Mixed feelings

The past, present and future of Atlanta's real estate market can be summed up in two words: job growth. Atlanta has enjoyed unequaled job growth during the past decade, averaging about 90,000 new jobs annually, according to Urban Land Institute Chairman Ron Terwilliger, who is also CEO of Atlanta-based Trammell Crow Residential.

The benefits of robust job growth were obvious. It created demand for office space, manufacturing and distribution space, as well as apartments and condominiums.

The impact was never as strong as it was last year, when the real estate market reaped the benefits of the 113,000 new jobs created in 1999. The office market set a record for annual net absorption with nearly 7 million sq. ft. The industrial market also posted great stats, with a net absorption of almost 13.9 million sq. ft. Apartment occupancy and rental rates rose or held steady.

“Throughout the latter half of the 1990s and through year-end 2000, Atlanta was arguably the best commercial real estate market in the country,” said Sam Holmes, executive managing director in the Atlanta office of New York-based Insignia/ESG. “We had the nation's best job growth and record-breaking absorption while maintaining a great balance between supply and demand.

“As we move further into 2001, things are definitely cooling, but the reality is we're returning to a more sustainable level of growth — we couldn't keep that pace going forever and everyone knew it,” Holmes continued. “The surprise is how fast the slowdown is occurring.”

So what happens this year, with the country teetering on a recession and with the dot-com and technology firms that propelled Atlanta's real estate market shrinking or dying?

For starters, Atlanta's job growth will suffer, according to statistics provided by Georgia State University. It predicts the metro area's job growth this year will fall to 27,100 from 77,500 in 2000. That's a 65% decrease, and one that's bound to impact the real estate market.

The segment that will be most affected is Atlanta's office market, which has continued to befuddle Wall Street analysts with its strong performance during the past five years. This year, however, absorption could fall by as much as 50%, according to developers, brokers and lenders.

The Midtown and North Fulton submarkets, which attracted large numbers of high-tech and dot-com firms, will be most susceptible as companies downsize, file for bankruptcy and go out of business. In contrast, Buckhead, where obtaining a sewer permit for a new office tower nearly is impossible, is the strongest office submarket in Atlanta, according to brokers and developers.

“2001 will clearly not approach the record absorption we enjoyed in 2000,” said Clark Gore, executive vice president of locally based Holder Properties. “Part of the decline will be driven by a ‘retreat’ of the 2000 numbers, as a result of space leased in 2000 being vacated in 2001 by failed and down-sizing companies, and part of the decline will be driven by a real reduction in demand as a byproduct of a slowing economy.”

Gore said he expects the economy to rebound in the second half of 2001. He leads the marketing of Millennium in Midtown, a 13-story, 400,000 sq. ft. office building under construction at 10th and West Peachtree streets. Originally the building targeted high-tech companies, but Holder and building owner Chicago-based RREEF Funds now also are focusing on professional-services firms.

Holder is competing for tenants with the Proscenium, a 24-story, 527,000 sq. ft. tower at Peachtree and 14th streets in Midtown, and Atlantic Center Plaza, a 23-story, 500,000 sq. ft. tower at 14th and West Peachtree. The Proscenium, developed by Dallas-based Trammell Crow Co. and Huntsville, Ala.-based Triad Properties, was scheduled to open April 19, with 55% of its space leased. Atlantic Center Plaza, which will open in October, is 53% preleased, according to locally based developer Pope & Land Enterprises.

2001 started with a nice upswing in prospect activity at Millennium in Midtown, Gore said. “If the prognosticators are correct and the economy begins to retrench and trend back upward during the latter part of the year, we could recover momentum quickly and see an absorption figure that would probably be best described as average, around 3.5 million to 4 million sq. ft.,” he said.

At New York-based CSFB Realty, local Managing Director Steve Morgan projects net absorption to be 3 million to 4 million sq. ft.

“The overall health of the Atlanta office market is good, although absorption this year will clearly be affected by a slowdown in the overall economy,” Morgan said. “The downturn in the stock market and the technology sector will have an impact on the market as a whole, in terms of capitalization and the potential for companies to grow. We have seen some technology companies putting sublease space on the market, but rather than weakening the entire market, these spaces will mainly provide a discounted rent opportunity for tenants who can fit into them,” Morgan added.

It's too early in the year to project where Atlanta's office market will be at the end of the year, said Ken Ashley, a broker at Cushman & Wakefield of Georgia.

“The level of activity can change dramatically in a short period of time,” Ashley said. “The market seems to be catching its breath at this point. It is worth noting that Atlanta's economy is stronger and more diversified than many and will handle this period of slowness better than most. Additionally, lender restraints and requirements for preleasing should have a significant impact on numbers of new building starts marketwide.”

Ashley, who for the past couple of years has specialized in representing start-up and dot-com firms, said the space that high-tech companies abandon will impact the office market “more than we originally thought.”

“The most visible impact has been on the availability of the subleases themselves, which have served to compete in some measure against direct space,” he said. “Also, in certain markets, as a result of these subleases there is now more pressure on the rates, for example, in Midtown and Alpharetta.”

Holmes agreed that the subleases, along with the economy, will have the biggest impact this year on Atlanta's office market.

“Obviously, the slowing economy and uncertainty as to when things will pick back up are affecting Atlanta and every other city,” he said. “This is compounded by the amount of space in the construction pipeline and the increasing levels of space returned to the market in the form of sublease space by both traditional companies and the formerly high-flying dot-coms.

“This ‘phantom development’ that occurs as space is added to the market in the form of subleases will dramatically impact vacancy rates and, therefore, lease rates,” Holmes continued. “I believe there is an opportunity for entrepreneurial landlords to be creative in procuring or retaining users now. If history proves correct from the last slowdown in the early '90s, many institutional and public-sector landlords will have a six-month reality lag between 2001 projections and current conditions. Buildings that appear near 100% leased with no near-term lease rollover will probably have substantial sublease space that will need to be addressed.”

Holmes also said, “It's important to note that it's not just the dot-coms that are subleasing space. Many traditional economy companies such as Coke, Prudential, BellSouth and others are putting space back on the market as they consolidate operations or downsize.”

The slowing economy, which will lead to fewer new jobs being created, also has large users concerned. As a result, they're delaying decisions about whether to expand their work forces and increase their space needs.

“The biggest factor we've seen is so-called ‘decision delay’ in which larger companies with potentially bigger requirements are waiting to see how the next 60 to 90 days unfold,” Cushman & Wakefield's Ashley said. “However, the dates don't change either. By that, I mean that there are lease expirations pending and that people will either have to decide to renew or eventually to pursue that new requirement.

“At least temporarily, this decision delay has resulted in a slowing of absorption and more options for tenants who are in the market at this time,” Ashley concluded.

Mixed reviews for industrial as well

“As we move further into 2001, things are definitely cooling, but the reality is we're returning to a more sustainable level of growth — we couldn't keep that pace going forever and everyone knew it.”
— Sam Holmes Insignia/ESG

The outlook for Atlanta's industrial market is similar to the office outlook. Atlanta is seeing some benefit from the consolidation craze, as large companies shut down smaller warehouse and distribution facilities in second- and third-tier cities and group them at monster operations in metro Atlanta. On Atlanta's Southside, developers are chasing several 500,000 sq. ft.-plus bulk warehouse and distribution deals with companies such as Battle Creek, Mich.-based Kellogg Co. In mid-April, Kellogg reportedly was on the verge of leasing a 900,000 sq. ft. Southside distribution center from Los Angeles-based Majestic Realty Co.

Still, John Decker, a partner at locally based Childress Klein Properties, said decreased job growth, waning consumer confidence and postponement of corporate spending will impact Atlanta's 350 million sq. ft. industrial market.

“As we speak, I think the health of Atlanta industrial is OK,” Decker said. “Nobody sees any good news on the horizon and nobody is forecasting a repeat of 2000, but I don't hear anyone expressing a concern about their level of unleased inventory or projecting a substantial rise in vacancy rates. Generally, I don't see 2001 being much fun.”

The most optimistic predictions that Decker has come across for Atlanta forecast that the area will create 45,000 new jobs this year. “In other words, 2001 will be a happy medium between 1992 and 1999,” he said. “It's pretty hard to get excited.”

Although the first quarter was good at locally based M.D. Hodges Enterprises, where vacancy rates for the company's portfolio fell for the first time in several years, President and CEO Jeff Small said the surge in demand might be temporary.

“Slower than expected retail sales the past two quarters have caused a backlog of inventory that is taking up space in warehouses today,” he said. “On the other hand, factory production across the country is declining significantly due to the slowdown in the economy. The third and fourth quarters of 2001, therefore, will see declining industrial demand and rising vacancy rates.”

Small said the overall economy will have the largest impact on the industrial market.

“The market seems to be catching its breath at this point. It is worth noting that Atlanta's economy is stronger and more diversified than many and will handle this period of slowness better than most.”
— Ken Ashley Cushman & Wakefield

“Industrial demand is directly correlated with [gross domestic product] growth but with a lag time built in. As growth continues to fall, so will industrial demand,” he said. “Relating to the economy, my biggest concerns are the stock market and energy prices. The sinking stock market is rapidly eroding the ‘wealth effect’ that drove consumers to spend over the past several years, prolonging this historic period of growth.

“We are already seeing the effects in reduced retail spending with consumers becoming more conservative,” Small continued. “OPEC continues to talk about cutting oil production, which would increase energy prices yet again. Increasing energy prices not only make it more expensive for many businesses to operate, but it also increases inflationary pressures, making it more difficult for the Federal Reserve to cut interest rates significantly.”

The dot-com shakeout also is affecting the industrial market. In March, Amazon.com closed its 800,000 sq. ft. distribution center in Henry County, where it had about nine years remaining on a 10-year lease. Amazon hired locally based Colliers Cauble & Co. to lease the building, which is owned by First Industrial Realty Trust of Chicago. The large building adds inventory to the already healthy amount of new space under construction in South Atlanta.

Still, no specific industrial submarket appears to be in trouble this year, said Decker of Childress Klein.

“Historic patterns of tenant demand will continue through this slow period, only at lower levels,” he said. “South Atlanta and the Northeast will continue to be strong. The North Central and Fulton Industrial submarkets will continue to lag due to continuing tenant demand trends. The key will be developers' ability to respond by controlling production at appropriate levels.”

South Atlanta led the area in net absorption, with 4.5 million sq. ft., according to Bethesda, Md.-based CoStar Group. Northeast was second with 4.1 million sq. ft. Both submarkets listed more than 3.5 million sq. ft. of new industrial space under construction at year end, according to CoStar.

Southeast Investment Properties, an Alpharetta, Ga.-based industrial developer, remains bullish on both markets, President Steven C. Smith said.

“The airport area will continue to be in demand, especially with the start of construction of the fifth runway,” he said. “There also will be demand for South Atlanta (Henry County) as it offers access to I-75, the major distribution corridor of Florida. The Northeast submarket will continue to grow farther out I-85 and I-985 to accommodate demand. The Gwinnett/I-85 corridor is the dominant distribution route to the Carolinas and beyond,” according to Smith.

Smith's company has successfully filled two large distribution buildings near Hartsfield Atlanta International Airport and is developing another in the I-85 submarket. He believes Atlanta's industrial market is “very healthy.” The overall vacancy rate for metro Atlanta, he points out, was 8.2% at year end. The industrial market should remain sound this year, he said.

“Atlanta will continue to benefit from the national trend of consolidating smaller distribution facilities into larger, more strategically located buildings,” Smith said. “A major challenge we face as developers is locating reasonably priced sites that are near the desired distribution corridors to facilitate construction.”

Softening apartment market

Multifamily developers tend to base much of their future plans on job-growth projections. The sudden drop-off predicted for Atlanta likely will apply downward pressure on occupancy rates.

“The apartment market is currently balanced in terms of supply and demand. However, a slowdown in job growth could create excess supply,” agreed Ed Geraghty, president of the Eastern Division of Chicago-based Equity Residential Properties Trust. “Job growth has fueled demand and kept the market stable despite a strong pace of development. Job growth is currently projected at 25,000 to 75,000. That's a large range, so, clearly, there is a lot of uncertainty.”

Still, several major multifamily developments were announced in the first quarter. In Midtown, a partnership between Marietta, Ga.-based Wood Partners and Atlanta-based Novare Group plans to start construction this month on 933 Peachtree. The project will feature 498 apartments and condominiums in two, 21-story towers with retail space. Atlanta-based TMW Realty Advisors also is a general partner in the project.

Wood and Novare also plan to start construction this fall on an apartment tower on Pharr Road in Buckhead. It will include 398 units that will be converted to condos as soon as market conditions allow.

In one of the most ambitious projects announced, Houston-based Hines said it will develop two multifamily towers that also will feature 300 luxury hotel rooms and retail space as part of a mixed-use project that will house a new hall for the Atlanta Symphony Orchestra. Hines expects to start construction on the first tower, which will include apartments and the hotel, in about 18 months.

But Geraghty said multifamily development will slow this year. “Construction lenders react to uncertainty by making it harder for developers to get financing,” he said. “Fewer deals are getting approved today than there were at this time last year, and we see development slowing down even more.

As of March 31, metro Atlanta's apartment occupancy rate registered 95.5%, according to Dallas-based M/PF Research's Atlanta Apartment Report.

In the first quarter, rental concessions became more prevalent and the ability to increase rents waned, according to the report. Effective rates for new leases rose just 2.8% during the first quarter. Annual rent growth averaged 4% to 5% from late 1998 to early 2000. The survey measures rent changes on a same-store basis by comparing rental rates in March 2001 with March 2000.

“With a notable slowdown registering in Atlanta's economy during late 2000 and early 2001, the metro [area] is seeing fewer new household formations, and thus less demand for housing,” said Greg Willett, director of research products at M/PF. “Deliveries of new apartments remain quite substantial, however, forcing property owners and managers to sacrifice rent achievement in order to lease new projects and retain residents at existing communities.”

Atlanta's monthly rents averaged $808 overall and $915 at properties built during the past decade, according to M/PF.

As with the office and industrial markets, the apartment market is dependent on a strong economy and job growth. “From an operational standpoint, job growth fuels apartment demand and therefore puts pressure on rents,” said Kevin Geiger of CB Richard Ellis' Atlanta Multi-Housing Properties Group. “With anticipated job growth of 40,000 this year, compared with 80,000 in recent years, this trend will have a big impact. Many of the Class-A properties had residents who worked in the dot-com community. With what is going on there, we could see a slowdown.”

Some softening already is evident

“We are beginning to hear of a little weakness in the upper-end communities. Buckhead has been hit hard with new construction and condo development,” Geiger said. “Consequently, performance seems to be weakening. I can think of several other communities that were built within the last few years, and they, too, have experienced a drop in occupancies.

“Class-A is probably averaging around 93% occupancy — not bad but not as good as the past few years,” Geiger continued. “For every Class-A property that reports a slowdown, however, there are two Class-B or C deals that I can tell you are doing extremely well.”

On the investment sales side, multifamily properties remain attractive, Geiger said. Los Angeles-based CB Richard Ellis' Multi-Housing group is projecting $1.3 billion worth of investment sales transactions to close this year in metro Atlanta.

“The outlook is good, especially if you have a three- to five-year horizon,” Geiger said. “Also, look at the other investment niches. Office and retail are not performing well at all. Industrial and multifamily seem to be in favor.

“Even in a slowing economy, people need a place to live,” Geiger said. “Apartments are not recession-proof, but they are a good real estate investment vehicle.”

Looking ahead, most interviewed for this story said 2001 will be a year of “wait and see.” Developers will have to wait and see whether companies seeking large spaces will move forward with expansion or relocation plans. They'll also have their eyes on monthly job-growth figures, trying to determine whether the predictions of a 65% drop-off will prove true.

“Despite the less than optimistic view of the current state of the market, the long-term outlook for metro Atlanta is still positive.”
— Leigh Martin CB Richard Ellis

“The [office] vacancy rate for metro Atlanta (both urban and suburban markets) will continue to increase in 2001,” said Leigh Martin, a CB Richard Ellis broker. “Additionally, the amount of shadow space — space that is under lease but that is being marketed for sublease or re-lease — will continue to increase in the near term.”

However, the long-term outlook is more positive, Martin said. He cites Harry Dent, author of The Roaring 2000s, which focuses on the Internet's move into the mainstream and how our work, organizations and lifestyles will change.

“Despite this less than optimistic view of the current state of the market, the long-term outlook for metro Atlanta is still positive,” Martin said. “I believe that there is validity to the impact of the Baby Boom and Internet phenomena as presented by futurist Harry Dent, and that Atlanta is well-positioned to continue as a beneficiary.”

For the Atlanta Journal-Constitution, Tony Wilbert covers commercial real estate like the dew covers Dixie.

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