CITY HIGHLIGHT, DECEMBER 2006

LEXINGTON CITY HIGHLIGHTS
Steve Pulliam and Todd Harrett

Lexington Industrial Market

The old adage, “There are two sides to every coin,” is particularly applicable to the Lexington/Fayette County industrial real estate market. On one side, the county’s larger industrial spaces waver between stable and struggling, and on the other side, the smaller owner/user product is in tremendous demand thanks to low interest rates, which are creating new opportunities for potential buyers.

Fayette County’s larger industrial building market is operating at an approximate 20 percent vacancy, which is down from about 28 percent 3 to 4 years ago. In part, overall vacancy in this product type is due to several large buildings of approximately 100,000 square feet that remain at or near empty. Yet, it still is far from the success level being achieved by Fayette County’s smaller owner/user inventory, approximately 10 million square feet of mostly light industrial and distribution space, which sits at approximately 10 percent vacancy.

Industrial rents have remained virtually flat for the past several years. Depending on amenities, access and date of construction, rents range from approximately $3 to $6. Rents on larger industrial buildings that are newer and well occupied, such as the local Link-Belt, Amazon.com and FedEx facilities, average in the $5 and $6 per square foot range and will sell for around $60 to $70 per square foot. However, larger vacant buildings are trading at a much lower $20 to $30 per square foot. Owner/user space is selling for as much as $50 per square foot.

While Lexington benefits greatly from being within one day’s freight to most points in the nation, it ironically struggles from an employment standpoint. The cit of Lexington contains a highly educated employment pool that is not necessarily well suited for manufacturing positions. As a result, it is not uncommon for business owners to live in Lexington, but own a manufacturing company in eastern Kentucky where labor and land are cheaper.

Lexington also is at a disadvantage when it comes to air transportation. In comparison to the Cincinnati/Northern Kentucky International Airport, which in 2005 processed 1.6 million pounds of goods via cargo airlines, and the Louisville International Airport, which in 2005 accommodated 4 billion pounds of cargo, freight and mail, the Blue Grass Airport in Lexington continues to remain a secondary airport system. Outside of some railroad activity, this leaves distributors dependent on Interstates 75 and 64 as primary routes for goods.

Lexington’s West, Northwest and Northeast quadrants, which are closer to the interstates, have a larger inventory of light industrial and distribution space, including the Toyota plant in Georgetown that produces the Toyota Camry. Further-out markets like the South and Southwest are supported primarily by tradesmen occupying smaller industrial space.

The key to Lexington’s industrial real estate future may lie in finding the highest and best use of industrial space in each of these markets. This is even more critical considering that the value of industrial land, which in Fayette County will sell for more than $100,000 per acre, makes it much more expensive to build than to buy. In the current market, investors may want to consider opportunities to turn large, possibly vacant, industrial space into parceled owner/user space. Maybe by breaking down space, we can simultaneously break down the challenges facing the large-building side of the Lexington industrial coin.

— Steve Pulliam is a senior advisor in the Lexington, Kentucky, office of Sperry Van Ness.

Lexington Multifamily Market

While Lexington may be best known for its prized thoroughbred farms, the local multifamily sector is becoming increasingly well known for its success within the commercial real estate market.

After significant overbuilding in the late 1990s, Lexington’s multifamily inventory has rebounded in many ways. On the construction front, development restrictions have kept inventory levels in check, with only 1,000 new units delivered during the last 2 years as compared to the thousands that were built almost annually just under a decade ago. In turn, economic occupancy rates have improved to near 90 percent and concessions are burning off after more than tripling last year from 1.7 to 6.1 percent of gross potential rent, according to The National Apartment Association’s Survey of Income & Expenses.

Though rent growth continues to hover at approximately 2 percent and rents remain at a solid $590 per month average, stabilization in the multifamily sector has done much to encourage metered new development in select submarkets. Downtown Lexington, for example, has been injected with a host of multifamily units, many of which are for-sale residences that are incorporated into mixed-use plans. Main + Rose is one such development which features 96 high-amenity, creatively designed loft units situated above 25,000 square feet of retail space. Just east of Lexington, Georgetown and Richmond are also active on the building front, with new residential communities spurring the development of Hamburg Pavilion, one of the area’s first big box open-air lifestyle retail centers. The entire development spans more than 100 acres and includes new office condominiums and a mix of approximately 2,400 new homes geared toward the town’s high-income demographic.

On the job front, Lexington remains the commercial Mecca of central Kentucky and holds a prime position at the epicenter of the U.S. population. It’s pro-business attitude and investment in the local business market is part of what helps keep residents moving to Lexington and bolsters the interest of multifamily property investors, who by year’s end are expected to close on an estimated $150 to $175 million in multifamily sales. At the start of the fourth quarter, 2,101 units already had traded in eight significant multifamily properties at an average per-unit sale price of $55,830. It should be noted that this average is slightly skewed by the sale of two of Lexington’s five student-housing complexes, which had per-unit sale prices of approximately $117,000 and $114,000. A third Lexington student-housing complex is also now in escrow.

In the year to come, Lexington multifamily buyers — 75 percent of which are from out of state — should continue to find this a market of lower costs and higher yields. In addition to rolling green hills and picturesque horse farms, buyers with as little as 20 to 25 percent down have the ability to cash flow at 7, 8 and even 9 percent.

— Todd Harrett is an advisor in the Lexington, Kentucky, office of Sperry Van Ness.

Lexington Office Market

With an affordable cost of living, renowned quality of life, diminishing land supply and a major university that serves as both an economic force and a safety net, the Lexington office sector is faring well.

Across the market, the strength of the University of Kentucky as a growth engine is hard to ignore. According to the University’s Web site, the institution, due to its $1.4 billion annual budget, is the ninth largest economic enterprise in the Commonwealth. It also is one of only seven universities in the country with a teaching and research campus and medical center in one central location.

Strategically located on 687 acres adjacent to downtown Lexington and an employer of 11,000 people, the University has a tremendous effect on the surrounding economy. The ripple effect of such an organization and its ability to encourage spin-off businesses ranging from medical technology to research endeavors has done much to bolster the downtown market.

In Lexington’s Central Business District (CBD), which represents approximately 3 million square feet of office inventory, space is renting from $12 per foot for Class B developments and up to $20 per foot for Class A offerings. Vacancies are in the low teens, but improvement is anticipated since there has not been any significant new office space built downtown in many years — outside of urban residential projects — and no significant new construction projects are planned for the near future. However, that is not to say that the submarket is stagnant.

In outlying areas, the automotive industry — including a nearby Toyota plant — attracts office users that have become part of the backbone of approximately 4 to 4.5 million square feet of suburban office space. Low interest rates have spurred the aggressive development of suburban office condominiums; however, this new development has simultaneously conjured speculation regarding over-development in this sector. The trend toward ownership has had somewhat of a flattening effect on rents, which typically sit between approximately $10 and $18 per square foot, but it has done little to move vacancy rates, which remain between 10 and 15 percent. Employers continue to move into the market, attracted in part by a highly educated employment pool, of which 70 percent are college graduates. Those looking to buy office space in Lexington can expect to pay from $95 per square foot for older downtown space up to $130 for the newest property. Cap rates continue to hover around 7 percent to 9 percent.

The expansion of Lexington’s urban boundaries may still be several years away, but the growing population and shrinking land supply translates into rising values for current office owners, investors and developers watching the market, as Lexington is beginning to have few places to go but up.

— Steve Pulliam is a senior advisor in the Lexington, Kentucky, office of Sperry Van Ness.