CITY HIGHLIGHT, SEPTEMBER 2006

LOUISVILLE CITY HIGHLIGHTS
Javan Montgomery, Aaron Johnson and Phil Scherer

Louisville Multifamily Market

Bolstered by a diverse local economy and increased demand for rental apartments, multifamily market conditions in Louisville are solid. Expansion in the light manufacturing and healthcare industries will stimulate the local economy and provide new jobs to area residents. The city’s largest employer, UPS Inc., recently announced a $1 billion expansion at its main air hub, which will add at least 5,000 new jobs. A few local healthcare institutions have their own expansion plans in the works. Specifically, Norton Healthcare, a system of five local hospitals and Jewish Hospital & St. Mary’s Healthcare, are expected to open new facilities in the Louisville area.

Looking at operating fundamentals, concessions are on the decline, vacancy rates continue to drop and effective rents are increasing steadily. A number of first-time homebuyers in Louisville have been pushed out of home ownership and into rentals because of rising interest rates and low single-family home affordability. The overall apartment vacancy rate at the end of the second quarter of this year plummeted 50 basis points to 8.5 percent from the first quarter. While vacancy is expected to remain stable by year’s end, Marcus & Millichap predicts that it will drop to 8.6 percent in 2007.  Apartment rents have been increasing gradually. Asking rents reached $604 a month at mid-year  and are expected to rise to $619 by year’s end. Estimates for 2007 put asking rents at $634 a month.

Demand for apartments is expected to heat up in several submarkets of Louisville. The areas ripe for new development include the northeast quadrant of Interstate 265, the Outer Loop, the Taylorsville Road area, the Summit area, Middletown and Easton. New retail property developments, such as a new Wal-Mart Supercenter and The Home Depot, are spurring the construction of residential apartment properties. In the Highland and Bardstown Road areas, older homes are being converted into businesses, while some large homes have been redeveloped into condominiums.

Following the inner city growth trends of other metropolitan areas, Louisville’s central business district also continues to boom. There is substantial urban redevelopment occurring downtown, which should not abate in 2007. However, as in other big cities, the downtown condo market will be challenging for the remainder of the year and into 2007.

Out-of-state investors will continue to dominate multifamily acquisitions in Louisville because of its attractive pricing and cap rates. Primarily, this investment capital is coming from California, New York, Florida and Chicago. Last year, 80 percent of apartment buyers were located out of Kentucky. Median sales prices have climbed significantly since last year, when they averaged $10.25 million. Real Capital Analytics expects the median sales price to reach $19.5 million by year’s end, based on properties priced at $5 million or higher. Currently, Class A properties are trading at cap rates of between 6.25 and 7 percent, which is comparable to other Southeastern cities. Meanwhile, cap rates for Class B and C properties range between 7.5 percent to 9 percent. Quality is the key, good properties in quality locations are setting new sales records.

Although operating fundamentals will remain strong in Louisville, sales velocity has slowed down compared to last year, due to a lack of quality product on the market. In addition, apartment properties are expected to remain on the market for a longer period of time than last year. Despite these concerns, investors will still take advantage of the city’s relatively low cap rates and relatively inexpensive property prices. Sellers will always be selling, and buyers will always be buying. Next year will be a strong year for Louisville’s multifamily market.

— Javan Montgomery is a multifamily investment specialist in the Louisville office of Marcus & Millichap. Aaron Johnson, a senior associate in the Louisville office of Marcus & Millichap, also contributed to this article.

Louisville Industrial Market

Louisville continues to grow in stature as a major distribution center, driven by yet another planned expansion of the UPS facilities located at Louisville International Airport. UPS recently announced a $1 billion expansion that will include as many as 4,900 new jobs. Needless to say, this announcement has fueled the activities of major industrial developers in the metropolitan area including Lauth Property Group, Main Street Realty and ProLogis.

The Louisville industrial market renewed strength during the second quarter of this year posting solid performance in both sales and leasing activity and net absorption. Sales and leasing activity of 2.21 million square feet boosted the mid-year total to 3.5 million square feet, slightly ahead of least year’s mid term total of 3.4 million square feet. More than 60 percent of the sales and leasing activity came from the warehouse/distribution sector.

Industrial net absorption, which rebounded after a slow first quarter, reached 1.57 million square feet at mid-year, well ahead of last year’s pace. Several major transactions contributed to absorption including the UPS Supply Chain Solutions purchase of an 822,500-square-foot facility at the Louisville Metro Commerce Center, a 303,000-square-foot lease to Dixie Warehouse Services at Airspace II on National Turnpike and a 165,000-square-foot lease to Best Buy Geek Squad at ProLogis Park 65 in Bullitt County.

While the overall industrial vacancy rate increased at mid-year from 7.5 percent to 8.1 percent, the increase was largely due to second quarter construction completions of 2 million square feet. Year-to-date construction completions of 2.89 million square feet have already reached record setting levels with an additional 1.88 million square feet of construction deliveries in the pipeline. The previous record for construction completions was 2.74 million square feet in 1999 for the year. Barring any interruption of market momentum as a result of a Middle East tension, the second half of this year should see additional net absorption and a corresponding decline in vacancy rates pushed higher by record construction completions during the first half of the year.

The Interstate 65 corridor, south of Louisville International Airport and the UPS Worldport continues to attract most of the warehouse/distribution activity. At mid-year, the South and Bullitt County submarkets, both located on the I-65 corridor, captured two-thirds of the 1.57 million square feet of industrial net absorption. Not surprisingly, these same two submarkets accounted for more than 75 percent of year-to-date construction completions. Major land positions, established by Lauth Property Group, ProLogis and Main Street Realty along the I-65 corridor will provide for future growth to meet the growing demand for warehouse/distribution facilities in the metropolitan area.

Adequate inventory to meet the growing demand has served to offset upward pressure on rental rates, which currently range from $3.35 to $3.44 per square foot for warehouse/distribution product. Likewise, competition with Memphis, Indianapolis and Cincinnati has kept rental rates at very attractive levels throughout the Midwest and upper South.

— Phil Scherer is president and office services advisor of Louisville-based Commercial Kentucky, Inc.

Louisville Office Market

The $380 million, 61-story mixed-use Museum Plaza in Louisville, Kentucky.

Renewed interest in the downtown, driven by plans for Museum Plaza, the new arena, and a burgeoning downtown residential condominium market, has had a positive impact on the market for downtown office space. The mid-year Class A office vacancy rate of 9.4 percent should decline even further by year’s end given the recent commitment of Atria Senior Living Group Inc. to lease 71,705 square feet in the Brown & Williamson Tower. In addition, Hilliard Lyons is scheduled to move from the Hilliard Lyons Center to PNC Plaza before year end, further reducing the Class A vacancy rate and applying upward pressure on those rental rates, which currently stand at $19. The increased activity in the Class A market has come at the expense of the Class B market as those former tenants compete for affordable Class A space. Class B vacancy rates will increase well above the current 26 percent level when Atria and Hilliard Lyons vacate more than 200,000 square feet of Class B space in the Hilliard Lyons Center by the end of the year.

Suburban office activity continues to pale in comparison with downtown. Two consecutive quarters of Class A negative absorption, coupled with 88,000 square feet of construction completions, pushed the Class A suburban vacancy rate to 15.9 percent at mid-year. The overall suburban vacancy rate stands at 17.6 percent but with more than 250,000 square feet in the construction pipeline, including Faulkner Real Estate’s 171,273-square-foot Ormsby Three office building in Hurstbourne Green, suburban vacancy rates are likely to increase during the balance of the year. With large blocks of contiguous space available at multiple suburban locations, suburban rental rates have leveled off at $17.44 for Class A space.

— Phil Scherer is president and office services advisor of Louisville-based Commercial Kentucky, Inc.

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