COVER STORY, AUGUST 2006

OFFICE MARKET UPDATE
Vacancies drop as job growth remains steady.
Daniel Beaird

Southeast Real Estate Business recently spoke with developers and lenders about the current office climate in certain Southeastern cities. Vacancy rates are dropping as the Southeast experiences good job growth.

The South Florida office market has enjoyed the benefits from a rising population, strong labor market and good economy. The office vacancy rates have dropped dramatically into the single digits, which, according to John Geisen, president of the real estate brokerage and management divisions of Codina/Flagler Development Group, have led to significant lease rate hikes. “In Coral Gables, for example,” Geisen says. “The average asking rental rate per square foot has jumped by $2.70 or 10 percent compared to 1 year ago.” Land prices in South Florida continue to rise along with construction costs and leasing rates are not keeping pace. As a result, in Miami-Dade, Broward and Palm Beach counties have experienced a surge in the suburban office condominium market. An effect not witnessed across the nation. “Suburban office development is virtually at a standstill in so many other parts of the country,” Geisen says.

With the scarcity of land in South Florida, much of the office condominium projects in the area have been condominium conversions. According to Codina Group’s numbers, approximately 3 million square feet of office space has been converted during the past 18 months in Miami-Dade County. In Broward County, 25 percent of existing office tenants opted to buy their offices when their buildings converted to office condominiums.

Businesses have looked at other areas of South Florida such as Miami’s Airport West and Doral due to lower rental rates as compared to South Florida’s central business district. Businesses are also seeking out locations in mixed-use projects containing residential, office and retail components. “Mixed-use projects are very popular in downtown Miami and Brickell such as Infinity at Brickell, Capital at Brickell and 900 Biscayne Bay,” Geisen says. These mixed-use projects will contain office space on the lower floors as well as ground-floor retail space. “More and more people are leaning towards properties that are conducive to the idea of live, work and play within pedestrian-friendly communities,” Geisen says.

Burger King’s headquarters on South Le Jeune Road in Coral Gables, Florida.

Just as strong as the urban infill movement in South Florida, is the office park movement. State Farm and Regions Bank have both signed leases for 61,507 square feet and 22,000 square feet, respectively, at Building 1100 in the Flagler Station office park, which is currently under construction. According to CB Richard Ellis’ Broward County office market report, there is an additional 603,765 square feet under construction in the suburban markets. Five Class A office buildings were under construction at the close of last year including Royal Palm at Southpointe II, Lake Shore Plaza, Weston Pointe IV, Miramar Centre III and Heron Bay Corporate Center III. “Although quite different from what the region is witnessing with urban infill, the office park trend is just as strong of a movement,” Geisen says. One of those office parks is The Village at Beacon Lakes, which is comprised of more than 6 million square feet of warehouse distribution, office and retail space as well as build-to-suit options. Located at State Road 836, Northwest 25th Street and the Florida Turnpike, Beacon Lakes is close to downtown Miami and Coral Gables.

The office market in South Florida is witnessing rising construction costs, low vacancy rates and scarce land supplies, which are pushing demand significantly past supply. “It is a broker’s market,” Geisen says. “The South Florida market is being affected by more buyers. It is a very entrepreneurial market and everyone wants to own. It is a good time to be in business and we are seeing this reflected in the growth of smaller, family-owned businesses looking to expand and buy larger spaces in area like Doral,” Geisen says.

Washington, D.C.

Much like South Florida, there is little developable land left in the nation’s capital. Washington, D.C.’s office market also faces the challenge of height restrictions that do not allow developers to build any structure higher than the Capitol Building. Typically, the maximum height is 12 stories tall. “The scarce land in the traditional office areas like the central business district and the East End has forced office development down K Street and into NOMA (North of Massachusetts), Southwest and Southeast,” says Rob Hartley, director of market research for Trammell Crow Company in Washington, D.C. “These areas often lack the amenity base the more developed submarkets enjoy. As a result, developers are looking back into the core areas to rehabilitate existing locations.” The renovations of the traditional office areas have led to the elimination of Class C product and a significant reduction in Class B space in those submarkets.

A good example of the rehabilitation and new construction taking place is the Executive Building, located at 1030 15th Street NW in the East End submarket. Lincoln Property Company started work on this 314,234-square-foot office building during the second quarter of this year. The building will expand from 172,701 square feet. The completion date is set for the third quarter of 2007. The asking rate for the rehabilitated building is between $35 and $38 per square foot on a triple net basis for the space. “In 2002, Lincoln Property Company purchased the property with the idea that they would demolish the building and construct a new, larger building on the purchased site and an adjacent parking lot,” Hartley says. “However, after calculating the cost of demolition and reconstruction, they opted to build a new structure on the adjoining parking lot and integrate it with the existing building.”

Another example of Washington, D.C.’s rehabilitation to its office market is 2101 L Street NW, located in the central business district. Construction on the project will begin this quarter with delivery set for the fourth quarter of 2007. “The Charles E. Smith Company plans to reduce the building to its skeleton and renovate the entire project,” Hartley says. “This revitalization project will add new trophy product to the west end of the central business district. This project, along with Lincoln Property’s project, will further erode the Class B inventory by rehabilitating the properties into trophy product.”

Washington, D.C.’s traditional office markets have seen two large office building transactions recently. Republic Place, located at 1776 Eye Street, NW in the central business district, sold for $12.6 million. Ralph Dweck purchased the 214,304-square-foot building from USAA Real Estate. Another large transaction took place along Eye Street when The United Press building, located at 1400 Eye Street, NW in the East End submarket, sold for $41.4 million. JOSS Realty purchased the 170,000-square-foot building from Cambridge Associates.

The pending sale of The Marshall Coyne portfolio, which includes 1101 and 1156 15th Street, NW and 1620 Eye Street, NW in the East End submarket, is another example of a large Washington, D.C., office transaction. According to Hartley, Rock Rose is expected to purchase the Class C buildings for a sub 5 percent cap. “It is largely rumored that they will renovate the buildings into Class A-/B+ product, which will once again further erode the Class B product in Washington, D.C.,” Hartley says.

The Washington, D.C., office market is very healthy. Demand and supply have been strong and the vacancy rate has remained stable, according to Hartley. “While the market is strong, the Southeast submarket is still largely unknown,” Hartley says. “Certainly, the new baseball stadium and its associated retail will be a boon, but that is far into the future.” According to Hartley, though, some developers like Lerner and Opus are expected to break ground on a number of projects in the Southeast submarket by year’s end in order to place themselves ahead of the curve. “New speculative construction is expected to break ground primarily in NOMA and Southeast during the next year,” Hartley says. “However, with more than 6.4 million square feet under construction, some developers are starting to approach new construction more cautiously. These developers are requiring substantial pre-leasing in place before starting a new project.”

Charlotte

Much like the larger markets of South Florida and Washington, D.C., the Charlotte office market has expanded, so the submarkets do not have to compete directly with one another like in the past. “Density, traffic congestion, housing and amenities have all contributed to Charlotte’s submarkets standing more and more on their own,” says Mike Ortlip, senior vice president of Laureate Capital in Charlotte. “Submarket vacancy rates, ranging from 6.5 to 23.8 percent, illustrate the fact that office is not purely a commodity product in Charlotte, and location matters.”

Charlotte is preparing for an expansion of its urban and suburban office supply. “The completion of sections of Interstate 485 has opened up new areas for office and other development, and this trend will continue,” Ortlip says. According to Ortlip, Charlotte will also see new office buildings developed on a stand-alone basis downtown, in SouthPark, and in prime suburban submarkets. “Charlotte is also experiencing substantial office development as part of mixed-use projects,” Ortlip says. Projects such as Providence Plaza, Midtown, and EpiCentre are all examples of Charlotte’s attraction to mixed-use developments.

Piedmont Town Center, another mixed-use project, recently delivered 200,000 square feet of space in the submarket. “Piedmont Town Center is part of an expansive mixed-use development in SouthPark encompassing several restaurants as well as a significant residential concentration,” Ortlip says.

Office condominium development has been brisk in the suburban areas, according to Ortlip. “Demand for space by professional entities in smaller or stand-alone buildings has been very solid,” Ortlip says.

Charlotte’s office market is a mixed bag across the board. Exciting submarkets like SouthPark highlight the area, and the completion of I-485 will open new office markets in the city, but vacancy remains high in other areas. “Rising construction costs and interest rates will create pressure on all property sectors as equity returns continue to compress, and these costs will inevitably have to be passed to the tenants,” Ortlip says.

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