COVER STORY, DECEMBER 2006

2007 SOUTHEAST OUTLOOK
Brokers and developers like region’s growth potential.
Daniel Beaird

As the commercial real estate industry leaves 2006, Southeast Real Estate Business takes a look ahead to next year by examining different property types across six different regions throughout the Southeast. In Georgia, the office market is dominated by Atlanta, the hub of the Southeast. Atlanta has seen a record-breaking year in office sales as the highest price ever paid per square foot in Atlanta was broken twice this year. While the office market has taken after the city’s Hotlanta nickname this year, it remains to be seen if the trend will continue as many local employers are expected to cut jobs. In Florida, the multifamily market has passed through its conversion phase of 2005, and showed signs of settling down in 2006. The rental market is ready to be a player once again in Florida as single-family homes and condominiums are priced too high for some portions of Florida’s workforce. Kentucky and Tennessee’s central location in the United States continues to make it easy on those states to be players in the distribution game. Interstates 55, 65 and 75 provide great access to Kentucky and Tennessee industrial properties; and with companies like Nissan relocating to Nashville, the industrial market there will continue to grow.

The expansive residential growth in Washington, D.C.’s suburbs has led to excellent conditions for retailers to enter the market. With a highly educated workforce and the rise of mixed-use developments, the Mid-Atlantic region has seen high-end retailers follow the rooftops. Mixed-use developments are also taking off in the Carolinas where cities like Charlotte, Charleston and Columbia have seen the successes of these developments in larger cities and have adopted the idea for themselves. And finally, the Gulf Coast is still recovering for the damage of Hurricane Katrina. While it continues to be a long, hard road, the spirit of the people has pushed through some commercial developments in New Orleans. Meanwhile, Baton Rouge has experienced an explosion in population and is adjusting to the feel of being a larger city.     

CAROLINAS MIXED-USE

Birkdale Village, developed by Crosland and Pappas Properties, is located on Sam Furr Road in Huntersville, North Carolina, 15 miles north of Charlotte.

Much like many other cities nationwide, cities in North Carolina and South Carolina have witnessed a strong demand for mixed-use developments. The mixed-use concept is viewed very favorably by the development community in the Carolinas as one way to skirt rising land prices by building all uses in one. Because of the increased cost of land, developers are forced to build up and not out, which makes ground-floor retail with office space or residences above very attractive.

“Mixed-use developments seem to be springing up everywhere in response to market forces,” says Steve Mauldin, vice president of mixed/multi-use development for Crosland. Pressure is also coming from many municipalities to emphasize clustering commercial development and infrastructure together. “Based on the continuance of these issues, the near future for mixed-use development appears bright,” says Erin England, an associate with Colliers Keenan retail services group, based in Charleston, South Carolina. 

“Activity is widespread, but mainly in major metropolitan and suburban locations, driven by population, demographics and governmental support,” Mauldin says. “However, it is important to understand the complexities of mixed-use developments in terms of time, resources, creativity and expertise, which are all required for success.”

Some of the prominent mixed-use developments in the Carolinas that have recently been built include Birkdale Village in Huntersville, North Carolina; Phillips Place in Charlotte, North Carolina; Biltmore Park Town Square in Asheville, North Carolina; The Village at Sandhill in Columbia, South Carolina; and Belle Hall in Mount Pleasant, South Carolina.

Mixed-use developments have gained a lot of support in the Carolinas as the developments are targeted at a well-educated consumer. For example, The Noisette Company is redeveloping the Charleston Naval Base into a 340-acre mixed-use project called the Navy Yard. High-end tenants like Whole Foods, Newton Farms and Earth Fare are entering the Carolinas through these mixed-use projects. In the Charleston suburb of North Mount Pleasant, the Market at Oakland is a 79-acre mixed-use development that will be anchored by a Wal-Mart Supercenter. Big box retailers such as Wal-Mart and Target are getting in on the action of mixed-use projects in the Carolinas as well.

One of the largest mixed-use developments in the Carolinas resides in Charlotte. Crosland’s 270-acre Blakeney has opened at Rea and Ardrey Kell roads in south Charlotte. It is anchored by Target and Harris Teeter. The population within a 3-mile radius of Blakeney is predicted to grow by more than 27 percent by 2010.   

“Some of the suburban areas like mixed-use projects because if the projects are done well, they can become a gathering point for the suburban communities,” England says. “Some people are just tired of the commuter lifestyle and some want a more urban experience like one might find living on the peninsula in Charleston where work, shopping, dining and recreation are all in the same area.”

“The projects are so new to the Carolinas that it is not yet clear what the long term tenant interest will be,” England says. “The initial projects seem to be enjoying success and as the mixed-use product type becomes better known, tenants will likely gravitate toward mixed-use developments if the developments meet the specific needs of the communities in which they are located.”

KENTUCKY/TENNESSEE INDUSTRIAL

The Kentucky and Tennessee industrial markets rely on three interstates: Interstate 75 in the east, Interstate 65 in the central, and Interstate 55 in the west. While the I-75 corridor used to be a strong point for automotive locations, Nissan’s move to Nashville on the I-65 corridor has shifted the balance of industrial power as the hottest markets in Kentucky and Tennessee are Nashville and Louisville, which both sit on the I-65 corridor. “All the big automotive from Ford to Nissan are located close to the I-65 north-south corridor,” says Trey Hollingsworth, managing partner of Hollingsworth Capital Partners.

Nashville and Louisville aren’t just home to the automotive players. Nashville continues to be strong across all product types of real estate and Louisville is a hot market to a few large developers. In Nashville, the recent sale of the MidSouth Logistics portfolio continued to prove the positive outlook for net-leased sales. “Nashville has been notably taking down its vacancy, and many of the Class B and C facilities have been the recipients of solid leases,” Hollingsworth says.

Just up the I-65 corridor in Louisville, developers Lauth and ProLogis have developed large spaces for sale, while First Industrial has sold off some of its local presence. “The trend in the Louisville area is for new big box development to be built in Bullitt County, just south of Louisville proper,” Hollingsworth says. According to Hollingsworth, discussions took place regarding Ford shutting down its Louisville plant due to repositioning, but those concerns have been alleviated and the Louisville plant remains one of Ford’s most profitable. UPS announced a $1 billion expansion to its Worldport facility in Louisville that will add more than 5,000 full-time and part-time employees during the next 4 years. 

To the west of Nashville and Louisville, Memphis remains the anchor along the I-55 corridor, and is the largest distribution market in the two states. “FedEx’s continued strength has helped Memphis, and UPS’s recent push into supply chain management has opened many industrial locations next to the Memphis airport,” Hollingsworth says. The tax abatement incentives offered by the state of Mississippi, however, have pushed some of Memphis’ industrial market south of the Tennessee–Mississippi state line. “For that reason, Memphis’ industrial market has a black eye with many institutional investors, which has slowed the churn of capital in the market,” Hollingsworth says. However, due to Memphis’ central location in the country, it remains a strong distribution center and currently has the largest average of user size, in terms of square feet, between the two states.

The distribution climate in Kentucky and Tennessee is strong with many tenants looking for space and many active buyers looking for net-leased investments. “Many brokers have reported activity well above average levels for the past few years, but consummated deals haven’t seemed to follow in lock-step with the rise in activity,” Hollingsworth says. “The deals have been higher, but not to the level of all the activity.”

The industrial trends in Kentucky and Tennessee, much like elsewhere in the country, have been towards more contiguous square feet. Bulk warehouse facilities are growing larger as tenants search for a small number of larger locations, which goes against the early 1990s trend of a high number of smaller distribution centers.

“As the ports on the eastern seaboard become more critical to imported goods, Kentucky and Tennessee hope to see a rise in the development of distribution centers,” Hollingsworth says. “The states are within a day’s drive of most eastern ports, which makes them an ideal layover stop.” In addition, there has been a trend towards more secondary locations within the two states to avoid some of the burdens of metropolitan locations.

“The strength in the market is expected to continue in 2007,” Hollingsworth says. “Most brokers and developers are expecting a positive year.”

MID-ATLANTIC RETAIL

Retail has been stimulated in the Mid-Atlantic region by job growth and population gains during the past few years. Retail follows rooftops and that has led to the trend of the “power town” in the Mid-Atlantic region. The power town incorporates traditional big box retail with a small town center component, in a mixed-use format, with office space either above or adjacent to the lifestyle component. Through this concept, the region has seen more retail projects being built recently. The increase in retail property may put pressure on vacancy rates, but the population gains should help fill the gaps rather quickly.

The Mid-Atlantic region has traditionally spent more on retail than the national average because of the number of government and semi-government related jobs. “These jobs come with non-monetary perks that translate into a larger available disposable income,” says Gerald Divaris, chairman and chief executive officer of Divaris Real Estate. “This additional disposable income finds its way into the retail market.”

The success of retailers in this part of the country has led to mixed-use developments opening across the region like The Town Center of Virginia Beach in Virginia Beach, Virginia, and the Oyster Point City Center in the Hampton Roads area of Virginia. “The success of these mixed-use developments has spurred that kind of development in the Richmond, Virginia, market,” Divaris says. 

However, these mixed-use developments have not hindered the success of big box retailers in the area, hence the formation of the power town. One such power town is The Marquis in Williamsburg, Virginia, a 1 million-square-foot development anchored by Kohl’s, Target, JC Penney and Best Buy that is scheduled to open in fall 2007. Another power town is Landstown Commons in Virginia Beach, a 475,000-square-foot development anchored by Kohl’s, Best Buy and Ross Dress For Less, which will also open in fall 2007.

With the vast amount of retail development occurring in the Mid-Atlantic region, developers must stay ahead of the curve to keep pace. “That’s the greatest challenge facing retail developers in this region,” Divaris says. “With the rapid growth of residential communities in the Mid-Atlantic region, more subdivisions are being developed in outlying areas. Consequently, developers are purchasing sites ahead of the growth curve, anticipating being well located in the future. This adds an additional level of risk to the development process.”

One of those outlying markets that has taken off is the Hampton Roads area. “The retail climate in the Hampton Roads area is extremely active with retailers showing good increases in sales while the population and incomes continue to grow,” Divaris says. The strongest markets for retail growth in Hampton Roads are Virginia Beach, Suffolk, Newport News and Williamsburg.

The retail market in the Mid-Atlantic is strong and looks to remain strong into next year. “It will continue to remain buoyant in 2007 with additional growth and several new developments being announced. Population and income levels will continue to rise and retail, as usual, will follow,” Divaris says.

FLORIDA MULTIFAMILY

By now, most of the Class A multifamily product in Florida has already been converted into condominiums, and the craze that was condominium conversions has cooled considerably. As home ownership becomes more expensive and unattainable, the rental market will find a window of opportunity to be a major player on the multifamily scene again. According to Brad Suddath, a broker with JBM Realty Advisors in Tampa, Florida, reduced apartment inventory due to conversions and a lack of new rental construction, combined with an increase in rental demand, double-digit rental rate growth has become the norm again in most Florida submarkets. As developers and brokers look to the future of the multifamily sector in Florida, a strong effort will be made to bring affordable workforce housing to cities around the state.

“Governments and municipalities have finally awakened to realize they have priced school teachers, firefighters, police and nurses out of the marketplace,” says Tony Martin, executive vice president of Orlando, Florida-based developer Tarragon Corp. “These workers will leave for other locations if a solution isn’t found. Workforce housing will be a viable business once municipalities ease their regulations and provide an environment in which developers can build a reasonable product and price it within the income range of this working segment.”

Workforce housing, or any sort of multifamily product, would be the first consistent ground-up product built in awhile. “The market seems to be showing some signs it has reached its bottom as large volume investors are starting to inquire about buying product again,” Martin says. “Inventories seem to be liquidating, albeit slowly, and deals are still being made. Prices seem to be holding somewhat although concessions on the back end are very popular and competitive.”

As the Florida multifamily market has maxed out its potential for condominium conversions, more ground-up developments are being considered and mixed-use projects sit at the top of the list. “Mixed-use developments are very viable partly due to rising land costs coupled with the New Urbanism of work, live and play,” Martin says. “Given expensive land costs, developers have to build up to get the density needed to make a deal work; and ground-floor retail meets both needs.”

As brokers and developers search for multifamily uses, the most notable trend has been the value-add acquisition, according to Suddath. “A Class B property will be acquired in a Class A submarket. The property will be extensively renovated and reintroduced to the market as a Class A property with Class A rents,” Suddath says.

As developers search the state for good deals, Central Florida is very popular as job creation is strong around Orlando. The combination of significant population growth and a rapid increase in the employment base has made Orlando a desirable location for developers and investors. To accommodate the growing population, Orlando was swept up in the conversion craze as well. According to Cushman & Wakefield, as many as 12,000 units have been removed from Orlando’s multifamily inventory as a result of condominium conversions, which accounts for nearly 8 percent of Orlando’s multifamily housing. In turn, occupancy rates have jumped to all-time highs and rental rates have jumped as well, by 8 to 12 percent.

The condominium conversions have created the healthiest multifamily market Orlando has ever experienced. However, like most Florida cities, conversions are on the downturn as increased construction costs and rising insurance expenses as well as the 2004 and 2005 hurricane seasons have slowed development activity in the Sunshine State. Also like most cities in Florida, Orlando suffers from a lack of developable land. So, the downturn on conversions will extend into next year.

Condominium conversions have ground to a halt in South Florida as well. However, population and job growth provide South Florida the means to absorb the space from unsold condominium inventories. A small percentage of the rental community that was taken away by conversions has been replaced by new construction. But, land scarcity in South Florida does not allow for much new development. Therefore, the rental market has tightened significantly.

With the condominium conversions cooling off considerably in Florida this year, the apartment market shifted its attention to income investors, who are drawn to the state’s solid market fundamentals. Rents are increasing and markets are at nearly full occupancy due to population and job growth. The question for next year is when will the Florida multifamily market see new developments rise from the ground. That depends on how accessible land becomes to developers and how long the recent downturn in development lasts.   

“New development of rental housing is difficult in any market today,” Suddath says. “The high cost of construction materials, labor and land continues to make purchasing existing projects much more economically feasible than building new. However, there has been some downward pressure recently on construction costs and land prices.”

JBM Realty Advisors expects a very active Florida multifamily market in 2007 as well. “The value-add investment strategy should continue to create transaction incentive for both owners and prospective purchasers,” Suddath says.

GEORGIA OFFICE

As the hub of the Southeast, Atlanta obviously dominates the office sector in the state of Georgia. Consisting of the Buckhead, Midtown and Downtown submarkets, the Atlanta office sector has seen vacancy rates consistently drop since the end of 2004, and in turn, rental rates rise. Atlanta’s office market has also witnessed strong expansion figures in recent years with the Buckhead submarket leading the way. More than 3.5 million square feet of annual absorption in 2005 marked a return to levels Atlanta had only seen in the late 1990s. The numbers are not quite as high this year, but new development continues at a brisk pace with 1.4 million square feet of office space completed this year and another 2.4 million square feet under construction. As of the third quarter, Atlanta had just below 2 million square feet of net occupancy growth for this year. The metro office market has dipped below the 20 percent vacancy mark for the first time in 4 years, but the absorption numbers will not catch the levels of 2005.

“Continued absorption and lower vacancy rates are leading to some new construction, but this will be somewhat curbed by high construction costs,” says Leigh Martin, a senior vice president of CB Richard Ellis in Atlanta. “Mixed-use and urban space is more in vogue as evidenced by what is happening in north Downtown at Allen Plaza, in central Perimeter at Perimeter Place and everywhere in Buckhead.”

Many Class A office properties in Atlanta have changed hands this year including Cumberland Center III, One Overton Park, Tower Place 200, Alliance Center, One Atlantic Center, Colony Square, Bank of America Plaza, 191 Peachtree and 1180 Peachtree. According to Grubb & Ellis, more than $2.5 billion was paid for office properties in the third quarter alone and a whopping 74 percent of that included trophy buildings. The highest price per square foot ever paid for a Class A office property in Atlanta was topped twice in the third quarter as Cousins Properties sold Bank of America Plaza, Atlanta’s tallest building, for $347 per square foot to an affiliate of BentleyForbes; and Hines sold 1180 Peachtree, also known as Symphony Tower, for $379 per square foot to General Electric Pension Trust.

Cousins Properties was involved in a couple of the largest leasing transactions in Atlanta as well as CompuCredit leased 411,000 square feet at Concourse Five and Six in the central Perimeter submarket, the largest leasing transaction in the city since 2003; and the American Cancer Society will occupy the entire 273,000-square-foot Inforum Building in the Downtown submarket. CB Richard Ellis brokered both transactions.

“The market is on fire,” says Bill Kilborn, senior vice president of CB Richard Ellis in Atlanta. “Properties keep trading hands over and over. It seems that investors just want to get a piece of the pie.”

While investors might want to get a piece of the pie, these record-setting deals might slow the process down for the future of Atlanta’s office market. “From a transaction perspective, these huge asking prices owners are paying for these buildings has tended to slow the process down once the transition from one owner to another is factored in,” Martin says. “Tenants need to factor this in to their process timeline. A new owner means new leasing guidelines, new decision makers, new leasing agents and potentially new property management.”

While Atlanta’s office market is very active and relatively hot, it remains to be seen if office demand can continue to gain strength in coming quarters. Absorption has not kept pace with last year’s progress and a number of local employers — BellSouth, Georgia-Pacific, Ford, GM — are expected to cut jobs during the next couple of years. Even with those concerns in place, though, Atlanta’s office market still plays the role of a favorite.

“It’s vibrant right now and if that trend continues, the market will be very good for landlords in 2007,” Kilborn says.

GULF COAST

Hurricane Katrina had devastating effects on the Gulf Coast in 2005, bringing forth one of the more trying times for a single region in American history. Alabama, Mississippi and Louisiana were all hit by the massive hurricane, but New Orleans by far received the most extensive damage.

Prior to Hurricane Katrina, the majority of New Orleans’ residents lived in the parishes of New Orleans proper and Jefferson, which were also home to much of the area’s commercial and industrial real estate development. These parishes lost huge population numbers as did the rest of the city as the total MSA of New Orleans dropped from approximately 1.3 million people to a little more than 1 million people after the storm.

So, how has New Orleans and the Gulf Coast tried to bounce back from Katrina? Fortunately, New Orleans’ downtown office market has shown resiliency. According to NAI Latter & Blum, downtown Class A occupancies are at 91 percent, up from pre-Katrina levels of 89 percent. Downtown Class A rates have remained steady at $15 to $18 per square foot. Increased insurance rates should keep upward pressure on rates during the next year.

However, insurance uncertainties still make the market somewhat questionable. “Commercial lenders have pulled out of the area due to insurance uncertainties,” says Buck Landry, managing director of public finances for Morgan Keegan in New Orleans and Baton Rouge, Louisiana. “Many are taking a wait and see attitude to gauge insurance costs as to whether to get back in the market or not.”

An increased population in Baton Rouge, due to the evacuation of New Orleans, has greatly benefited the office, retail and industrial sectors in Louisiana’s state capital. Occupancy rates for Class A and B office properties are in the low to high 90s, prompting the first new office construction in 4 years. Retail vacancy rates are about 6 percent in the Essen Lane and Bluebonnet Boulevard submarkets, and industrial occupancy rates are in the low to mid 90s.

The Gulf Opportunity (GO) Zone Act has sparked investment in the multifamily sector in Baton Rouge. The Act offers incentives to build new multifamily projects or renovate existing projects. In addition, New Orleans is also experiencing multifamily development due to the GO Zone Act.

“The non-residential commercial real estate will begin to flow in New Orleans after residential real estate returns,” Landry says. While it depends on the speed of the insurance companies, Landry expects it will take New Orleans at least 5 years to rebound from the effects of Hurricane Katrina.

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