area remains diverse in its core industries of aerospace, technology, biotech and Asia-Pacific distribution.  With the coming inflation and the lack of developable land, local investors and owners potentially stand to enjoy another round of rent increases heading into the second decade of the 21st century.

— Thad Mallory is an associate vice president with GVA Kidder Mathews in Seattle.

Retail

Small box retail is the new Seattle trend and small-shop local retailers are rising to the top. Investor groups are primed, seeing this market as a cherry-picking field of opportunities. Strong big box retailers are shopping a surplus of space that has gone dark.

The vacancy rate in the Puget Sound area is 7 to 8 percent, with 4 percent the norm in prior recessions. Many mid-box retailers have vacated without immediate replacement. Spaces formerly occupied by the likes of Circuit City, Linens & Things and Joes Sports & Outdoor. Developers/landlords have struggled to crunch numbers that mid-box retailers can digest, relative to consumer spending.

Retailers still seek “Main & Main” locations. Small shop space now commands 25 percent lower rents, but remains competitive due to lack of new construction. From small to large space, tenants should expect to see rates in the low teens, even single digits in one-off markets. After many peaked above current market rates, renewal rates have now dropped in order for landlords to retain tenants. Often space that would have commanded $36 to $40 per square foot 2 years ago, now goes for -+/- $30.

Both the upper-income suburban locations and the in-city mixed-use sites that were once hyped with attention now experience diluted interest. Whether due to the lack of availability of funds or the departure of prospective tenants, active developments are struggling to start or finish lease-up; examples are Issaquah Highland in Issaquah, Whole Foods Marketplace projects in West Seattle, The Landing in Renton, Ballard Blocks in Ballard and Tacoma Mall in Tacoma, the south side lifestyle addition.

There are new retail projects ramping up in the market: Maple Valley Town Center, developed by Powell Development and anchored by Fred Meyer; Interbay, developed by TRF Pacific and anchored by Whole Foods; and recently opened The Shops at The Bravern, developed by Schnitzer West and anchored by Neiman Marcus.

— Jeffrey Rosen and Elizabeth Best are senior retail advisors at Seattle Pacific Realty Inc. in Seattle.

Office

The good news is there is nothing extremely negative to report. Vacancy rates increased, but the change was not worse than what was expected. Landlords continued their quest to retain tenants with attractive deals, but rates were only incrementally lower. Tenants in the market are showing early signs that they are getting closer to making decisions. About half of the participants’ tentative perception is that the bottom is close. However, the other half is strongly expecting another major adjustment, similar to those seen in September 2008 and January 2009. While the economy in general appears to have reached a plateau, the foreboding issue of billions of dollars of CMBS debt coming due in the next few years remains. If a significant amount of that financed property is placed into forced sales, the highly discounted pricing would allow those buyers to drop rents even further.

The net result of these conflicting forces was another decrease in leasing activity overall. Using the Seattle market as an example, 177 deals were reported so far in the third quarter for a total of 675,000 square feet. This is compared with 268 deals in third quarter 2008 involving 901,000 square feet. Performance along these same levels is expected for the remainder of the year, tied directly to higher employment loss forecasts.

The regional vacancy rate reached 12.1 percent in the third quarter, up from 11.3 percent in the second quarter and 10.2 percent in the first. Improvement is not expected until late 2010, as job losses are now expected to reach 3.4 percent or about 46,300 jobs in 2009. As cutbacks continue, most employers are expecting growth out of the recession to be slow and cautious. This will mean additional downsizing at tenant renewals. With very few tenants actively searching for new space, landlords are finding there are currently few takers at any price. An opportunistic leasing spurt at the bottom of the cycle will require very strong signs of an overall economic recovery.

Sales activity remains very quiet with property owners selling only if they have to. There are some larger properties under contract: the Seattle Tower and Post-Intelligencer Building are the primary examples in the Seattle market. Pricing of those properties are reportedly about half of their purchase prices near the market peak. As with the national market, these are being sold by highly motivated owners. Locally, most buyers are waiting to pick off distressed properties and waiting to see if some liquidity can be found to rescue properties facing CMBS loans coming due. No clear answer is seen for institutional-level properties; buyers and sellers are both in holding patterns hoping for different results. Local buyers of smaller properties are the most active, and owner/users who can utilize SBA loans see this as a good time to buy.

— Jason Smith is a senior vice president in GVA Kidder Mathews’ Bellevue, Washington office.

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