CITY HIGHLIGHT, JANUARY 2006

RALEIGH/DURHAM CITY HIGHLIGHTS
James Scofield, Elizabeth Raiford, Curtis D. Dean, Joaquin Canals, Kerry Saunders

Multifamily Market

Apartment developers are poised to begin new apartment communities in the Raleigh-Durham-Chapel Hill or Research Triangle market in North Carolina, but the biggest question they face is “When to start?” Developers enjoyed great success in the late 90's building for an under-supplied apartment market, but have faced an uncertain future since the tech bubble burst in 2001. Development uncertainty continues as apartment owners struggle to return to their historically low vacancy rates and higher rental rates they used to enjoy.

To put everything in perspective, the counties that comprise the Triangle have a total population of 1.4 million for more than 86,400 units, according to Karnes Research and the Triangle Apartment Association, which only surveyed communities of 50 units or more. Their statistics show that 4,250 units per year were constructed leading up to the tech bubble explosion, with another 8,073 units constructed before the spigot could be turned off. The resulting oversupply drove the vacancy rate to 13 percent in 2002. Since that time developers have added an average of 1,565 units per year waiting for the market to recover. The vacancy slowly dropped to as low as 7.9 percent in 2004, but has climbed back up to 8.7 percent where it stands today.

Developers are poised to begin construction again and have planned 7,110 more units in addition to the 1,947 units presently under construction. H.H. Hunt, Trammell Crow Residential Services, Wood Partners, ContraVest and TICON have been the most active developers, with The Crosland Group rapidly catching up with three exciting mixed-use projects on the heels of their very successful Oberlin Court project in central Raleigh.

The only obstacle developers face is the lukewarm rental market and anemic rental rates. Triangle vacancy has averaged 9.1 percent the last 2 years and is presently at 8.7 percent, according to Karnes Research. Vacancy is expected to go north during the slow winter leasing season, possibly above 10 percent.

Worse yet, the average rent of $760 for an existing apartment is the lowest it's been since 2000, and when concessions are figured in, average rents are 5 percent to 20 percent below their 2001 peak. Average rents for newly constructed communities are significantly higher at $966, but concessions are market-wide with approximately 67 percent of all communities offering concessions ranging from free rent to reduced rents on selected units.

With one exception, the majority of Triangle development has been near Research Triangle Park, the area's economic engine. Northwest Wake County and southern Durham County are adjacent to the Park and have enjoyed the most development. The Cary-Morrisville-Apex submarket is also adjacent to the southern end of the Park, and when combined with northwest Wake County, accounts for almost 50 percent of the proposed developments. The exception is Northeast Wake County which has only 10 percent of the market's apartment inventory but received more than 21 percent of its new construction.

The majority of the new development is upscale with amenities and finishes that are much like those found in for-sale condominiums and townhomes. Upgraded cabinets, lighting, moldings and flooring, along with resort-like pools, decks and grounds are being constructed for community differentiation, to attract would-be homeowners and set the stage for future condominium conversions.

Condominium conversions are starting to happen in the Triangle, with even one rental project being considered for conversion before completion. Avera Place at Brier Creek is close to Research Triangle Park and under contract to condominium converters before its final phases are completed.

Another interesting trend in the market has been the sale of the finished product shortly after stabilization. Several examples include Trammell Crow Residential's sale of Alexan Farms, Wood Partners' sale of The Verge student housing community, and ContraVest's sale of Courtney Creek, Courtney Estates and Colonial Grand at Arrington. These sales greatly benefited from the record multifamily investment frenzy that has come to the Triangle market and driven average CAP rates down to just below 5.7 percent, an 80 bps drop from the 6.5 percent average CAP experienced in 2004.

Considering all the factors, it would be easy to start construction again if apartment operations were better and rents were higher. While the Triangle has great potential, it's anybody's guess when the region will once again live up to it.

— James Scofield, SIOR, is seniorinvestment advisor with the Raleigh, North Carolina, office of Sperry Van Ness.

Industrial Market

The Triangle is primarily an office market as the region has just 35 million square feet of industrial space, five times less than its sister city, Charlotte. As a result, just a few sizeable transactions can translate into a significant drop in vacancy. So after 5 years of rising vacancy, the Triangle industrial market is at last improving. Since hitting a high of nearly 29 percent in mid 2004, warehouse vacancy has fallen by 590 basis points. Approximately 775,000 square feet was absorbed through the first 3 quarters of last year, the strongest demand since 1999 and a far cry from the negative absorption of 1.2 million square feet at the height of the downturn in 2003. The flex sector made gains early in 2005, but most were wiped out late in the year when lease expirations for space, formerly occupied by companies such as Interpath and Solectron, placed large vacancies back on the market. In addition to the hangover from the tech recession, flex space is experiencing significant competition from office buildings where asking rates remain heavily discounted. At the end of the third quarter, flex vacancy stood at 21.2 percent, just 40 basis points below its year-end 2004 figure. As the office market continues to improve and asking rates rise, the flex sector will follow in recovery when it once again becomes a cost-effective alternative to traditional office space.

The most significant industrial news of last year included two sales transactions that signaled investor confidence in the region. Transwestern Investment paid $52.8 million for the 1.7-million-square-foot Research Tri-Center, located on the outskirts of Research Triangle Park. Since that time, one of the buildings has been flipped to Silver Line Windows, one of numerous home improvement, storage and moving-related companies positioning themselves to take advantage of the region's exploding population and housing market. In the second quarter, the Jack Parker Corp.'s 63-building portfolio went under contract to BPG Properties. If the transaction closes for more than $250 million as expected, it would represent the region's largest commercial real estate investment since Highwoods Properties went public in 1994.

While the Triangle's industrial market has another 12 to 18 months to go before reaching equilibrium, the long-term outlook is good. Bargain basement prices are at last giving companies incentive to act,   such as with Silver Line, before they even need the space. Recent economic development news also bodes well for the region. Biotech appears to be gaining a foothold and the high-tech sector is recovering. Tekelec and Arysta LifeScience are moving to the region from California, and Biolex Therapeutics plans to build a new plant to double its manufacturing space. With speculative construction almost nonexistent, vacancy for both flex and warehouse space should begin to fall more rapidly in 2006 as the economy continues to improve. Newer facilities and those that can be subdivided to accommodate small to mid-size users will be leased, while older more obsolete properties may be adapted for alternative use or redeveloped altogether.

— Elizabeth Raiford is vice president, marketing and research, with Raleigh, North Carolina-based Grubb & Ellis|Thomas Linderman Graham.

Office Market

Despite heightened activity and an increasingly optimistic outlook among real estate professionals in the Raleigh-Durham office market during last year, occupancy rates only slight increased, from 84.36 percent to 84.50 percent, in the first half of 2005. However, the optimism may have been on track, with the 39 million square foot office market absorbing more than 350,000 square feet in the third quarter, and pushing the market-wide occupancy level to 85.34 percent. While the improvement may appear lackluster, it is a welcome relief from the thirteen consecutive quarters of negative absorption ending at year- end 2003, and the very slow growth that followed in 2004.

The rental rate recovery continues to occur at a slow pace, with lease terms remaining competitive but not as aggressive as in past quarters. Class A rents dropped as much as $3 per square foot during the market decline, and concession and tenant improvement packages were very aggressive. But while rents have just started their recovery, concession and improvement packages are reducing at a noticeable pace.

Supported by improving national trends, local market improvement and some pre-leasing, developers have more than 1 million square feet of office product under construction in the Triangle, and several more projects on the drawing board. Although there is a significant disparity between rents in new Class A office buildings and those for space in existing office properties, pre-leasing has been healthy, reflecting a positive economic outlook by local businesses.

While our 14 million-square-foot flex market showed noticeable improvement in the first two quarters of the year, the third quarter was plagued by move-outs and downsizing tenants, which mitigated much of the year-to-date improvement. The occupancy level in that market sector still hovers around 21 percent.

The industrial market, which has remained painfully below the 75 percent occupancy level since early 2003, is finally experiencing some relief with more than 500,000 square feet absorbed during the third quarter. As a result, the occupancy rate in that 20 million-square-foot market has now been pushed above 77 percent.

The Research Triangle Park/Interstate 40 (RTP/I-40) corridor merits close attention as it represents not only the largest but also the most active of the Triangle's office, flex and warehouse submarkets. With nearly half of the region's office and warehouse net absorption occurring in that submarket during recent quarters, developers and investors will stay focused on that area. The continuation of Interstate 540 (Raleigh's new outer loop), is forcing what used to a very fragmented market to behave more as one large metro-market by reducing drive times from residential pockets to major commercial submarkets, and by creating development opportunities along its path.

The major exception to the focus on the RTP/I-40 locale is the presence of small mini-markets that are being created in lifestyle centers, such as Brier Creek and the redevelopment of North Hills. Strong demand will continue from retailers and office users for this type of live-work-play environment, as well as from residential tenants and buyers.

— Curtis D. Dean is executive director with GVA Advantis – Raleigh.

Retail Market

Retail investments continue to be strong in the Raleigh-Durham area of North Carolina. Consumer spending is up and the population continues to grow. Accordingly, investments will be made in redevelopments or into expanding existing centers. Approximately 1.5 million square feet was under construction at the end of 2004 with more than half pre-leased. During 2005, more than 1.7 million square feet of retail space was under construction. Most of that space can be found in Developer Diversified's Beaver Creek Crossing, a 700,000-square-foot center in Cary,   as well as Midland Atlantic Properties' Renaissance Village, a 300,000-square-foot center in South Durham. More than 3.2 million square feet are proposed for this year, which is coming on the heels of two mega-malls — each more than 1 million square feet —   developed in recent years and other regional power centers built in 2003.

Vacancy rates have hovered around 5 percent to 6 percent during the last few years, with North Durham and East Wake exhibiting the highest vacancy numbers. Absorption was strong in 2004 at 8 percent, down from a high of 10 percent in 2002, which was the highest rate since 1988.

Unfortunately, Winn-Dixie closed 11 stores in the Triangle by the end of last year. Although competing grocers bought four of the Winn-Dixie stores, the closings have caused a slight increase in the vacancy level moving into this year.

Rental rates in the Triangle average between $22 and $32 per square foot, with outlying areas charging less.

This year, Kane Realty will commence on the final phases of North Hills mixed-use development. The project is bringing the four ingredients — retail, office, hotel and residential space — of a true, urban, mixed-use development to this market for the first time. Also, Whistler Investment Group will break ground in the third quarter on the first phase of The Galleria at Crabtree, another mixed-use development with 133,000 square feet of retail space, 56,000 square feet of office space and more than 300 apartments.

As construction on the Outer Loop continues, new pockets of opportunity will open at the major interchanges. Other growth corridors that need to be considered this year are Wake Forest Road inside the Beltline corridor, Tryon Road in South Raleigh, US-1 near Apex, and the Brier Creek, SouthPoint Mall and Triangle Town Center areas.

Watch the health of department stores like Lord & Taylor as category killers (Dick's Sporting Goods, Bed Bath & Beyond, Ross, PetSmart, Linens 'N Things, Old Navy and Home Goods) continue to make substantial inroads into this market. However, the Triangle will continue to be one of the strongest retail markets in the country.

— Joaquin Canals is director of leasing and Kerry Saunders is marketing & research director with Raleigh, North Carolina-based NAI Carolantic Realty, Inc.


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