COVER STORY, NOVEMBER 2008

OFFICE FACES CHALLENGES
Southeast markets confront region-wide slowdown.
Jon Ross

Many forces are to blame for the current sluggish office market in the Southeast, but the downward spiral in office leasing and development has been a long time coming. Unlike the stock market losses of last month, the office market’s change has been spurred on by a slow decline in tenant demand coupled with an increased zeal for office developments. “We’ve seen the market basically slow down for the last 12 to 16 months,” says Bruce Matthai of Colliers Pinkard in Baltimore. “It’s been a very gradual slowdown.”

Thomas Fulcher of Studley’s Washington, D.C., office echoes Matthai’s experiences. Fulcher notes that the economy in Washington is still relatively sound due to the presence of the federal government, but he still sees some of the effects of the slowdown. “Brokers have the sense that there’s still a relative level of health here,” Fulcher says. “There are people who are being much more cautious in the moves that they’re making, in terms of trying to spend less money, trying to reduce the cost of build out, trying to move into spaces that may already be built out.”

In Orlando, the story is much the same. Tenants are taking their time to find exactly the right property or have simply chosen not to enter the market unless it’s absolutely necessary. “People are a little hesitant to make as quick of a decision as they would have before all hell broke loose,” says Desiree Stahley of Orlando-based Lincoln Property Company. “We would love to get deals done as fast as possible, but I think tenants are just kind of seeing what’s out there a little bit more and taking their time.”

Smaller submarkets, those in city suburbs as well as markets in rural communities, are facing rising office vacancies just like their larger neighbors. Brokers and developers in Ballantyne, North Carolina — a submarket of Charlotte — and Spartanburg, South Carolina, are feeling the crunch despite their smaller community base. “The rising unemployment and the tightening of available credit is serving to really slow down the office market,” says Howard Bissell of Bissell Companies, which concentrates on leasing and development in Ballantyne. “Unemployment was slowly rising, and you could sense that there were fewer transactions in the marketplace.” In Birmingham, Pat Walters of Daniel Corporation says that while overall occupancies are more than 90 percent, the market is as tight as he’s seen in 20 years.

In the midst of the current financial crisis and the uncertainty surrounding the collapse of large banking institutions, the office market faces many of the same pressures other commercial real estate markets have been going through. Unfortunately, brokers don’t see the office market changing any time soon. Most likely, the market will regain its luster exactly the same way it became stagnant: gradually. Jones Lang LaSalle just released its third quarter U.S. office property clock, which illustrates the relative health of office markets around the nation. All the major cities in the Southeast — from Atlanta to Charlotte to Miami — are either held hostage by a falling market or are experiencing development stagnation. In a measure of how economic troubles are affecting the entire nation, Jones Lang LaSalle rates none of the major U.S. cities as being in a rising market.

“Landlords have taken steps to prepare for what they see as potentially a long-haul situation,” Matthai says. “They’re talking to existing tenants earlier; they’re trying to tie tenants into buildings, trying to renew them.”

“The economy can turn around pretty quickly,” says Andrew Lechter, executive vice president of Studley’s Atlanta office. “This time last year, things were pretty good. That said, I don’t think things are going to change a lot in the next 12 months.”

The Bonanza Market

For tenants, there is a bright side to the current office market. A weak economy and buyer uncertainty means vacant office buildings across the Southeast need tenants, and landlords are more apt than they were 12 months ago to dole out concessions just to get tenants in the buildings. “From a tenant standpoint, the current state [of the office market] is really good,” Lechter says. “From a landlord’s state, it’s anxiety provoking.”

Towers Crescent Plaza will deliver next fall in Tysons Corner, Virginia.

In some Atlanta neighborhoods, development has outpaced tenant demand on a massive scale, taking power away from landlords. In Buckhead, four new properties — the Terminus complex under development by Cousins Properties, Tishman Speyer Properties’ Alliance Center project, Crescent Resources’ Phipps Tower and 3630 Peachtree by Pope & Land Enterprises — are all vying for the same tenant base. “They’re competing in a no-growth environment,” Lechter says.

New developments in Atlanta are also up against older properties that are hovering at a 25 to 30 percent vacancy rate. “It’s really a bonanza for tenants because you’ve got a limited number of tenants, and you’ve got what seems like an unlimited supply of space,” Lechter says. “The landlords are going to beat each other up, and the winner of that fight is going to be well-positioned tenants.” In markets across the Southeast, tenants are in the driver’s seat. “Landlords are being more aggressive with the fewer tenants who are actually in the market today,” Matthai says, “offering concessions in terms of free rent, tenant improvement dollars, lower introductory rates and lower annual escalation.”

In the smaller areas, Lechter says, business isn’t affected as much by the slowdown because there simply aren’t as many buildings in the area. “I think because the pace of development has always been faster in larger cities, the problem gets exacerbated,” he says. Andy Hayes of Spencer/Hines Properties points out that tenants aren’t being drawn to office space in his South Carolina market. “There is an excess of space available for lease and very little demand,” he says. “There does still seem to be some demand for small office space users only interested in purchasing.” Hayes also says that the office outlook in the entire Southeast is similar to what he’s seeing in his area, but that unlike other sectors of the region, things haven’t changed much since last year. “I’m sure the current economy has not helped the office market,” he says, “but our office market was in a similar state prior to the existing economic conditions.”

Bucking the trend is the Birmingham office market, where concessions to tenants are actually on the decline and rates are rising. Walters says the city’s soft market is starting to firm up, leading him to note that Birmingham is generally more healthy office-wise than the rest of the Southeast. But even with hints of stabilization, things still aren’t what they were in the past. “The interest level among prospects remains high,” Walters says, “but decision makers are in a wait-and-see mode due to the state of the economy.”

Tenant Base is Key

An office market’s tenant base is an accurate measure of how well the area can ride out the economic crisis. In Washington, D.C., the office market is relatively stable because the major tenant in town is the federal government. Secondary tenants crop up to support the government in day-to-day operations — law firms to wade through legalese and contractors to handle large government projects — so large buildings outside the city are also leased up. The Washington market, Fulcher says, is doing well because it’s not dependent on an industry, such as Detroit’s reliance on automobiles. “Washington in general is sort of an anachronism,” Fulcher says. “It would be a stronger market than what you’re going to find outside of this area.”

In the NoMa section of town, the Justice Department has signed a lease for 500,000 square feet, and National Public Radio will soon move into the area. In Tysons Corner, Va., a suburb of Washington, Quadrangle Development Corporation recently topped out its new office development. When it delivers next fall, the 295,000-square-foot 1850 Towers Crescent Plaza will offer 14,451 square feet of ground-level retail space.

Because of its proximity to Washington, the Baltimore office market benefits from a respectable employment rate of 4 percent, a stable workforce for its two major tenants, the medical services industry and the financial sector. A little more than a year ago, one of the city’s major financial space users, Legg Mason, moved into 300,000 square feet in a property built for the company, and T. Rowe Price is now lining up to take additional space in its Owing Mills Campus.

Smaller markets in South Carolina have seen office development take hold. A phased 3 million-square-foot, 310-acre office park has been proposed by Trammell Crow in Summerville, with the first phase delivering in the second quarter of next year, and Greenville recently welcomed the British company Deltex Medical Group into the area. Hayes recognizes the Spartanburg market is soft, but says that the healthcare industry is helping the sluggish office market. “Within the last 2 months, we have done tenant representation work for a number of medical-related office users,” he says. “The demand for medical office or medical-related office space continues to be steady.” In Birmingham, Daniel Corporation is also developing medical office buildings. In 2008, the company purchased the 103-acre Cahaba Center at Grandview and plans to develop office buildings in the area.

 Tenants run the gamut from law firms to government logistics companies in Orlando. To make more room for these varying industries, Lincoln Property Company has just completed a 40,000-square-foot building in Avalon Park, an affluent community in Orlando. Elsewhere in Florida, Economos Properties is developing a 71,000-square-foot office, the Griffin Corporate Center, which is expected to deliver in October 2009. The building will be part of a mixed-use development that will feature two hotels.

Office development in Charlotte is tied to financial institutions. If banks are doing well, business is good. When an economic downturn hits, and banks start to feel the pressure, the dominoes start to fall. “When the banks slow down, it has a huge effect because the banks themselves don’t need as much space. That means they’re not sending as much work to their service providers, so the law firms don’t need as much space,” Lechter says. “It’s really a vicious cycle.” The recent acquisition of Wachovia by Wells Fargo, however, seems to be the best possible option for the office market, according to Bissell. He says if CitiGroup’s proposed takeover had gone through, much of Wachovia’s office space would evaporate from the market. “The Wells deal seems like it would be a friendlier deal than the Citi transaction,” he says.

Turning Office Space Green

Now that the greening movement is in full swing, it’s difficult to find a development under construction that isn’t trying to attain an environmentally friendly LEED rating. And with office developments on the downturn, this means that an even larger number of the office projects in major markets that are getting built are going green. 

“You’re getting to the point that if someone isn’t doing that at as high a level as they can possibly get, it sounds strange. There are examples of people who are saying, ‘I won’t look at a building unless it’s some LEED rating,’” Fulcher says. “Not everyone makes that an important part of the decision, but that may actually drop a building out if it’s not there. Before, people didn’t care.”

But the trend has been slower to take hold in the smaller markets. In Orlando, green is happening, but a little more hesitancy. “It’s a lot slower here than I think it would be,” Stahley says. “You are seeing more people starting to add in the green components because a lot of tenants are asking for that.” Taking into account the advances in building materials, Stahley thinks that many of the buildings are going to eventually attain some sort of LEED rating regardless of whether they’ve been built with that in mind. She says that code will start being more green. Bissell chalks the green divide he sees in Ballantyne up to regional versus national tenants. His company is developing 800,000 square feet of space in the market, all with an eye for Gold LEED certification. “Many of the larger tenants — there’s more interest there than with other tenants,” he says. “There’s probably more pressure from the larger national corporations, but we’re starting to see more regional tenants show an interest in it as well.”

Through it all, Stahley maintains a sense of optimism that her colleagues echo in measured tones. By marketing her company in new publications and getting out the word about new projects, she’s helping to fight the economic downturn. While she can’t make tenants move into buildings, she does have hope for the long term.

“People aren’t going to get any faster at making decisions, but I don’t think it’s going to get any worse,” she says. “It’s just going to hold here for a little while.”

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