Commercial Investment Real Estate

MAR-APR 2016

Commercial Investment Real Estate is the magazine of the CCIM Institute, the leading provider of commercial real estate education. CIRE covers market trends, current developments, and business strategies within the commercial real estate field.

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29 March | April | 2016 CCIM.com DEVELOPMENT PIPELINE SLOW TO FILL by Beth Mattson-Teig Given the pace of the offi ce market recovery, it is no surprise that new ground-up development has been slow to return. Although construction is on the rise, it is still low compared to historical norms. The estimated 68.9 million square feet of new space added in 2015 is up from the 44.0 msf delivered in 2014, according to CoStar. However, activity is below pre- recession levels where annual new supply surpassed 100 msf. In 2005 and 2006, for example, the net new supply grew by 100.1 and 117.4 msf respectively. New construction remains lower for obvious reasons. Many metros are still dealing with elevated vacancies and tenants who are reluctant to pay the higher rents needed to support new con- struction. In addition, tenants are using space more effi ciently and shrinking the amount of space they need per employee. "A lot of corporations have looked very hard at their space usage and have tried to decrease the number of square feet per worker," says Hans Nordby, a managing director at CoStar Group in Boston. Although that trend may be starting to fl atten in some metros, it has had an impact on the demand for space, he adds. "The markets that saw construction fi rst were those that had the most successful economies," Nordby says. Four to fi ve years ago, those cities that took the lead in emerging from the recession were energy and tech markets such as Houston and Seattle. Development remains a ways off in the future for many metros, while others are seeing that turning point drawing closer. In Fresno, Calif., for example, lease rates have not reached levels that justify spec offi ce building. However, the vacancy is dropping to the low single digits and lease rates are starting to climb, says Brett Visintainer, CCIM, a vice president, investment division at Newmark Grubb Pearson Commercial in Fresno, Calif. "It will only be a matter of time before Fresno starts seeing new development go up from developers that are looking to spec offi ce buildings," he says. "I would expect to see some dirt moving late 2016 and early 2017 based on current market conditions." CoStar is forecasting a gradual expansion of construction activity. In fact, 2016's new supply is likely to be slightly below that of 2015 with the market expected to add 64.9 msf fol- lowed by 79.7 msf in 2017. "That is a good picture of what is happening nationally, but there are dramatic differences in what is happening in individ- ual metros," Nordby says. For example, San Jose, Calif., is "on fi re" because the local economy is very hot. The job growth and the local economic growth occurring at the local level is a good leading indicator of what lies ahead for both new ground- up construction, as well as opportunities to rehab existing buildings, he adds. house more people in their space. Landlords in the Midtown area are responding to that new competition by investing heav- ily in their buildings, Evans says. "It is a very robust market. T e key thing when you are buying a f xer-upper in this market is to understand the functional obsolescence that can and can- not be cured," he says. For exam- ple, New York City has specif c requirements on life safety issues, which controls maximum occupancy on f oors based on the size of stairwells and amount of people they can safely evacu- ate in the event of an emergency situation. Even if a landlord suc- cessfully completes a renovation to create more ef cient space, the property could be hindered by existing building codes, he says. Fighting for Talent Today's younger employees are attracted to work spaces that offer features such as shower facilities for employees who bike to work, outdoor terraces, and common area lounges. And given the war for talent among companies, "Landlords are investing in those somewhat expensive amenities to draw and retain tenants," Evans says. "If they don't do it, they will not be able to attract the quality of tenants that have anchored the buildings for the last 50 years. Those tenants will move to other locations," he says. T e of ce market in Peoria, Ill., is a far cry from that of New York City. Peoria's downtown is still struggling with signif - cant office vacancies near 25 percent, compared to Manhat- tan's rebound where vacancy has dropped below 9 percent. Yet Peoria's building owners are facing many of the same chal- lenges of trying to attract and retain tenants in a market where there has been a seismic shif in the type of space that appeals to today's millennial workers. Particularly for buildings where asking rents are very close, within 2 to 5 percent, the look and feel of a property can swing decisions, says Katie Kim, CCIM, CEO and director of the commercial division at Keller Williams/The Kim Group in Peoria. "With our vacancy the way it is, companies going into these spaces are demanding that landlords do those renovations in order to get their business," says Kim. Today's tenants are feeling the pressure to attract workers. "T ey need their space to say we are an exciting company. We're inviting. Come work for us. And they are putting a lot of that back on the landlord," Kim says. For example, one tech start-up com- pany that Kim recently worked with requested a slide between the second and f rst f oor. T e landlord complied. Overcoming Challenges As in many metros, Peoria's landlords need to manage the cost of renovation versus cur- rent rental rates. "T ere is a gap with what the current rental market will bear, and the cost of construction does not allow for great returns for a lot of our of ce tenants," Kim says. However, as part of its ef orts to entice companies back down- town, the city of Peoria is of er- ing a number of economic incen- tives to promote development and redevelopment in targeted areas such as its River's Edge District. Owners and develop- ers can access federal and state historic tax credits and other tax credits specif c to the River's Edge Redevelopment Zone that

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