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October 10, 2016

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U.S. Office Markets Continued to Tighten in Q3, But at Slower Pace

World Property Journal

 

Slowing Absorption, Declining Vacancy and Rising Rent Characterized the Quarter According to global real estate consultant Cushman and Wakefield, the U.S. office market continued to gradually tighten in the third quarter of 2016. That tightening reflects the more moderate pace of job growth,...

 


Seaport redevelopment: Many questions remain

San Diego Union Tribune

 

The proposed $1.2 billion redevelopment of Seaport Village faces numerous questions about feasibility, financing and legality, the port staff said in a report released Thursday night. And at its meeting next week, the San Diego Unified Port District board will have to decide whether to put the...

 


Golf Shaft Maker Aldila Leases Industrial Space in Carlsbad

San Diego Business Journal

 

Poway-based Aldila Inc., which makes and markets graphite golf shafts, plans to occupy more than 25,000 square feet in Carlsbad after signing a $2.3 million industrial lease, according to brokerage firm Lee & Associates. Brokers said the company has signed a long-term...

 


City Council Approves Plan for Additional Tower at Sharp Chula Vista Medical Center

San Diego Business Journal

 

Sharp HealthCare has won local approval of its plans for a new, seven-floor hospital tower at its existing medical center in Chula Vista. The Chula Vista City Council signed off Oct. 4 on the 197,000-square-foot project’s conditional use permit, precise plan and...

 



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What Private Buyers Should Know About Rents

GlobeSt.com

 

Sellers’ assumptions about rents may not hold true, so buyers need to do their due diligence on each property’s rent potential, taking into account many factors, Cushman & Wakefield SVP Mark Avilla tells GlobeSt.com. Avilla recently joined C&W’s new private-client investment advisors team here, along with Peter Curry,...

 


Why the Office Market is Still Struggling

GlobeSt.com

 

As companies continue to seek greater efficiencies in office space and demand more tenant improvements, the office sector continues to struggle with occupancy rates and subdued demand, Green Street Advisors’ senior analyst Jed Reagan told attendees at a company webinar yesterday....

 

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U.S. Office Markets Continued to Tighten in Q3, But at Slower Pace

World Property Journal

 

Slowing Absorption, Declining Vacancy and Rising Rent Characterized the Quarter

According to global real estate consultant Cushman and Wakefield, the U.S. office market continued to gradually tighten in the third quarter of 2016.

That tightening reflects the more moderate pace of job growth, which has slowed from the strong rate of the previous two years. Net absorption of office space totaled 13.2 million square feet ('msf') in the quarter, down from 17.9 msf in the second quarter. In the first three quarters of 2016, the amount of space absorbed totaled 42.2 msf, more than 31% lower than the 61.5 msf absorbed in the first three quarters of 2015.

The amount of space absorbed was still larger than the 11.3 msf of new office space completed across the U.S. during the third quarter and, as a result, the U.S. office vacancy rate continued to decline in the third quarter of 2016, dropping to 13.2% from 13.3% in the second quarter. It is the lowest national vacancy rate since the first quarter of 2008. Since reaching a peak in the first quarter of 2010, the national vacancy rate has fallen 420 basis points.

"From wild swings in the stock market early in the year to Brexit, Federal Reserve policy and now the upcoming election, U.S. companies have had a lot to digest this year," said Kevin Thorpe, Cushman & Wakefield Global Chief Economist. "Although they continue to expand, they are doing so more cautiously."

Job growth, the key demand driver for office markets, has downshifted during 2016 following the blistering pace of 2014/15. A slowdown is not unexpected at this stage of the cycle, as the economy approaches full employment and companies have a harder time finding qualified workers.

As absorption is slowing, the construction cycle is picking up momentum. At the end of the third quarter, slightly more than 103 msf of office space was under construction, the highest level for the construction pipeline in the current cycle. It could well be that 2017 will turn out to be the inflection point when new construction exceeds absorption, and national vacancy rates bottom out. Markets with the largest pipeline of office space are Midtown Manhattan, with 9.5 msf under construction, followed by Dallas/Fort Worth (7.7 msf), Silicon Valley (6.3 msf), Seattle (4.6 msf), Washington, DC (4.2 msf) and Northern Virginia (4.1 msf). Relative to the size of its inventory, the market with the largest pipeline of new construction is Nashville, TN, where the 3.7 msf of new construction represents 10.5% of the market's total inventory. Other markets where new construction represents a significant proportion of inventory include Brooklyn (7.2%), Seattle (7.5%), Puget Sound (5.3%) and San Francisco (4.8%).

The vacancy rate declined from the second to the third quarter in all major regions of the country (Northeast, Midwest, South and West). Markets with significant declines in vacancy during the quarter were North Bay San Francisco (-160 bps), Fort Lauderdale (-130 bps), Indianapolis (-130 bps), Tampa (-120 bps) and Puget Sound Eastside (-120 bps). At the other end of the spectrum, there were large increases in vacancy during the quarter in Tulsa (+130 bps) and Houston (+110 bps) as the softness of the oil sector continued to weigh on energy-centric markets.

For the most part, vacancy rates improved during the quarter. Of the 87 markets tracked by Cushman & Wakefield, the vacancy rate declined in 57 and only increased in 22--the others were unchanged. The lowest vacancy rate in the nation is in Nashville, TN, at 4.7%, followed by Midtown South in Manhattan (6.7%), Charleston, SC, (7.0%), San Mateo County, CA (7.5%), and San Francisco (7.7%). Many markets with very high vacancy rates are all or almost all suburban, such as Westchester County, NY (22.8%), Fairfield County, CT (21.5%), Suburban Virginia (21.1%) and Suburban Maryland (21.2%).

"There appears to be an emerging slowdown in tech markets across the U.S.," noted Ken McCarthy, Principal Economist and Applied Research Lead. "In 2015, the top 12 tech markets in the U.S. accounted for 35% of total absorption in the 87 markets tracked by Cushman & Wakefield. Thus far in 2016, these same markets have accounted for only 13% of absorption." Absorption was strongest during the first three quarters of the year in Dallas/Fort Worth (3.6 msf), Phoenix (2.8 msf) and Chicago (2.4 msf).

The national weighted average asking rent increased 1.4% from the second quarter and 5.5% from a year earlier to an all-time high of $29.45. Since reaching a bottom in mid-2011, average asking rent has increased 19.8%. In the third quarter, the fastest rent growth was in the Northeast region where average asking rents rose 2.3%, followed closely by the West region's 1.5% increase. Large increases in Brooklyn, Manhattan and Boston were responsible for the average rent growth in the Northeast, while in the West it was San Francisco, Orange County and Seattle that helped to pull rents up. In all, rents increased during the quarter in 56 of the 87 markets tracked by Cushman & Wakefield while declining in 25.

The most expensive markets in the U.S. were dominated by Manhattan and San Francisco. Midtown Manhattan retained its position as the most expensive market, with average asking rent of $79.91 per square foot. Midtown South had the second-highest rent at $70.29. San Francisco ($69.21), Downtown ($59.13) and San Mateo County at $56.55 rounded out the top five. Number six was Washington, DC, at $51.93. For the second consecutive quarter there were six markets with average asking rents above $50 per square foot.

Rent growth was generally strongest in the markets with low vacancy. Compared to a year ago, asking rents rose strongly in Brooklyn (14.5%), San Francisco North Bay (+13.9%), Dallas/Fort Worth (+13.2%), San Mateo County (+11.9%), and Silicon Valley (+11.0%). Not surprisingly, many high-vacancy markets experienced declines in rents compared to a year ago, including Suburban Virginia (-4.0%), Pittsburgh (-2.9%) and Fairfield County, CT (-2.8%).

-Michael Gerrity

Seaport redevelopment: Many questions remain

San Diego Union Tribune

 

The proposed $1.2 billion redevelopment of Seaport Village faces numerous questions about feasibility, financing and legality, the port staff said in a report released Thursday night.

And at its meeting next week, the San Diego Unified Port District board will have to decide whether to put the project on hold or move to the next phase in the approval process, an exclusive negotiating agreement with the  development company that’s being set up, 1HWY1, and the management partnership, Protea Waterfront Development.

“Staff anticipates continuing exclusive discussions would take approximately six to eight months, during which time 1HWY1 has indicated that they would also conduct onsite due diligence and work with staff on confirming a project description and design,” said port business development managers Lucy Contreras and Penny Maus in a 19-page staff report.

In July the port selected 1HWY1 over five other bidders to focus on as the developer best positioned to replace the 36-year-old Seaport Village specialty retail center at the foot of Pacific Highway on the downtown waterfront. The 70-acre site  also takes in the G Street Mole south of the USS Midway Museum, Tuna Harbor and the Chesapeake Fish Co. building in what is called the Central Embarcadero.

1HWY1, represented by veteran development project manager Yehudi “Gaf” Gaffen, proposes “Seaport San Diego” include:

Three hotels: San Diego’s first Virgin Hotel with 500 rooms; an “affordable luxury” hotel (at $193 per night in current dollars)  by Yotel with 350 rooms; and a 225-room, 475-bed hostel by Freehand.

SkySpire: A 480-foot observation tower by Orlando-based ThrillCorp.

OdySea San Diego Aquarium:  A 151,000-square-foot for-profit aquarium, 16,000-square-foot butterfly exhibit and 12,000 square feet of retail space by the Scottsdale, Ariz., company that opened a similar project last month  in that city.

A 600-student charter high school focused on maritime subjects; a specialty cinema; manmade beaches; a floating swimming pool; and other athletic and recreational features, plazas, promenades and public spaces.

Office space: 19,000 square feet of maritime-oriented workspace on third-floor levels.

Retail and restaurants: 390,000 square feet,  nearly four times the space at Seaport Village;  Terramar Retail Centers will lose its  lease on the property in 2018 but will continue its lease at The Headquarters, a shops and restaurant complex in the former police station next door.

Enlarged and upgraded commercial fishing industrydocks and more slips for recreational boats and mega yachts

The port stands to earn a projected $22 million per year in rent from the Seaport redevelopment, more than five times what it currently receives annually from the present users.

The other bidders proposed similar elements with some differences: a sports and concert arena, performing arts hall, wave-making pool,  and Ferris wheel. Until the port enters exclusive negotiations with Gaffen’s team, those runnersup remain legally eligible to take over, port officials say.

The port staff sought answers to nearly 140 questions and concerns and now has posed 26  recommendations for the board’s consideration. They include a call for feasibility studies, economic analyses and financial details. They also ask if 2,845 parking spaces will meet demand.

“It’s been a ton of work,” Gaffen said. “The last two months have been almost all-encompassing.”

He said many of the new questions repeated some of the issues already addressed and some answers will have to await further detailed design that will come much later in the development process.

Gaffen said he hopes the board will add a commitment to his team in the staff’s proposed resolution, assuming the next round of answers is acceptable.

So far, Gaffen said, his team has “value engineered” some changes to its original plan to save about $15 million in the $154 million budget for public improvements and infrastructure.

The most noticeable design change is to eliminate a drawbridge that would have linked  the north and south arms of Embarcadero Marina Park.

The port expressed concern about the principals’ lack of experience in major mixed-use development and wondered about the role of one of their partners, RCI Group, a Miami-based marina developer. Gaffen submitted details of the team members’ qualifications in response.

The financing requires further detail, the staff said. The bidders propose $15 million in predevelopment costs that the principals would cover personally; $501 million in personal and private equity; $752 million in debt financing; and a $1.05 billion permanent loan. They presented three “preliminary letters of interest” from lenders but no binding agreements — a step not normally taken until a developer receives final approval for a project.

Also needing further evaluation, the staff said, is the idea of a charter school, since an educational use is generally not allowed on state tidelands. Commercial office space and a movie theater also are not considered allowable unless they also have a primarily maritime focus.

Dan Malcolm, one of the seven port commissioners, said he had not yet read the staff report and hundreds of pages of backup material. But he said  design and programmatic changes are common at this early stage and plenty of information has already been submitted.

The development is expected to take about six years to complete once it wins final approval from the port and the California Coastal Commission, probably not likely for another three years. A new port master plan and accompanying environmental impact report would be sought prior to seeking approval for  Seaport San Diego, the staff said. Another major project, the redevelopment of a portion of Harbor Island, plus a master plan for the Chula Vista bayfront, also have been tentatively approved.

“Any one of these projects would be a huge project,” Malcolm said. “The fact that the port is working on these projects at the same time is really unprecedented in the history of the port. I think we’ll deliver some really great public benefits.”

-Roger Showley

Golf Shaft Maker Aldila Leases Industrial Space in Carlsbad

San Diego Business Journal

 

Poway-based Aldila Inc., which makes and markets graphite golf shafts, plans to occupy more than 25,000 square feet in Carlsbad after signing a $2.3 million industrial lease, according to brokerage firm Lee & Associates.

Brokers said the company has signed a long-term lease for 25,066 square feet at 1945 Kellogg Ave., in a free-standing building located on 1.68 acres within the Carlsbad Airport Center business park.

The landlord, GTF Properties, was represented by Rusty Williams and Chris Roth of Lee & Associates, and Brandon Keith of Voit Real Estate Services. Aldila was represented by Jed Stirnkorb of CBRE Group Inc.

-Lou Hirsh

City Council Approves Plan for Additional Tower at Sharp Chula Vista Medical Center

San Diego Business Journal

 

Sharp HealthCare has won local approval of its plans for a new, seven-floor hospital tower at its existing medical center in Chula Vista.

The Chula Vista City Council signed off Oct. 4 on the 197,000-square-foot project’s conditional use permit, precise plan and design review, all of which were required in advance of a groundbreaking set for next month. The council’s approval extended to measures Sharp proposed to lessen impacts identified in an environmental review of the project.

State permitting through the Office of Statewide Health Planning and Development is pending.

The tower proposed at Sharp Chula Vista Medical Center would include 138 private patient rooms, six operating rooms and 10 intensive-care-unit suites. Sharp plans to remodel the first and second floors of its existing hospital tower to connect to the new building.

-John Cox

What Private Buyers Should Know About Rents

GlobeSt.com

 

Sellers’ assumptions about rents may not hold true, so buyers need to do their due diligence on each property’s rent potential, taking into account many factors, Cushman & Wakefield SVP Mark Avilla tells GlobeSt.com. Avilla recently joined C&W’s new private-client investment advisors team here, along with Peter Curry, Brooks Campbell and Duncan Todd. With more than 80 years of combined experience and a 10 year-history of closing 260 sale transactions totaling more than 6.1 million square feet and $1.5 billion in sales volume, the team specializes in investment sales under $20 million located in Southern California.

We spoke exclusively with Avilla about the strategies private clients are using to get ahead and what his team is advising them to do at this point in the cycle.

GlobeSt.com: What strategies are private clients are using to get ahead?

Avilla: There are really two different types of private clients: buyers and sellers. The buyers will have a lot of different strategies because not every buyer has the same angle, so it’s important for us to understand the buyer’s criteria. Private clients are very different from institutional folks, who are much more sophisticated buyers; private clients are either individuals or a group of individuals looking to put their money in real estate rather than the stock market where returns are low.

Some private clients may not understand real estate so well; they might do one or two deals a year and are not necessarily hands-on people. They might be better served to invest in triple-net-lease deals. We will work with the triple-net-investment people in our company and can transition them to that arena. It’s important to understand each person’s objective and what they’re looking to achieve.

By and large, big thing is treating these investors like you’re investing your own money, how you would look at a deal yourself—is it a good deal? Are the returns accurate? Are the assumptions that the seller and seller’s broker have made on rents realistic, can you push them for a better return or are they farfetched? The main thing is looking out for them and understanding their objectives.

On the sell side, it’s almost the reverse. We try to figure out how to maybe reposition an asset so that we can achieve more rent or better price down the line. We’re looking at the property from start to finish, understanding the process. We’re being realistic, but we’re also trying to push the assumption and also look at the deal and how to try and possibly reposition or attach value to it. Everybody on our team has a lot ofleasing experience; I started as a leasing-transaction person, doing 100 deals a year. I have done 2,000 leases, and I understand—as does the rest of the team—how the mechanics of value are formed: through leasing, tenants’ makeup and the rents they’re paying. So, for sellers, it’s a matter of how can you reposition rents to push value?

GlobeSt.com: What are you advising your private clients to avoid doing right now?

Avilla: One of the issues I think we’re seeing in the cycle right now is thatinstitutional investors are becoming very cautious. A lot of them were pursuingvalue-add deals, of which there were a lot in the market two to five years ago. But they have dried up, and we’re not seeing institutional investors in a lot of value-add deals now. The private-client group has filled that void. They’re looking typically at not more than $20 million to $30 million. They’re one-off transactions, not a portfolio.

We caution buyers to be very careful on the assumptions that sellers are putting in for rents. Things aren’t escalating now the way they were in the last two to three years. It’s customary for brokers to put 5% to 7% increases in rents or CPI growth rates for deals, but 3% growth is more traditional. Depending on the submarket, you have to be careful because there’s been a slowdown in rents last couple of years.

GlobeSt.com: As this cycle approaches its end, what is this group of investors considering investing in?

Avilla: It really depends on the buyer and the buyer’s profile. There are a lot of buyers that don’t like office, industrial or retail, so that is very buyer dependent. But I would say that it’s not necessarily changing due to the point in the cycle. Value-add stuff has kind of gone away, but there may still be ways to create value. I don’t think that the market, from a leasing standpoint, has necessarily reached the top; we’re still going to see an increase in rents in San Diego—it’s a great market to grow in—but people are just a little more cautious.

From the seller’s standpoint, it’s tough to sell non-core assets. You really have to look at the value in your own property and peel the onion back and find ways to create value. Some of that might be repositioning a standard office building into creative or converting flex space into a creative-office campus with amenities. Project amenities are a big focus for sellers and buyers.

-Carrie Rossenfeld

Why the Office Market is Still Struggling

GlobeSt.com

 

As companies continue to seek greater efficiencies in office space and demand more tenant improvements, the office sector continues to struggle with occupancy rates and subdued demand, Green Street Advisors’ senior analyst Jed Reagan told attendees at a company webinar yesterday. The webinar, titled “US Office Real Estate: Fundamentals & Valuation,” gave a breakdown of office fundamentals and how they compare to previous cycles—and the overall answer was, “Not well.”

Reagan started off by explaining that office-demand growth has been subdued compared to job growth—the driver for office-demand growth—in this cycle. He said he expects that office demand will stay subdued for the short term because companies are now focused on efficient use of space, which translates to putting more employees into fewer seats.

Fortunately, supply has been in check in most markets, Reagan said, with supply on an annual basis has been modest this cycle compared to previous ones. The Sunbelt and tech markets are seeing more supply, but absorption has been steady in those markets, so “it’s pretty decent story by and large,” he said. Fundamentals are expected to slow in New York due to supply coming in, he pointed out.

Net absorption has picked up in recent years, but is still quite a bit less than the prior cycle, and Reagan said tenants are taking more of a pause due to macro headwinds. Tech markets are leading the pack in terms of absorption, whereas Houston and the DC metro have been sluggish.

“Demand has been sluggish this cycle, with net absorption weaker than in previous cycles, which means there’s not enough demand to produce meaningful occupancy growth,” said Reagan. The nation’s current office-occupancy rate is 84%, which does not compare favorably to previous cycles.

One consequence of tougher occupancy is that leasing costs remain high, Reagan pointed out. “This speaks to a softer recovery, tougher fundamentals and the fact that tenants are changing the way they think about space and are demanding high improvement dollars to fit out their space.

What Green Street calls RevPAF growth—changes in occupancy and net effective rents blended into one metric—pales in comparison to what the office markets achieved in the late ’90s and prior to ’07, said Reagan. He predicted that rent growth will be “steady-ish,” with acceleration expected to come later than the other major sectors. He added that the outlook for office is favorable compared to other major property types for the long term.

So where are we in the cycle? For office, most property types are still in growth mode, said Reagan. “Low-barrier-to-entry office is still early in the game—on the cusp of recovery and expansion—and has lagged other major sectors. High-barrier-to-entry office is a little bit further along in the game.” For example, the San Francisco and New York markets are showing signs of deceleration, and he expects this trend to continue in the coming years.

NOI growth, on the other hand, presents something positive for office, which has been slower to recover in this arena. Because of longer average lease term, tends to lag in recovery mode, but also tends to outperform in deceleration because of long-term leases, Reagan said. “Office is poised to hit the sweet spot over the next few years in terms of NOI growth; we expect a good story in the next few years.”

Also positive is that asset values are sitting at all-time highs for office real estate, at about 10% above the prior peak in 2007, Reagan said. Office values are lower than the overall Green Street Commercial Property Index, cap rates have flattened out and there is some evidence that lower-quality office real estate has seen cap-rate pressure and downward value pressure. “We are still in a yield-starved environment globally. We will see a lot of capital looking for a home in US gateway real estate.”

With regard to office transaction volume, (and this information is focused on CBD transactions), overseas buyers are busier than ever, particularly in gateway markets. Also, domestic private buyers have been net sellers. This is in contrast to the last cycle where domestic private buyers were very aggressive. “Looking at 2016, REITs are in a position of being net sellers after being net acquirers over the previous several years, but this is still developing,” said Reagan.

Office total returns have lagged historically in both public and private markets, and office has underperformed the majority of sectors in both public and private, unlike self-storage, which has been a very strong performer in the public market for the last 20 years, Reagan said.

Regarding pricing, office still looks expensive if you consider average returns. And except for the lodging sector, office has highest capex of all. “Landlords need to spend a lot of money to scratch out a pretty meager income growth for some time.” Reagan added that office is trading at a 7% discount to gross asset value, and expected returns on public office real estate are low, so this is not a great story.

Regarding high-barrier-to-entry vs. low-barrier-to-entry markets, high-barrier has been the consistent winner between 2005 and 2016 in both public and private markets, Reagan said. What has led to this? First, capex as a percent of NOI takes a much smaller bite out of high barrier than low barrier, and over the long term NOI and rent growth has been significantly better for high-barrier markets than low-barrier markets; high-barrier consistently outperformed low-barrier markets.

Will high-barrier markets continue to show this kind of outside growth in the years to come? Reagan said while high-barrier markets are expected to continue to outperform low-barrier markets overall, there are a number of markets (San Francisco and Midtown Manhattan, for two) that will see meaningful deceleration due mostly to supply creeping in in New York and the tech market beginning to slow in San Francisco—other regions are coming in to fill the demand from the tech market. Some key high-barrier markets are decelerating.

Over the long term, high-barrier markets will have meaningfully better NOI growth over low-barrier ones, but the advantage may not be quite as strong as what we’ve seen in the last 20 years, said Reagan. Historically, the spread has been higher than 250 bps, but both types of markets are priced pretty closely together today. Reagan said he thinks high-barrier markets are still a better bet for the long term, but for investors with shorter time horizons (say, five to seven years), it’s a toss-up. The most attractive markets are the higher-growth western US markets.

An attendee survey showed that 43.5% of attendees thought high-barrier office markets were the most attractive investment opportunity; 37.2% said low-barrier markets with repositioning potential were most attractive, and 19.3% said it was about even. Reagan said the toughest market for new development as far as high-barrier markets go is West L.A. because of its congested layout.

-Carrie Rossenfeld

Daily Brief October 10, 2016 unsubscribe