Portland Office Vacancy Rose During Second Quarter

Central City office vacancy increased to 12.73% during the Second Quarter, with negative 242,145 sf absorbed. About 40,000 sf of this negative absorption was from multiple tenants leaving the historic Stevens Building. The Church of Scientology of Portland purchased it in 2008 and planned to inhabit the whole building, but it was found to be unsuitable for the organization and is for sale. This quarter the Church of Scientology bought downtown’s historic Sherlock Building for $6.4 million to serve as its new home. In a highly-anticipated decision, the Portland Development Commission opted to remain at its current location in Old Town (but in 10,000 fewer sf), rather than move to the stalled Park Avenue West, its other primary option. It is uncertain when construction will restart at Park Avenue West, as the project lacks financing. Active tenants downtown include alternative energy groups, who seek environmentally friendly buildings. Many tenants are also seeking moderatelypriced Class A buildings with quality buildouts.

Suburban office vacancy rose about two percentage points to 23.92%, with negative absorption of 179,725 sf. This is the 7th consecutive quarter of negative absorption for the suburbs. Kruse Way saw the most significant increase in vacancy, from just under 23% last quarter to 29.36% during Second Quarter. Kruse Woods V had nearly 100,000 sf of negative absorption, as Northwest Evaluation Association vacated about 108,000 sf to move to the former Port of Portland building in Central City. However, Black & Veatch filled some of the space at Kruse Woods V, leasing about 25,000 sf. Vacancy in I-5 South rose significantly to 28.10%, but some large leases occurred, including State Farm’s lease of nearly 24,000 sf at Fanno Creek Building B. Brokers are seeing a flight to quality in the suburban submarkets, with healthy activity in nicer buildings.

Vancouver vacancy rose slightly to 18.55%, with negative 11,634 sf absorbed. The most significant deal was the $18.5 million sale of The Columbian Building to the City of Vancouver for its new city hall. The 118,000 sf building, previously listed at $41.5 million, was turned over to Bank of America early this year after the Columbian Publishing Co. filed for bankruptcy.

The full report is available here.

Portland Apartment Vacancy Rising, But Market is Poised for Upswing

Robert Black, Associate Vice President, NAI NBS

Portlanders may be noticing more “For Rent” signs on apartment buildings around the city this summer, one of the more noticeable signs of how this recession has affected the apartment market. Apartment vacancy is rising across the metro area and multifamily investment sales are down, but the Portland market will recover from this economic downturn and be well-positioned for a comeback.

NAI Norris, Beggs & Simpson’s Second Quarter 2009 reports show a slight increase in apartment vacancy from the previous quarter to an overall 5.03 percent; this report only surveys select apartment complexes with more than 100 units, so vacancy across complexes of all sizes could likely be a bit higher.

The increase in vacancy doesn’t mean that people are moving out of the city. In fact, the Portland metro area’s population has been increasing in recent years. The U.S. Census Bureau estimates that Multnomah County’s population rose 2.2 percent in 2008, and that the greater Portland area’s population reached 2.2 million people last year. Portland’s relatively low cost of living, in addition to diversified job prospects and plentiful outdoor activities, continue to attract new residents.

So where are the renters living, if they’re not leaving Portland? Many of them are doubling up in apartments, moving in with family, or renting single-family homes. Though Portland unemployment decreased slightly to 11.6% in June, renters are still concerned about job security and layoffs, so they are taking any steps they can to save money.

Some tenants are also choosing to purchase homes. With median home sale prices down 13.8 percent from this time last year, an $8,000 first-time home buyer tax credit from the federal government and historically low interest rates, buying a home is becoming an option for more people.

Landlords are doing everything they can to attract the fewer active renters in the market. Concessions today in certain submarkets are sizeable, including up to two months free rent on a 13-month lease for some new properties in the downtown area. Renters looking for a new place to live are shopping around for the best deals they can get, and existing tenants are also tuned in and looking for bonuses to extend their leases on expiration.

The Portland-area submarket that everyone is keeping an eye on is downtown. Downtown has seen a building boom over the past five years, and with the condominium market softening at the end of 2007, developers looked for conversion options for projects proposed and under construction.

What resulted was one of the largest deliveries of new units the market has ever seen. Between February 2008 and today, the market added about 2,030 new units in the Central Business District (CBD), according to NAI NBS’ research, with another 450 units under construction delivering between fall 2009 and spring 2010.

This may seem like a large number, but there’s a reasonable explanation. From 2003 to 2007, more than 1,500 existing apartment units in the CBD were actually converted into condominiums. This loss of rental units helped drive the surge in the CBD apartment market, and when the new units began delivering in early 2008 the CBD had strong fundamentals, with the largest historic rental rate growth and vacancy below 3 percent.

If history is our guide in estimating demand for CBD apartments, it will take time to absorb the new product, but once the market stabilizes, in about 24 months, vacancy will tighten and rent growth will return, since there will essentially be no building in the remainder of 2009 and 2010.

Vacancy in the suburban markets is increasing, but because much construction of the past few years occurred nearer to the city’s core, they are well-positioned for when tenants become more active again. And when this happens, the suburbs will likely be underbuilt, driving demand and pushing rental rates back up to 2008 levels and beyond.

Multifamily investment sales have been seriously affected by the recession. The Portland metro area has seen approximately $137 million in apartment sales so far this year through the end of July, according to data gathered from CoStar, a commercial real estate information company. That figure for January to July of 2008 was around $656 million. This equates to a nearly 80 percent drop in sales.

2008 was a record year for apartment sales, and one critical component to the sales volume that year was the number of institutional sales, which we define as sales valued at $20 million and above. In 2008, $380 million worth of transactions was in individual sales over $20 million, while thus far 2009 has produced just one transaction above $20 million. When we omit the institutional transactions, the volume in 2009 compares more favorably, at about 43 percent of the volume in 2008.

Despite the impact of the recession on the apartment market, Portland is in a good position for the upswing. U.S. News & World Report recently named Portland and its commercial market one of the ten cities “primed for a real estate recovery,” due to its green economy and overall economic health. When the job market and overall economy starts to improve, Portland’s multifamily market will be in a strong position for a rebound.

City’s Core Possesses Potential Aplenty

As businesses and residents return to greater downtown area, new retail investment possibilities emerge

Denis O'Neill, Associate Vice President, NAI NBS

Tired of doom and gloom in the real estate world? We are clearly in a down cycle driven by the implosion of the financial markets. However, if you are not inclined to spend 2009 searching the globe, do solid retail real-estate-investment opportunities exist right here in Portland? Here’s a tip: Follow the money.

Since the late 1970s, civic and business leaders have pursued a strategy to stop the suburban flight of retail and office businesses. Through the Portland Development Commission, public resources were channeled back into the core, initially through the establishment of the urban renewal districts, and later through substantial infrastructure investment in light rail and the streetcar. Propelled by the city’s desire to increase residential density around mass transit and fueled by property tax subsidies, we saw an explosion of condominium units.

New commercial investment followed residential growth and continues throughout the Central Business District and Northwest Portland. The Pearl District’s success is flowing both across Burnside to the west side of downtown and up Burnside toward Northwest 23rd Avenue.

On the south end of downtown, Portland State University and Oregon Health Science University’s ambitious expansion plans are linked both by the streetcar and the tram to Portland’s newest neighborhood, the South Waterfront District. South Waterfront boasts multiple high-rise apartment and condominium buildings, such as the John Ross and Meriwether, and a growing number of retailers, from a bank and restaurants to a neighborhood market and dry cleaner.

Dead zones are disappearing and districts are growing together. For years, talk of a 24-hour downtown was a planner’s mantra and little more. A city where people lived, worked and played seemed futuristic. Are we at a tipping point?

Two demographic trends appear irreversible. First, no one wants to commute. The rebirth of neighborhoods and commercial corridors near downtown, such as Southeast Belmont, Southeast Hawthorne, Northeast 28th Avenue and now, North Mississippi, were early indicators that an increasing percentage of people were rejecting the suburban lifestyle.

People are seeking a more diverse, urban lifestyle, minimizing the need for a car for work and play. An estimated 11 percent of the Portland metro area’s workforce walks, bikes or rides mass transit to get to work. The increase in gas prices has only encouraged this trend, and TriMet ridership continues to rise.

Portland’s unique neighborhoods and downtown are heralded by travelers and national publications alike. For instance, Travel + Leisure’s America’s Favorite Cities 2008 ranked Portland No. 1 for public transportation and pedestrian friendliness, safety, cleanliness, public parks and environmental awareness.

Second, young professionals and creative types want to work close to downtown. Leasing agents consistently report that companies are now trying to relocate from suburbia to the core, and recruitment and retention of talent are the drivers. This is a fundamental business shift.

So where are the investment opportunities? If you believe the lure of working and living near the core is going to only grow stronger, downtown real-estate values will surely benefit.

For the last year we have been dealing with a wide gap in the “ask” and “bid” resulting in a nationwide drop in the number of investment sales. Though buyers were quick to price in new financing costs, sellers were not ready to accept lower prices. Prices are now falling as available financing shrinks. The average cap rate for core office and retail properties is now about 7.5 percent, up from the low 6-percent level in early 2007. In addition to a rollback in rental rates, credit restrictions have finally forced sellers to acknowledge the new financing realities.

In emerging commercial areas like South Waterfront, the ground-floor retail space is being built as an amenity to attract condominium buyers. Until a critical mass of retail is reached, the retail components are being offered for lease and sale at subsidized rates. Rents are in the $25 NNN per-square-foot range, 10 to 20 percent below the market for established spaces. This translates to sale values in the low $300 per-square-foot range, well below construction cost for a Class A building.

However, South Waterfront has distinct advantages over earlier urban renewal areas. For the initial retail developments to be successful they must generate customers besides neighborhood residents. OHSU, Portland’s largest employer, is an engine that will continue to deliver research and medical space to South Waterfront and its 35-acre Schnitzer campus.

Plus, the sheer scale of the density and construction is unprecedented. Despite the downturn, South Waterfront will deliver more residential units, office and retail in five years than seen in the first 10 years in the Pearl.

South Waterfront may be the obvious example of where public and private investment creates opportunities for investors. But years of investment in Portland’s core, ever-increasing density, lifestyle and demographic trends make solid purchases in all of Portland’s areas near downtown a very good bet.

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.