If You Build It, They Will Come

Developers bank on demand for Class A office space in Central Business District

Sean Turley, Vice President, NAI NBS

If you build it, will they come? The popular answer to this question is yes. Developers are building new office space to meet demand and fill the limited supply in Portland’s Central Business District. First & Main will be the first CBD building to be delivered, providing approximately 350,000 square feet in 2010, followed by Park Avenue West adding an additional 330,000 square feet of Class A office space.

So why are developers pouring hundreds of millions into new construction, while tenants remain jittery about cash flow and may be tightening belts rather than loosening them? The answer is simple: supply and demand economics. Single-digit Class A vacancy, rising rental rates and diminishing supply of larger blocks of office space suggest that Portland’s CBD isn’t experiencing the economic doom and gloom of other markets in the nation. Sure, downtown has had to navigate its fair share of slow periods, and the meltdown in the credit markets didn’t help, but overall the CBD remains healthy for development.

Tripwire’s recent 36,000-square-foot lease at One Main Place has further diminished the availability of large blocks of space, and larger users are feeling the squeeze. With One Main out, now KOIN Center and Crown Plaza are the only existing Class A buildings that can accommodate a tenant seeking more than 30,000 contiguous square feet – just two buildings to choose from in the entire CBD. Developers are paying attention, and as a result, cranes are in the air.

It is clear that the limited supply points favorably toward development, but the concern has always been demand. Several signals suggest that demand will be there, but only time will tell.

The first signal is renewed interest in downtown. Blame it on high gas prices, but the CBD is seeing a resurgence from suburban tenants interested in relocating downtown. This is a fundamental shift, since for years the CBD lost tenants seeking abundant free parking and a more favorable tax situation offered in suburban markets. The ability to draw from a deeper employment pool, central location and easy public transportation options are helping drive this shift.

Another factor helping drive demand in the CBD is sustainability. Firms are feeling increased pressure to be environmentally conscious and provide a healthy work environment for their employees. Most new construction is being developed to some level of LEED (Leadership in Energy and Environmental Design) standard while most existing buildings have few to zero sustainable elements. LEED-certified construction is in demand as it helps companies recruit and retain employees, especially in environmentally conscious Oregon. Further, “green” is arguably the new growth industry coming to town, as wind, solar and other sustainable industries are growing and expanding across the metropolitan area.

Lastly, demand could come from outside Oregon. Even though rents are on the rise, Portland is still the low-cost leader when it comes to West Coast options. It is not out of the question for demand to start coming from growing or relocating firms from the San Francisco and Seattle areas. Although Portland is courting business from other markets, historically absorption in the CBD occurs from organic growth. Typical lease up for new construction comes from existing tenants looking for newer and more efficient office space. This usually leaves a sizable hole to fill in the tenant’s former building and will create some opportunity for tenants in the Class B and C markets. Landlords with this product still have to compete for deals, but even these rates will eventually be pulled up by the limited supply in the Class A market.

The health of Portland business needs to be strong as it will clearly have to absorb higher rental rates in the coming years. Contributing to these increased rates are rising costs for both new construction and those to provide tenant improvements. Institutional buyers looking for opportunity in Portland are also adding to higher rents. These buyers have concluded that they can press rental rates in Portland easier than other areas of the nation. As a result, institutional buyers have paid top dollar for Portland assets and immediately pressed rates to justify their purchase price.

With limited supply, clear projections that rental rates are on the rise, and reasonable assurance that demand is healthy, developers are feeling confident that if they build it, tenants will come.