The last quarter of 2001 is a difficult time to forecast commercial real estate trends. Economic uncertainty abounds, causing both investors and users to hedge bets by sitting on the sidelines for a while. Certainly this general observation applies to the Baltimore market, where new construction is slowing and late 1990s absorption levels have been greatly reduced.

It remains to be seen what the long-term impacts of September 11th might be on this market. As an overlapping metro area with Washington, D.C., its neighbor to the south, there are some speculations that Baltimore might benefit from a new federal commitment to antiterrorism initiatives. With a substantial federal presence in facilities such as the National Security Agency and Aberdeen Proving Grounds, major defense contractors such as Northrop Grumman and Lockheed Martin and world class biomedical centers in Johns Hopkins University and the University of Maryland, Baltimore, the region may well benefit from the new initiatives bound to emerge from the Capitol. In the short term, however, business is cautious and slowing.

Industrial

The Interstate 95 corridor, servicing the East Coast, bisects Baltimore and represents the main artery of this area's industrial marketplace. The Baltimore Harbor divides the market into north and south segments. The southern portion, known as the Baltimore-Washington Corridor, has a base of 27 million square feet and is responsible for 60 percent of the market's industrial activity. Ideally situated between two cities whose combined metropolitan areas constitute the fourth largest consumer market in the country, this submarket has attracted international, national and regional developers, together with REITs and major realty investment advisors.

ProLogis has developed 1.9 million square feet in this area, and in the third quarter of 2001 delivered a 314,025-square-foot state-of-art distribution facility for Mack Truck. A design of Beery Rio & Associates, this project was constructed by Obrecht Phoenix.

The northern segment has been influenced by the many build-to-suits dotting the Harford County stretch of I-95. In the past 5 years, companies have ballooned the industrial base in Harford County to 6.7 million square feet, including Saks Fifth Avenue (470,000 square feet), McCormick Spice (370,000 square feet), Clorox (650,000 square feet), Crown Cork & Seal (300,000 square feet) and Rite Aid (900,000 square feet).

FRP Development Corporation has successfully developed Lakeside Business Park with a planned build-out of 1.4 million square feet. To date the company has developed and leased six buildings.

The predominant future challenge lies in identifying suitable sites for development. The dwindling land inventory is forcing developers to take a long term perspective and acquire sites with limited or no entitlements, taking on the time, money and market risk to guide these sites through the lengthy entitlement and site development approval process.

Investment

The investment markets in the Mid-Atlantic region have been severely disrupted by the uncertainty generated by the recessionary economy and the events of September 11th.

The depth of America's resolve, helped by the proactive workings of our government and the prospects of improving consumer confidence over the course of the next several quarters, will produce positive trend indications in many markets starting in the fourth quarter of 2002 and the first quarter of 2003. It is felt that the investment market has changed significantly and is adjusting to the increased risk of owning real estate in the United States.

The need to balance product type allocations places both garden apartments and bulk industrial property in the preferred property winners' circle, followed by grocery- and drug store-anchored retail. Significantly lagging in the favorite property category are central business district (CBD) office, suburban office and hotels.

The equity and debt markets are in a suspended state of confusion, resulting in more conservative underwriting, more rigorous due diligence and commitments being made more cautiously. When closings occur, they are inevitably over a protracted time period. The diverse product type multi-submarket experiences all indicate the greatest interest of investors in Class A locations and quality product.

The uncertainty that exists in the Baltimore market has virtually paralyzed the issuance of disposition request for proposals (RFPs) since the first quarter, and there are many owners who have denied the shift in the markets and held out for higher pricing as the cycle moved past the peak. It is anticipated, however, the current annual property reviews will focus on diluted internal rates of return, downgrading evaluations and reducing the spreads between seller expectations and buyer pricing. Over the last 12 months, these spreads were witness to a number of sellers formally withdrawing their properties from the market, such as Prentiss Properties , MIE Properties, Sunlife, Combined, Questar and Continental Realty.

When consumer confidence does reappear and interest rates start ticking up, refinancing will become a less attractive alternative than it has been in the recent past. Owners of income-producing real estate will become proactive and more highly motivated to sell in order to salvage part, if not all, of the value they created as evidenced by the dozen or so large transactions that have closed at higher cap rates than originally anticipated. Good examples are Nottingham Properties' sale of Rumsey Center and Snowden Center in Columbia; UBS Realty's sale of the International Landing/Airport Square, a six-building suburban office building portfolio in Linthicum; Boston Properties' sale of an industrial building portfolio in Prince George's County; and Times Square's sale of two bulk industrial buildings in Riverside.

CBD Office

The most significant real estate trend in downtown Baltimore over the past few years has been an expansion of mixed-use development along the city's northern and southern waterfront east of the existing Inner Harbor. Several new projects have been completed with numerous conversions of once active waterfront industrial properties into office, retail and residential projects. This area along the outer harbor has been dubbed the "Digital Harbor" by the media, local developers and local economic development officials. While the Digital Harbor growth has slowed down due to the technology sector downturn in 2000 and 2001, a significant trend has been established, which continues today with new construction starts.

One of the most successful projects in the Digital Harbor is an adaptive reuse of a Procter & Gamble soap making factory renamed Tide Point. This redevelopment by Struever Bros. Eccles & Rouse is a 405,000-square-foot, five-building office complex became the hottest product in downtown Baltimore in 1999 and 2000 for its fun, creative waterfront atmosphere that included free parking and easy access to the traditional CBD (by boat or car) and to the rest of the metropolitan area by quick access to the interstate systems. Just prior to the success of Tide Point, Struever Bros. Eccles & Rouse had completed another historic adaptive reuse of a former can manufacturing plant renamed the American Can Company. This project, along with several smaller ones, made the Canton neighborhood of east Baltimore a "hip" office address.

Also a part of the Digital Harbor is an area just east of the CBD and south of Little Italy known as Inner Harbor East developed by H&S Properties. Three new projects were built in the past 5 years that include office, apartments, retail, hotel, parking and a major convention center hotel. Inner Harbor East has three additional major mixed-use development sites ready to begin construction as demand warrants.

This past summer, Struever Bros. Eccles & Rouse and H&S Properties joined forces to start the newest Digital Harbor project, Bond Street Wharf. This 200,000-square-foot, six-story waterfront office project is 30 percent pre-leased by its architect, RTKL Associates. This development will deliver in the third quarter of 2002, with additional phases including parking and residential.

The CBD got its first groundbreaking in a decade in the form of a new 340,000-square-foot office building, also designed by RTKL. The facility is an air rights building above a utility company substation developed by Willard Hackerman, the owner of The Whiting Turner Contracting Company. Constellation Power has pre-leased 20 project of the project, which will be delivered in 2003.

Suburban South Office

Three of Baltimore's primary suburban submarkets, identified as Columbia, Annapolis and the Baltimore-Washington International Airport area, are located south of Baltimore's CBD in portions of Howard and Anne Arundel counties. For all intents and purposes, each of these markets has existed for approximately 25 years, and as expected, each market's greatest growth took place during the "boom" years of the late 1980s and late 1990s.

What differentiates these markets from the balance of the Baltimore metropolitan area is that during the "boom" years of the late 1990s, Baltimore's Suburban South office market substantially outpaced the rest of the Baltimore region in terms of growth and absorption. The growth has been so substantial that the market has transitioned from an alternative, acceptable and futuristic location to a progressive, highly-desirable and, for many corporations, preferred location to conduct regional business activities.

Due to the positive long-term outlook, Baltimore's Suburban South office market experienced considerable speculative development as the market exhibited indicators of declining activity during the past 18 months. Nearly all of the speculative development has been driven by institutional ownership and/or institutional supported partnerships. Some instances of overbuilding are clearly related to fee-driven developers utilizing institutional equity. Today, there exists approximately 20 empty buildings and/or large blocks (±50,000 square feet) currently available or nearing completion. This product is equally divided between single-story office or office/flex and mid-rise office product. Rental rates for single-story office and office/flex product are in the $20 (gross) per square foot range, while the mid-rise product is in the $24.50 (gross) per square foot range. In an increasingly cost conscious economy, the ±20 percent differential in rental rates between the single-story and mid-rise product is proving to be a significant advantage for the well-located, single-story product.

Corporate Office Properties Trust has begun leasing on 1304 Concourse Drive, a new project adjacent to the Baltimore-Washington International Airport. The four-story, 100,000-square-foot development overlooks the Baltimore-Washington Parkway and is near business amenities such as restaurants, hotels and conference facilities. In Columbia, Corporate Office Properties Trust is nearing completion of One Gateway Exchange, a five-story, 125,000-square-foot office building. The project, which is located just off I-95, is targeting high-end corporate users and high-tech companies.

Historical high net absorption rates of 1.5 million square feet that the Suburban South office market experienced during the past 2 years will be cut by 75 percent in calendar years 2001 and 2002 and is projected to stabilize at the 600,000-square-foot absorption level in 2003. Accordingly, Colliers Pinkard projects a 2- to 3-year period to absorb existing inventory and return vacancy rates from an 8-year high of 16 to 17 percent to a more stabilized single-digit level.

Baltimore County Office

Baltimore County is comprised of three separate office real estate markets: Suburban North, Suburban East and Suburban West. The markets comprise a total of 22 million square feet. The bulk of the office product resides in the Suburban North marketplace and contains approximately 16 million square feet. The three markets are concentrated around the Baltimore Beltway (Interstate 695) and are bisected by major arterial expressways: I-95 in the Suburban East, I-83 in Suburban North and I-795 in the Suburban West. For years, development was concentrated in the Suburban North corridor. Towson is the county seat of Baltimore County and contains a large number of the area's legal and accounting firms. North Towson, Lutherville and Timonium, with their proximity to I-695 Baltimore Beltway and I-83, contains a large percentage of the area's sales and service firms.

Hunt Valley, which was originally a master development by McCormick Properties and was later sold to the Rouse Company, additionally has housed corporate headquarters and larger financial services companies. Strict zoning and contained commercial zoning has impacted commercial growth in the I-83 corridor.

About 15 years ago, county government realized that future commercial development opportunities were being lost due to their development restrictions. In response, it focused on two areas of development in the White Marsh/East market and in the Owings Mills/West market. The county spent tens of millions of dollars on infrastructure, and today the area contains most of the county's newer multi-story commercial office construction.

The Suburban North market is continuing its steady performance through year-end 2001. The Suburban North vacancy rate is projected to end the year at about 11.4 percent, which is a two-point increase over mid-year 2001 numbers. The Class A vacancy rate has increased to 11 percent. An estimated 20 percent of the available vacant space consists of sublease alternatives. In the Suburban North marketplace, Timonium is currently outperforming Hunt Valley and Towson, with the tightest Class A vacancy rate of 5.3 percent and Class B of 9.3 percent. Hunt Valley and Sparks are negatively impacting the market, with Class A and B rates of 16 to 17.5 percent. For the first time since 1997, the Suburban North market had negative absorption. Rental rates over the past year have peaked. Class A rates range between $21.50 and $25 per rentable square foot, full service. Class B rates range between $18 to $20 per rentable square foot. Tenant improvements outside of base building shell can reach up to $20 to $25 per square foot for Class A space and up to $10 per square foot for Class B space.

In the Suburban North markets, Liberty Property Trust recently acquired a site on Wight Avenue in Hunt Valley and will be constructing a 75,000-square-foot building, to deliver at the end of 2002. Millennium Chemical Company is pre-leasing approximately 55,000 square feet in the building.

Interest has increased in the Sparks/Loveton area of Baltimore County, just north of Hunt Valley, due to the lack of options elsewhere. Two corporate office developments exist in this market, Sparks Corporate Center and The Highlands.

The Suburban East marketplace is centered around the White Marsh Mall. Nottingham Properties is the master developer and has delivered predominantly one-story office and flex buildings. Recently it has begun developing multi-story buildings with good success, as evidenced by Comcast's recent lease of 75,000 square feet.

The Suburban West marketplace consists primarily of the Owings Mills and Woodlawn submarkets. Most of the new construction has been in the Owings Mills area. The market was initially established with the relocation of long-time Towson tenants Alexander & Alexander (now AON) and Blue Cross Blue Shield (now Care First) into the Owings Mills Town Center. To the south, the McDonogh School developed a 50-acre office park and has ground leased and sold lots to large tenants Baltimore Life and T. Rowe Price. Currently, T. Rowe Price's corporate campus is the largest employer within Owings Mills. Later, ADP (Automatic Data Processing) relocated from Towson, and last year Legg Mason expanded to the county in a Class A building on Red Run Boulevard. This building had been vacant for over a year. During this last quarter, Toyota Motor Credit announced its consolidation of its East Coast financial services divisions to 100 Red Run Boulevard, a 110,000-square-foot building set to deliver by the first quarter of next year.

Despite the absorption of 288,000 square feet over the first half of this year, Suburban West vacancy rates decrease only decreased .5 percent, from 18.5 to 18 percent. This lack of change is due largely to new construction in the area. David S. Brown has been the most aggressive developer within the county and has developed seven office buildings during the past 3 years. Merritt Properties has been successful with their one-story flex office space. In Owings Mills, the flight has been to quality and access, with the Red Run Boulevard being the demand supplier. Furthermore, the Red Run Boulevard corridor has become an attractive neighborhood and is being considered for most metro area requirements due to the quality of the infrastructure and the availability of land.

The Woodlawn market is comprised only of Class B buildings, and these vary from new construction to approximately 30-year-old buildings. The newer buildings, those that have been developed over the past 10 years, have effectively responded to the flight to quality required by some Woodlawn tenants. This has resulted in many of the older buildings suffering from chronic vacancies unless they are effectively repositioned to compete. It remains to be seen if market absorption will spill over beyond the new product to the older product availabilities in both Woodlawn and Owings Mills.

Walter D. Pinkard, Jr. is president of Colliers Pinkard.


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