Office market finds short cut to recovery - through the suburbs.

In 1991, the office market in Minneapolis was struggling with a 21.2% vacancy rate, and the market experts were predicting a long road to recovery.

"At one conference I attended, the speaker predicted it would take 17 years for the local market to absorb all of the current excess space," says David Jellison, regional vice president in the Minneapolis office of Dallas-based MEPC American Properties Inc.

Similar forecasts were made about the office sectors of many American cities, yet today, practically every market in the country seems to have discovered a short cut to healthier markets. In Minneapolis, just five years later, the vacancy rate now lingers around 8% for the entire market and about 5% for Class-A space and, furthermore, it is expected to continue its freefall.

"The market has come back much faster than anyone thought possible," Jellison says. And that statement is true of Minneapolis and many other markets as well.

While the distance to be traveled to recovery varied greatly from region to region and city to city, the short cuts taken had one thing in common: They all ran through the suburbs.

In San Francisco-based Grubb & Ellis' 1996 Real Estate Forecast, the company estimates that "the nation's suburban office markets have captured" about 75% of the office demand since 1990.

The perpetuation of this trend was underscored during the second quarter of this year when New York-based Cushman & Wakefield recorded the largest single-quarter drop in the national suburban vacancy rate in almost a decade (in a study of 41 suburban and 32 downtown markets), from 15.1% to 14.2%.

The allure of the suburbs is a story with several chapters, but the main idea is that corporations want to get closer to where their employees live.

"The suburban migration trend is fueled by companies seeking to be closer to where employees live, which in turn positively impacts their quality of life," says Grafton Tanquary, first vice president of Los Angeles-based CB Commercial Real Estate Group Inc.

"The way people work and communicate has become more casual and that is hard to achieve downtown," says Ernest Johnson, in the Los Angeles office of Houston-based PM Realty Group. "Companies have to go to where the good employees are. So it isn't so much money as it is the new lifestyle of employees."

But money plays a part; the cost of doing business in the suburbs is usually cheaper due to lower taxes and free parking. The impact of taxes is greater in some markets than others; however, "parking can cost a tenant as much as $2 per sq. ft. on the rent in the CBD," says Dave Lanier, director of Concourse leasing in Charlotte-based Faison's Atlanta office.

"It is a quality of life issue," says Thomas Bermingham, executive director of the New Jersey office of The Edward S. Gordon Co., New York. "Employees want to work closer to home. In return, companies can expect employees to work longer hours, be more productive and, in addition, remain with the company longer."

While most of the national markets have improved substantially, several suburban markets are well ahead of the rest and should attract the most development and investment activity in the next few years.


As is often the case, Atlanta leads the way in the Southeast region and perhaps the nation In suburban office growth. The city's overall Class-A office vacancy was just 6.4% at mid-year and considerably lower in some submarkets, according to Atlanta-based Jamison Research Inc.

The city's total suburban office inventory is more than 64 million sq. ft.

Characterized by declining vacancies and rising rents, "Atlanta could be the hottest market in the country for all types of real estate but particularly suburban office product," says Deming Fish, managing director of office leasing in Faison's Atlanta office. "There was concern here about a post-Olympic depression," he says, "but we don't see that happening."

As of July 1, Jamison reports that about 3.3 million sq. ft. of speculative office space was under construction in the city, with all but one of the projects (Monarch Tower in Buckhead) being built in the city's northern suburban markets.

Located about 15 miles north of the city, the North Fulton submarket, centered around Northpoint Mall and the Interstate 400 corridor, is seeing the most activity with 1.5 million sq. ft. of new product under development.

"The area around Northpoint Mall is clearly the hottest market in the city," says George McKenney, senior vice president with Atlanta-based CARTER, which is developing one of the new office projects, 4501 Northpoint Parkway, a 130,000 sq. ft. Class A building projected to open in April of 1997.

The four completed office properties in the submarket comprise 340,000 sq. ft., of which only 16,000 sq. ft. is currently vacant (a 4.7% vacancy rate), says McKenney. "The bulk of new construction is going on in the Northpoint area."

The Central Perimeter submarket, about six miles north of Buckhead, includes a quarter of the Atlanta market's Class-A space and has the lowest Class-A vacancy rate in the city at 3.8%. It also commands the highest rents, which are in the $22 to $26 per sq. ft. range, Lanier says.

Fish says the submarket has undergone a metamorphosis in recent years from a location for back-office, large-floorplate users, to an area for more high-tech computer software and communications companies, as well as headquarters for corporations such as Holiday Inn and United Parcel Service.

Buckhead's designation as a suburban market might be becoming a bit blurred, but the Class-A vacancy rate is just 4.1% out of 6.6 million sq. ft. of space, and rental rates are in the $24 per sq. ft. range. But the only speculative project is also Atlanta s largest. COMPASS 24-story, 575,000 sq. ft. Monarch Plaza is expected to open early next year and reported this summer to be in excess of 50% preleased.

In the Northeast submarket, five buildings totaling almost 400,000 sq. ft. are being constructed in the I-285/I-85 interchange area and are scheduled to open this fall or in early 1997, according to Jamison Research.

In the Northwest submarket about 450,000 sq. ft. of office space is planned or under construction, highlighted by Cousins' Wildwood-4200 building, a five-story, 250,000 sq. ft. project scheduled to go on line next September.

The Southeast's up-and-coming business center appears to be Charlotte. Although its suburban office inventory is considerably smaller than Atlanta's, at approximately 12 million sq. ft., Charlotte's vacancy rate is lower. The overall Class-A vacancy in the city stands at 4.4% and, unlike most major American cities, its downtown (8.1% vacancy) is healthier than the suburbs (9.1% vacancy) due in large part to the presence of NationsBank.

The low Class-A vacancy has helped the Class-B market improve as well, according to Faison's Year-end Market Focus for 1995.

But Charlotte is expected to see development of almost 2 million sq. ft. of suburban office space between 1995 and 1998, according to Atlanta-based Valuation International Ltd.'s Viewpoint 1996.

As elsewhere the tighter market is creating more favorable terms for landlords in the form of higher rents and less lease concessions, according to Dallas-based The Corporate Real Estate Services Alliance Inc. (CRESA). An owners market should drive investor interest.

The most active submarkets in the city are the Interstate 77/Southwest area and SouthPark, both of which are experiencing some of the speculative development. However, CRESA reports that the northeast submarket "has grown dramatically" in recent years with the addition of a number of large corporate facilities for companies such as IBM, First Union and Allstate.

The rental rates for the suburban markets averaged about $18 per sq. ft. for Class-A space in 1995, up $1.50 from two years earlier.


In the Midwest, Chicago's suburban office market continues to improve rapidly with the East-West Corridor and the Northwest submarkets leading the way.

The East-West Corridor is the city's largest suburban office submarket with about 31 million sq. ft. of space. "Vacancy in the submarket is around 11%," says Mary Spellman, senior vice president with Chicago-based Draper & Kramer, "and it is approaching single digits in some areas."

Draper & Kramer's Second Quarter Market Review lists rental rates for the East-West Corridor in the $16 to $19 per sq. ft. net range, and it states that vacancy levels are expected to continue to decline. "Rents are just getting to the point of speculative development," Spellman says.

As far as new development, Minneapolis-based Opus Development has begun construction on a 250,000 sq. ft. Class-A project at Highland Landmark, scheduled for completion in spring 1998. Draper & Kramer reports this is only the third speculative project in the East-West Corridor since the late-1980s.

In the northwest submarket, which includes about 25 million sq. ft., first quarter absorption topped 500,000 sq. ft., dropping the vacancy rate into the 13% range, according to Draper & Kramer statistics. Class-A rental rates in the submarket range from $13.50 to $15.50 net per sq. ft.

Although property values in the suburbs have increased, some good investment opportunities still exist. "Values are increasing rapidly because capital is moving toward the office sector," says John Moysey, executive vice president with Chicago-based Amli Realty. "But there is still a little upside left."

Elsewhere in the Midwest, Minneapolis' suburban office vacancy rate has dropped from 21% to 8% since 1991. Even less Class-A product is available with the vacancy rate under 5%, says MEPC's Jellison. "Nothing has been built since 1988, and the suburbs were never as overbuilt as the downtown," he says. "So it was a combination of business expansion and a lack of new product that has resulted in the quick turnaround."

CRESA's 1996 Tenant's Guide to National Markets states that "Minneapolis is seeing rents climb rapidly in the office sector but remain short of rents required for new construction."

But that could change quickly. "Class A buildings are full of tenants that are not paying Class-A rents," says Jellison. "Tenants that did five- to seven-year deals in the early-'90s are in for a shock when it comes time to renegotiate the lease. Their rents will probably double."

Anticipating this increase, a few developers have already begun speculative projects. Minneapolis-based United Properties has broken ground on a 130,000 sq. ft. Class-A project in Minneapolis' southwest suburb of Edina, and The Galbreath Co., Cincinnati, is developing a 70,000 sq. ft. property in Minnetonka, another Minneapolis suburb.

The Minneapolis office investment market is picking up "although there are no more entrepreneurial-type deals left," says Terry Kingston, principle with Minneapolis-based First Capital.

He says the major sales transactions so far this year involve the 505 and 605 Waterford buildings. Aetna sold 505 Waterford to Chicago-based Cornerstone for a price estimated at $119 per sq. ft. and, more recently, 605 Waterford was sold by Ryan Construction Co. to the Utah State Retirement System for around $ 115 per sq. ft.

"Nothing is normal," says Kingston, referring to the sale prices for the two properties, "because prices have risen so quickly. Values have doubled and tripled in the past five years."


In the Southwest, the markets of Las Vegas and Phoenix are experiencing a great deal of activity. In Phoenix, the investment market is king because the sale price for many office properties is still below replacement cost. However in Las Vegas, tremendous growth has already spurred speculative development.

Valuation International Ltd.'s Viewpoint 1996 estimates that 3.2 million sq. ft. of suburban office space will be completed or under construction in Las Vegas by 1998.

Alan J. Perlmutter, senior vice president with Las Vegas-based American Nevada Corp., reports that 1.25 million sq. ft. of office space is under construction in the Las Vegas area, including 250,000 sq. ft. in his company's Green Valley master-planned community, in the suburb of Henderson, Nev.

The Green Valley Community, comprised of 8,400 acres, will test the theory that part of the corporate attraction of the suburbs is its proximity to employees. In addition to its office component, the community is also home to 55,000 people.

The Las Vegas market has a lot of other business advantages as well. The state charges much less corporate tax, so the cost of doing business is cheaper, and the single-tenant space, says CB Commercial's Midyear Market Report on the Salt Lake area.

Absorption totals in the suburban market, according to CB Commercial's estimates, will be 471,646 sq. ft. this year. But only a lack of available product prevents it from being higher. The demand is certainly in the market.

At midyear, CB Commercial reported asking rents for suburban space now under construction at $17.36 per sq. ft. The company expects rents, which slowed their increase during the second quarter of this year, to continue to rise at a slower pace.


On the West Coast, which was the last area to experience the office downturn, the major markets are making strides toward recovery, says PM Realty's Johnson. San Francisco is absorbing space though rents are not rising very fast. In Los Angeles, the suburbs of Burbank, Century City and Santa Monica are bouncing back due to new opportunities in the entertainment industry.

"Any suburban market that supplies the entertainment industry will be immune to economic downturn," says Johnson. "It is a highly unregulated industry. It has no limit on exports, so the world is their market."

Johnson says all of Los Angeles' westside suburbs are seeing rents increase and vacancy drop. In Santa Monica and Century City, several major office properties have changed hands this year at prices as high as $265 per sq. ft.

Interest in Los Angeles office space should continue to increase if forecast prove correct. Cambridge, Mass.-based Cognetics Inc. projects Los Angeles County to gain 232,418 new office jobs over the next 10 years, a figure that leads the nation.

Orange County is absorbing space and seeing rents climb to $23.50 per sq. ft. for Class-A product.

The Orange County market has 55 million sq. ft. of office space, half of which is located in the John Wayne Airport/South Coast Metro submarket. Rents in this largest concentration of office space range from $19 to $27 per sq. ft.

At the close of 1995 overall vacancy was at 16%, according to figures compiled by CRESA, and no new product is being built. Absorption of Class-A space and rental increases have been slowed due to the availability of sublet space.

Net office absorption was positive in all submarkets except Central Orange County, according to CRESA and, due to the lack of new construction, office vacancy is expected to continue dropping.

The county's well-publicized bankruptcy has slowed the local economy, but some growth is occurring and employment growth is steady. When speculative development does return, it is expected to occur first in the South County submarket.

Further south in San Diego, the market is improving despite a reduction in the defense and aerospace industries that have traditionally driven the market.

In San Francisco, unlike most markets, the suburbs are not as healthy as the CBD, but that doesn't mean they are not improving. "People don't flee to the suburbs in San Francisco," says Johnson. "It is a 24-hour city." As a result rental rates downtown are in the $25 to $35 per sq. ft. range and only $18 to $28 per sq. ft. in the suburbs.

CRESA reports that the overall vacancy rate of 11.2% is the lowest it has been in the 1990s. In addition, Cognetics ranks San Francisco behind only Los Angeles and Atlanta in estimated new office employment over the next 10 years.

The suburbs do have their strong areas. In South San Francisco, office vacancy is less than 2%, while on the East Bay, Emeryville's vacancy rate is only 3.9%.

CRESA predicts that tenants renegotiating leases in 1998 and 1999 will probably pay 10% to 15% higher rents. Concessions, though they still exist, have been reduced.

In the Pacific Northwest, Portland has single-digit office vacancy rates and is seeing some new construction, as is Seattle, though the Seattle vacancy rate is around 12%. Johnson says the success of these markets is spurred by economic growth spawned by population and business growth moving in from California.

"Industry is seeing where the people are going, and Seattle and Portland have received the most benefit from California's economic downtown."

Seattle's overall office absorption total for 1995 exceeded 1 million sq. ft., while its Eastside suburban submarkets had a combined vacancy rate of 6.5% on an inventory of 13 million sq. ft., reports CRESA, and the lack of new construction was expected to lower rates to below 5%. In addition, average Class-A rents in the suburban markets have increased from $17.50 to $20.50 per sq. ft. since 1993.

In Portland, "all the suburban office markets show considerable strength," says CRESA's Tenant's Guide to National Markets. The report also says that 250,000 sq. ft. of new office space will be delivered this year and more than 80% of it preleased.

"Class-A rents are in the mid-$20 range and will probably push into the high-$20 range in the next 12 to 18 months," says Johnson.

Johnson says investment activity is low only because "there is not much product to buy."

1. Atlanta, Ga. 2. Minneapolis, Minn. 3. Las Vegas, Nev. 4. San Francisco, Calif. 5. Denver, Colo. 6. Portland, Ore. 7. Charlotte, N.C. 8. Richmond, Va. 9. Phoenix, Ariz. 10. Boston, Mass.

Source: Valuation International Ltd.'s Viewpoint 1996


Vacancy rate '9516.8%15.7% Vacancy rate '9617.1%13.7% Cap rates '95 9.9%10.0% Cap rates '96 9.7%9.7% Discount rates '9511.0%11.0% Discount rates '9611.6%11.9%

Source: Valuation International Ltd.'s Viewpoint 1996

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