Tight office market plus REIT action in industrial market propel city into 21st Century

Metropolitan Nashville's commercial real estate market is booming and healthy as the area's businesses prepare for the year 2000 and another decade of growth and prosperity.

The office market is the tightest in 25 years. Major office construction is on the drawing board and under way with Raleigh, N.C.-based Highwoods Properties leading the pack. Highwoods currently has four office buildings totaling 332,000 sq. ft. under construction in the suburbs with another 450,000 sq. ft. in design.

In the Nashville real estate market 566,500 sq. ft. of space now under construction, nearly half of which is already committed to by users. "The vacancy rate continues to drop as the supply continues to shrink. The low vacancy is leading to new construction and, so far, the new construction is appropriate for the demand in the marketplace," says C. Anthony Martin, senior vice president and managing officer of CB Commercial's Nashville office.

Office receives boosts Nashville's tight suburban office market, with a vacancy rate of less than 5%, will get several major boosts.

Highwood Properties Inc. plans to construct three new buildings in two submarkets.The developments ­ two in Maryland Farms and one in Lakeview Ridge Office Park near the Nashville International Airport ­ are scheduled to be completed next year, according to Brian Reames, Highwoods' regional vice president. Construction costs are estimated at $24 million.

"Nashville continues to experience the tightest office market in 25 years as first quarter 1997 vacancy rates fell to 6.32%," Reames says. The suburban markets, which account for nearly 70% of Nashville's inventory, dropped to an all-time low vacancy rate of 4.52%.

"The short-term trends in the marketplace will result in even tighter conditions through 1997 and into 1998 before new development begins to exceed absorption," Reames adds.

Duke Realty Investments say they plan to develop four speculative office buildings at a cost of nearly $50 million in Maryland Farms.

Maryland Crossing I will be situated on 5.35 acres of the 21.4-acre tract that Indianapolis-based Duke bought recently from Maryland Commons LLC, according to John J. "J.C." Caudell, assistant vice president of Duke's Nashville Group.

The first phase will consist of a four-story building is scheduled for completion in summer 1998. "It's my goal to build one office facility a year," Caudell says. "However, if the demand continues for new space in this market, additional buildings will start earlier."

The Metropolitan Airport Center Business Park is taking off with construction of a second office building and two others on the drawing board. Total build-out costs are estimated at $27 million. The $6 millionº Center II building will be available for occupancy in August, according to Prime Properties Inc., the developer, and The Mathews Co., the contractor and leasing agent.

James R. "Hap" Hewgley, director of development for Prime Properties, says plans for two additional buildings are before the Metro Planning Commission. They are Metropolitan Airport Center III - a $9 million, 73,000 sq. ft. structure, with construction expected in late summer - and Metropolitan Airport Center IV - a $12 million, 100,000 sq. ft. building, with construction scheduled to start in spring 1988.

The first phase will consist of a four-story building of about 112,800 sq. ft.

Brentwood/Cool Springs is now the most difficult place to find vacant office space in the greater Nashville area. The vacancy rate fell from 3.48% in the last three months of 1996 to 2.74% in the first three months of 1997, according to a report compiled by Nashville's Highwoods/Eakin & Smith.

At Haywood, Duke is developing Building 8, a 71,600 sq. ft. facility to be put in service this fall.

"This development, also 100% speculative, points to the strength of the airport submarket with a 3.4% vacancy rate and the demand for office/showroom industrial space," says Susan E. Wehrenberg, marketing coordinator at Duke's headquarters.

Highwoods' new projects include Harpeth V, a $7 million, 65,000 sq. ft. addition to the existing four Harpeth buildings, scheduled for completion next spring; SouthPointe, a 103,000 sq. ft., $11 million, building in Maryland Farms, set for delivery next spring; and Lakeview II, a $6 million, 61,200 sq. ft. development in the airport submarket, scheduled to come on line in February 1998.

Cindy C. Morse, Centennial Commercial Real Estate's director of consulting services, says the Brentwood/ Cool Springs office submarket continues to attract most of the new development, because of "land availability, general desirability and proximity to decision makers. Land costs are lower than in West End and Green Hills."

The spring 1997 issue of The Nashville Single Market Office Outlook, prepared by CB Commercial and Torto Wheaton Research, forecasts demand for new office space over the next two years to be about 604,000 sq. ft. with the largest share in the Brentwood/ Green Hills submarket.

"The amount of space going up in the Nashville office market is what we forecast demand to be for the next two years," says CB Commercial's Martin. About 224,000 sq. ft. is pre-committed, leaving about 340,000 sq. ft. available for lease.

Multifamily expands James A. Webb III, vice president and co-founder of Nashville-based Freeman Webb Inc., says that "there is significant multifamily construction in this market. And we're beginning to see unfettered expansion on the outskirts of Nashville ­ high growth areas including Smyrna, Murfreesboro and Cool Springs. We're watching this expansion to determine the impact on the Nashville market. Is growth in outlying areas merely satisfying demand in those markets, or will it draw renters from Nashville?"

Nashville's pending property tax increase may have the biggest impact on the industry this year.

Webb says that "the one positive impact of the tax increase is that it will most likely deter apartment development. If this occurs, demand for existing units will remain high, and it will allow us to increase rents."

Multifamily residential construction accounted for seven of the 10 largest permits in 1996 as apartment construction heated up.

"Traditionally, we have absorbed about 1,800 units a year," says Bobbi Turner, who compiles the Nashville/Middle Tennessee Apartment Association's quarterly surveys on occupancy and rent. "Currently, we have in the eight-county Metropolitan Statistical Area 7,100 units under way. Last year, in 1996, we completed about 3,500 units and, so far in 1997, we have completed 1,200."

"We are probably looking at 18 months to two years before we get back to a fairly stable 95% occupancy rate," Turner says. "Right now, our last numbers show it at 93.7%."

"It's a growth market with strong staying power because it has a dynamic economy, good job growth and a lack of properly zoned and buildable multifamily sites," says Steve Masses, senior vice president of CB Commercial.

Retail experiences positive growth Retail real estate development over the next 12 to 18 months is likely to focus on grocery-anchored neighborhood centers, according to Trammell Crow Co.'s MarketScope. "The retail market segment, while not as dynamic as the others, also experienced positive or stable trends last year," says Jeff Haynes, managing director and executive vice president of Trammell Crow.

"Shopping centers closed out 1996 with an overall vacancy rate of 6.65%, which is the lowest vacancy rate the Nashville retail market has seen in over a decade," says Carl D. Storey III, vice president of Trammell Crow Co.

"Institutional investors clearly have Nashville in their sights," he adds. About 1.65 million sq. ft. of leaseable space was available at year-end '96, representing a decrease in the city's vacancy rate to 6.57% ­ down from 6.86% in '95, according to MarketScope. The average quoted rental rate for retail space increased slightly from $13.99 per sq. ft. in '95 to $14.01 per sq. ft. in '96, the report notes.

Neighborhood and community centers for the Nashville market averaged about $10.25 per sq. ft., while regional shopping centers commanded an average rental rate of $23.69 per sq. ft.

"The big news is the reclamation and restoration of 100 Oaks, which has brought in 300,000 sq. ft. of users and attracted a 100,000 sq. ft. Home Depot across the street," says C. Anthony Martin, senior vice president and managing officer of the Nashville office of CB Commercial.

REITs spur industrial expansion With approximately 1.65 million sq. ft. of industrial space under construction in the marketplace, Nashville is the 21st most active out of 53 markets, reports CB Commercial.

Most of the new space here will be used by expanding companies, rather than by an influx of new companies, as the area's economy remains dynamic and job growth strong, CB Commercial's Martin says. Once the new space comes on line, there will be a stock of approximately 114.75 million sq. ft. of industrial space.

"The presence of industrial REITs here means that finally Nashville is building an underpinning of warehousing space, whereas before there had been very little high-quality inventory. This is important for external growth to occur," Martin says. He expects the market's historically high rates to head down to the $2.79 to $3.63 per sq. ft. range, depending on location.According to a new study by the Washington D.C.-based Society of Industrial and Office Realtors (SIOR) "the Nashville metropolitan area continues to experience brisk activity in its industrial real estate market.With an overall vacancy rate of 1% and more than 2 million sq. ft. under construction, the region continues to welcome companies interested in locating to the South."

"Our space has been absorbed at a record rate," says Norman Ray, broker at Nashville-based Frank L. Smith Commercial Real Estate and president of the Eastern Tennessee Chapter of SIOR. "Local industries have expanded rapidly, and we are showing up on corporate radar screens as the lowest-cost shipping point in the Southeast."

Opryland and Marriott lead hotels During the past year, Opryland Hotel unveiled The Delta, a 4.5-acre expansion that includes an indoor garden area, nearly 1,000 new guest rooms, 20 new meeting rooms, a 1.25-acre ballroom and more exhibit space.

The 2,054 rooms opened during the past year, combined with those under construction and those likely to be built in the next year, total about 6,000. That's a 25% increase in the number of hotel rooms in the Nashville area within just three years.

The Marriott flag probably will fly over a 400-room hotel that's going up on Metropolitan Development and Housing Agency land next to the Nashville Arena. And Marriott will lend its Courtyard name to a hotel in the former J.C. Bradford building at Fourth Avenue, North, and Church streets.

Construction will begin later this summer on a new Residence Inn by Marriott to be located at the corner of 23rd Avenue and Elliston Place. The 110-suite hotel is expected to be complete by mid-1998, according to Joe Harrison of West End Partnership, which will own the Residence Inn.

Music Valley, across McGavock Pike from Opryland, has two new hotels open and three under construction. Combined with the completion of the Delta expansion at Opryland, those five hotels will bring the total number of hotel rooms in the area from about 3,200 to 4,800.

Bob Battle is vice president and senior business editor of the Nashville Banner.

With the consolidation of the real estate industry, the growth in the size and sophistication of the real estate capital markets, and the trend toward ownership of real estate through large public companies, entity financing is coming into more frequent use.

Project financing has traditionally been the most common form of real estate financing ­ entrepreneurs or small companies typically forming partnerships with investors to develop or acquire assets. Today, investors are buying stocks or bonds of the real estate companies themselves ­ entities that own portfolios of commercial real estate and may have other interests such as providing property management.

Because of the consolidation and increasing concentration of ownership in the industry, real estate is coming to resemble other service sectors in the approach to raising, investing and managing capital, including a gradual shift to entity financing. This structural change, along with the push within the industry to create generally accepted standards for the disclosure of information, have helped to put the industry in a better competitive position in raising investment capital from pension funds and other institutional investors.

Financing matrix Today, real estate companies have more flexibility in the use of financing through entity financing, project financing or hybrids of the two. Furthermore, they can select between equity and debt financing, and the public or private markets. To take full advantage of the matrix of opportunities, real estate companies need to understand the advantages and limitations of entity and project financing.

Entity financing provides greater diversification and greater liquidity, among other benefits. Investors can buy the stock of a public real estate company, either in initial public offerings or secondary offerings; or they can invest in the company's debt securities, which are backed by its corporate assets. By providing a real estate company financing at the entity level, investors gain entry into all of the company's markets. With large regional or national companies, this can increase the opportunities for investors to spread the risks of development and investment ­ vs. investing in a single property or portfolio. Investors may see better opportunities in investing in real estate companies that operate more efficiently, have greater resources and opportunities, and cover a broad spectrum of markets.

Entity financing gives companies greater flexibility in raising and investing capital. For example, stock offerings can be structured to include not only common stock but preferred issues with a variety of terms such as convertibility. Likewise, on the debt side, issues can include convertible features as well as various classes of senior, mezzanine and subordinated debt. Cashflows from pools of assets can be securitized. Proceeds from equity or debt offerings can be invested in a range of development projects or property acquisitions, or used for other purposes such as refinancing corporate debt.

With project financing, entrepreneurs and investors are limited to investing in specific assets, repeating the time-consuming financing process with each project.

Furthermore, unlike the building boom of the late-1980s when financing was easy to obtain, lenders are now more conservative and usually require substantial equity investments. Financing costs may be higher as well.

Another limitation is that each project usually is owned through different ownership structures. Thus, project financing may be the only way to go.

Nevertheless, project financing has advantages such as facilitating off-balance sheet financing in order to contain risk, and enabling entrepreneurs and investors to limit the lender's recourse against the particular project.

With project financing, the entrepreneur and investors can part company if they choose. By contrast, entity financings are more difficult to unravel because investors have ownership interests in the corporate entity.

Entrepreneurs who want to keep close control of their organizations, and who do not want exposure to the demands of the public markets, may prefer to raise capital privately, whether through project or entity financing. Although privately owned, they may still be able to access the public capital markets indirectly through joint ventures with public companies.

Gaining the edge in financing The real estate industry is moving in the direction of entity financing, and that raises management issues. To gain the competitive edge in accessing capital, management must think and act differently than in old-line real estate organizations. Instead of viewing real estate simply as a collection of assets, management must take a business approach, with a focus on strategic planning, operations, technology and raising capital, including the use of entity financing.

Steve Shepsman is managing partner of the New York office of the E&Y Kenneth Leventhal Real Estate Group.

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