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Saturday, February 04, 2012
Feature: February 2009
Vacant, Flat and Crowded
A forecast of the commercial real estate market
Story by Adam Weintraub
The vacancy rate isn’t the only important number for anyone trying to get a handle on what’s happening in the commercial real estate market across the Capital Region. Just as important in 2009 — and into 2010 — is the unemployment rate.
“Office space is driven by jobs, and when jobs are being created any office market is thriving,” says John Frisch, managing partner at Cornish & Carey Commercial and a specialist in local office properties. “We’ve got job losses, and people need less space.”
Similar effects with different details are being felt in the markets for retail and industrial space. Bankruptcy filings and liquidations by Mervyns, Linens ‘n Things and other retailers that anchor local centers have created turmoil and opportunity. Things are a little less drama-fraught in the immediate Sacramento market for industrial leasing, largely because space has been tight for years, but now money is tight and rents could fall.
The latest forecasts suggest the economic softness that’s cutting demand will get worse before it gets better with no turnaround expected before late 2009. Economic reports recently released by UCLA and the University of the Pacific project the jobless rate — at 8.1 percent in the Sacramento metro and 8.4 percent statewide in November — will rise to 9 percent or higher statewide before things start to improve.
“I have tours lined up every week, but they’re looking at less space.”
— Jon Walker, senior vice president and office specialist, Grubb & Ellis Co.
That’s not to say the market is at a standstill. A certain number of tenants are always looking for space because their leases are due to expire; data from a national analyst covering much of the Capital Region shows close to 13 percent of office leases and 10 percent to 14 percent of industrial leases (depending on the type of space) are scheduled to end in 2009.
But market conditions have changed the way tenants and landlords are approaching those deals, from the amount of space needed to the rental rate to the length and other terms of the lease. Space available for sublease makes things even more complex.
“I have tours lined up every week, but they’re looking at less space,” says Jon Walker, a senior vice president and office specialist at Grubb & Ellis Co. “I’m happy grabbing a sublease or two years.”
“I’m running all over the place,” says John Fondale, a senior vice president specializing in industrial space for Cornish & Carey, “but it’s for one-year leases instead of five-year deals.”
Things in the Capital Region got wobbly for commercial real estate earlier than they did across the rest of the United States, just as in the residential market. The collapse of the housing boom hit homebuilders and rippled to financial companies that served the housing market, retailers that sold furniture or other goods to recent home buyers and other related businesses.
“It’s not uncommon to see deals in some well-anchored centers below $2.”
— Rick Martinez, senior vice president and retail specialist,
CB Richard Ellis Co.
“If you go out to a market like Gold River, you’ll drive around and see these empty buildings and you can point to the vacant floors and say ‘homebuilder, mortgage company, title company,’” says Jim Niethammer, managing principal in Sacramento for CresaPartners, which represents tenants in lease deals. “We’re a year ahead of everybody else.”
The credit crunch and turmoil in the financial markets made things worse. So did the long state budget stalemate, which choked off the flow of government dollars to many local businesses and workers, and roared back with new and bigger threats almost before the ink was dry on the months-late budget bill signed in September; without a fix, some estimate the state will be out of cash in February.
Yet the state is also contributing some stability to the Sacramento office market, brokers say. “The state still has (space) requirements, and some of those have been approved,” says Greg Levi, a senior vice president with CB Richard Ellis Co. Some agencies will consolidate from separate spaces downtown to a single, more efficient space, while others may look to nearby markets, such as the California Highway Patrol lease signed in June for 285,000 square feet in three buildings on North Seventh Street near Richards Boulevard.
Frisch also notes the recently signed California Department of Industrial Relations lease for about 38,000 square feet, roughly one-third of the space in an Opus West building at the developer’s Natomas Gateway Corporate Center. While dwarfed by other state leases, Frisch says, the move could open the North Natomas market to more state leasing.
The arrival of two major new Class A office buildings on Capitol Mall will also continue to reverberate through the downtown Sacramento market in 2009. U.S. Bank Tower at 621 Capitol Mall has already opened and lured law firm Downey Brand LLP from 555 Capitol. This summer will see another major firm, McDonough Holland & Allen PC, leave 555 for the new Bank of the West Tower being built at 500 Capitol.
“There’s going to be a lot of musical chairs and cannibalizing,” Frisch says. “People are going to be stealing tenants from each other for several years on Capitol Mall.”
And that’s in one of the brighter spots for the local office market. Office vacancies in downtown and midtown Sacramento were around 12 percent in the third quarter, according to Grubb & Ellis.
It was about the same in the Highway 50 corridor, where Frisch says there’s been more interest in spaces of at least 25,000 square feet than in smaller offices.
But things get brutal in outlying markets, where some of the office space was built recently and either didn’t lease or leased to companies that relied on home sales. Office vacancies in Folsom were at 16 percent, according to Grubb & Ellis; in North Natomas it stood at 18 percent, in El Dorado Hills and Roseville at 25 percent and in Rocklin, a staggering 40 percent.
“That’s biblical,” Frisch says. “You drive out (Highway) 65 and you can see the mountains right through those buildings. … Until they can create some jobs, you’re not going to chip away at that.”
Other market data showed office vacancy rates ranging from about 16 to 17 percent in Fairfield/Suisun City and Vacaville/Dixon, to nearly 24 percent in Benicia and Vallejo.
“The name of the game for ’09 is maintaining occupancy.”
— Mark Demetre, senior vice president and industrial specialist,
Colliers International
That has landlords getting creative. “They’re saying ‘Hey, we may be in this (market) for three years. Let’s get somebody in here and make it up on the back end,’” Walker says.
One of his clients had a 285,000-square-foot property on East Roseville Parkway that was running 26 percent vacant. The landlord slashed the rate from $2.10 a square foot to $1.49, a deep cut that drew interest.
The flip side of such moves is that landlords are unlikely to lock them in at such low prices for the long term. Expect that $1.49 to rise over the course of a five-year lease.
Niethammer of CresaPartners says landlords had been acting like homebuilders did at the start of the downturn and refusing to lower their advertised prices, but sweetening the deal in other ways. Where homebuilders threw in granite countertops, landlords offered months of free rent or extra cash for tenant improvements.
But eventually the prices fell. “We’re finally seeing the big landlords like Hines starting to lower their rates,” Niethammer says. “If there’s someone out there with a heartbeat, people are going to take a shot.”
Niethammer says the state of the financial markets makes it important for tenants to vet their landlords, and in some cases get the landlord’s lender to sign off on lease terms. “You want to get it in writing,” he says. “If you don’t, it may evaporate” if the landlord gets in financial trouble and files bankruptcy.
Things are even more complicated in retail: Location is a vital concern to tenants, and tenant mix is important to landlords. Some failing retailers are in prime locations, but some potential replacement tenants with deep pockets are playing a waiting game to see just how low rents will go, says Rick Martinez, a senior vice president at CB Richard Ellis who specializes in retail.
“Even if they would get a good deal by today’s standard, they’re holding back” and expecting that rents will sink lower, Martinez says.
“People are going to be stealing tenants from each other for
several years
on Capitol Mall.”
— John Frisch, managing partner and office specialist, Cornish & Carey Commercial
They’re already low by comparison with the boom years. Space in Roseville that was going for $3 a square foot is down to $2, Martinez says. “It’s not uncommon to see deals in some well-anchored centers below $2.”
The deals can be tenant-by-tenant or space-by-space, though. Martinez mentioned a tenant improvement allowance of $100 a square foot that’s available to certain tenants in the Blue Oaks Town Center, a project he represents in Rocklin that’s been hammered by bankruptcies and liquidation sales at several anchor stores. The space is for a restaurant and up to 3,500 square feet, making the perk worth as much as $350,000 for restaurants or other “food users that are going to drive traffic.”
Martinez expects centers in well-established neighborhoods to hold value and notes bright spots in Folsom, which has affluent demographics and among the lowest vacancy rates in the region, and Roseville, where the Westfield Galleria is expanding and The Fountains showed good results as the first lifestyle center in the area. Lifestyle “seems to be the right product right now,” Martinez says.
General Growth Properties Inc. is pushing forward with leasing the Palladio at Broadstone lifestyle center in Folsom, scheduled to open in 2009, even while the financially shaky retail giant has pushed back plans for the regional mall it plans to develop on the Lent Ranch site on the south edge of Elk Grove.
The industrial market is faring better than other commercial property, but demand is down. “The good thing about industrial is that we’re not horribly overbuilt, says Fondale. “While things are soft, we haven’t seen people losing properties” to foreclosure, although some space has opened up as tenants shrink or close.
Rents are declining, and will probably keep doing so until around March, says Mark Demetre, a senior vice president and industrial specialist with Colliers International. After that, rates will likely flatten until early 2010, he says, “at that time we expect to see a spike in rents” because demand will pick up and rents haven’t kept up with the cost of construction.
The industrial market, Demetre says, is like a freight train, slow to change its speed. “We’re still in the stage where the brakes are being applied.”
While every sector of the warehouse and industrial flex market was busy two years ago, in the Sacramento area all the action now is in spaces of 50,000 square feet or more, mostly as tenants consolidate or expand. “The name of the game for ’09 is maintaining occupancy,” he says.
Fondale says things are a little different south of Sacramento. In Stockton, Tracy, Patterson and nearby there are millions of square feet of vacant distribution space, built without a tenant signed, that have been completed in the past six to nine months. That area, with easy access to the Bay Area and north-south highways, has become a go-to destination for big-box customers, he says.
Sacramento, West Sacramento and Woodland were once the natural home for such projects, Fondale says, but the shortage of large parcels and flood concerns about Woodland shifted attention south.
“What really killed things is when Woodland was put in the floodplain,” he says. “That is a big, big deal for corporate America.”
San Joaquin commercial property update
Office vacancies inched up in the third quarter, reaching 18 percent in San Joaquin County, according to the Central Valley office of Colliers International. Similar to Sacramento metro markets, construction is down and government remains the largest contender for big deals. As such, the market will see stable to slightly positive absorption in 2009, says Wendy Coddington, senior vice president at Colliers.
“People in Class B or C space will be looking to move up because of the deals,” she says. Class A office space was the highest in Tracy at $1.82 per square foot and the lowest in Ripon, where only subleases were available, at $1.50 a square foot.
More than 191,400 square feet of Class A offices were under construction in San Joaquin, most of which is in the 160,000-square-foot Blue Shield of California campus in Lodi that’s now occupied. “Medical will stay resilient,” Coddington says.
Industrial vacancies were down 1.2 percent, hitting 10.6 percent in the third quarter, according to Colliers. Tenants signed several large deals, including Sears Roebuck and Co.’s 780,371-square-foot deal in Stockton. Large facilities are asking 32 to 35 cents per square foot on a triple net lease, and that’s for Class A warehouse, says Michael Goldstein, Colliers managing partner.
About 1.3 million square feet of industrial space wrapped up construction, and there were no construction starts. This trend was expected to continue for the rest of 2008 as several build-to-suit sites were under construction, including new buildings for Crate & Barrel and Home Depot, totaling 1.88 million square feet.
Moving into 2009, tenants with strong credit will have a problem getting financing, says Goldstein, adding that only special-purpose facilities will see build-to-suit space. “Nothing that needs a cookie-cutter program.”
Goldstein is still getting requests from potential tenants in retail distribution, but that could change after companies report fourth quarter numbers. “We see a lot of deals Sacramento doesn’t see because of the size of the facilities that we have,” he says.
— Stephanie Flores
