Several factors impacted Richmond, Virginia, during the last half of 2001. The events of September 11, economic worries and the collapse of Enron contributed to a lackluster finish for the year. 2002 is shaping up to be much like the last 3 years with low sales volume, few quality offerings and a persistent gulf between bid and ask prices. Primary activity is still coming from 1031 exchange individuals, with some advisors and real estate investment trusts (REITs) beginning to look at select opportunities.

Office

The weak economy has continued to take its toll on Richmond's office market. In the first quarter, the overall vacancy rate rose to 14.2 percent and absorption was negative in the primary suburban submarkets. Conversely, the central business district showed both improved vacancy and positive absorption compared to the previous quarter.

As expected, no new speculative product has been delivered in 2002, and none is imminent as institutional developers such as Highwoods Properties and Liberty Property Trust wait for existing inventory to be absorbed and occupancies to rise to levels that justify new development. There was substantial owner-built delivery in the first half of the year as Capital One completed and occupied the first two 160,000-square-foot buildings of its planned 1.5 million-square-foot campus on 318 acres in West Creek Business Park.

Following Alcoa's acquisition of Reynolds Metals Company in 2000, three existing buildings totaling over 500,000 square feet were added to the speculative inventory when they were sold by Alcoa in December 2001 and March 2002. Alcoa will continue to lease some space from the new owners.

There were fewer large blocks of sublease space at the end of the first quarter, but that category continued to be significant. One-third of the large blocks over 15,000 square feet were subleases. This trend is declining and should plateau by the fourth quarter.

Quoted rental rates have remained relatively unchanged since 2001; however, effective rates on recently completed leases are 5 to 10 percent lower in some cases. Time remains for tenants to take advantage of lower rates and significant concessions, but the window of opportunity may be limited, as rates are expected to rebound within 12 to 18 months as the market firms.

Office condo development has increased in recent months to take advantage of an increased demand for small office buildings. This product is experiencing notable demand as small office users find it more economically desirable to own than lease.

Retail

While retail construction has diminished due to the slowing economy and apparent near saturation of power centers, bankruptcies and closures raised the first quarter overall vacancy to 8.3 percent. Service Merchandise closed two area stores shortly after the first of the year as part of the chain's liquidation. As a result of Kmart's bankruptcy, two area stores are closing: the locations on Jefferson Davis Highway and at Ivymont Square on Midlothian Turnpike.

The Service Merchandise spaces are in good locations and have been subdivided and partially re-leased. Less desirable big box locations, however, have proved challenging to re-lease or sell. For instance, two former Home Quarters locations have been empty for almost 3 years. Others have eventually found new uses such as the former Jumbo Sports, on Midlothian Turnpike, that was sold to a car dealer. Recent sales of freestanding retail buildings include the 55,500-square-foot former Homeplace store at Brookhollow Center in Short Pump to Kroger and the 35,000-square-foot former Sears Home Life store on West Broad Street, which was purchased by Havertys Furniture.

The "poker game" has continued between the rival developers of two proposed regional malls -- Stony Point Fashion Park by Taubman Centers of Bloomfield Hills, Michigan, and Short Pump Town Center by Cleveland-based Forest City Enterprises and local developer Thomas E. Pruitt. Stony Point moved a step closer with a spring groundbreaking for its 690,000-square-foot open-air center to be anchored by Saks Fifth Avenue and Dillard's; the opening is planned for late September 2003.

BJ's Wholesale Club, a new retailer in the market, recently purchased a 15.8-acre site at Hanover Square South in Mechanicsville with plans to build a 108,000-square-foot store. Another newcomer, Cost Plus World Market, expects to open an 18,000-square-foot store on West Broad Street in the Short Pump area in early 2003.

Kroger is in an expansion mode for 2002 and beyond, as evidenced by the recent opening of a new 54,000-square-foot store, including its first "fuel center" in the market, at Creighton Crossing on Route 360 in Mechanicsville. The company plans to open three additional stores in the next year. Staples is also growing with three additional stores to be opened before the end of the year, two of which are in second-generation space in existing centers.

The better-than-expected first quarter retail sales posted by major retailers is a positive sign for the remainder of 2002. Other retailers may now be able to move forward with expansion plans, and there are numerous existing spaces available in good locations to meet those expansion needs.

Industrial

The best news for the industrial market was positive absorption that helped vacancy peak during the first quarter of 2002. However, demand remained generally soft with scarce signs of improvement on the immediate horizon. The number of large manufacturing buildings for sale continues to grow, as prices have not yet dropped enough to generate interest. Leasing improved but is still sluggish as larger companies continue to keep a tight reign on inventories. On the positive side, there is significant demand for smaller buildings for sale in the 10,000- to 40,000-square-foot range.

First quarter activity included logistics company U.S. Merchants' acquisition of 120,000 square feet at Southpoint in the Tri-Cities area, United Power/Danaher's 72,000-square-foot flex/light manufacturing lease at Eastport near Richmond airport and the beginning of Alfa Laval's 85,000-square-foot expansion, also near the airport. Sale prices generally range from $15 to $50 per square foot, while asking lease rates average $3.77 per square foot, triple net for warehouse/distribution and $8.36 per square foot, triple net for R&D/flex.

Leasing activity has been up in the first half of the year, as reported by Porter Realty Company. Richard Porter notes two of the company's significant transactions: Wella Manufacturing leased 317,000 square feet at Fairgrounds Distribution Center, and Cyberex LLC signed a lease for a 72,400-square-foot distribution warehouse complex in Eastport near the Richmond International Airport.

Development opportunities exist for high bay distribution in the Tri-Cities area and eastern Henrico County near the airport, and for flex product in the Interstate 295/Parham and Interstate 95 North submarkets.

"Porter Realty is running with several significant build-to-suit industrial projects which, with some good fortune, should materialize very soon," says Porter. "The build-to-suit option has become more common for larger requirements as users desire to get the maximum value from a design/build-to-suit while locating in low-cost tax localities."

Opportunities are also available for development or sale/lease-backs on smaller buildings catering to investors' tax-deferred exchanges or to user/ occupants. Challenges include the reduced number of companies looking to grow in or relocate to the area as well as regional competition for projects generating new jobs and investment. With continued pressure on local manufacturers, the most likely prospect for overall growth is in the distribution sector.

Multifamily

The multifamily market in Richmond is alive and well. In the past 18 months, developers have either started construction or closed on land for construction of over 2,554 market rate units and over 500 low-income housing tax-credit units. Additionally, there is a 240-unit project site up for rezoning, and another 300-unit project site is in the approval pipeline. If all of these projects are completed, Richmond will have more than 3,500 new units coming on line in the next 18 to 24 months.

This represents an aggressive amount of building for an area historically absorbing about 1,000 units annually. But most of the new multifamily projects should be able to perform, and some will flourish depending on location, if

w Capital One is able to achieve its projections of 5,000 new jobs in the next 3 years

w Route 288 is completed on time (connecting western Chesterfield County across the James River to Interstate 64 in western Henrico County)

w at least one of the two proposed regional malls is constructed and successful.

On the other hand, if Richmond hits another economic bump in the road and employment numbers suffer, some, if not all, of the newer AA projects will feel the economic pinch and be forced to offer concessions in order to survive.

Investment

The multifamily market was sizzling hot in 2001, as this sector set an annual volume record of $199.8 million with most of those sales occurring in the second half of the year. In a complete reversal of the last decade, the REITs and institutional players were, for the most part, selling to local individuals and families.

Retail had a good year with a major boost in the first half from First Washington's portfolio sale to CalPers. Total volume for the year was $145.6 million.

It was an off year for both the office and industrial sectors, with office finishing the year at a 7-year low of $47.9 million and industrial posting the second lowest showing since 1995 at $58.5 million.

With heightened concern about the upward direction of long-term rates, continued weakness in stock market returns and a gradual economic recovery gaining strength, Richmond should see increasing activity by the last half of 2002.

The following Grubb & Ellis | Harrison & Bates associates contributed to this article: John C. Gentry, senior vice president - office group; David M. Williams, SIOR, CCIM, senior vice president - industrial group; Brian Glass, vice president - retail group; Sam R. Worley, vice president - multi- housing group; and Michael W. Lowry, senior vice president - investor services group.


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