Office sector feels sting of economic doldrums

Not all that long ago, real estate professionals in just about every local market were claiming immunity from the downfalls other markets were experiencing. In recent months the tone has become conciliatory: if the national economy dips, we might also.

Well, the national economy has gone into a tailspin, and NREI thought it a good time to check in with several leading office markets in the Southeast — midtown Atlanta, Charlotte, Miami and Richmond, Va. — to see how they're faring in the present economic climate.

Midtown Atlanta gets a boost

“A huge shot in the arm” is how real estate professionals describe the latest big lease in the midtown Atlanta office market. New York-based PricewaterhouseCoopers (PWC) has announced it will consolidate 860 of its Atlanta-based workers into 112,000 sq. ft. in the new Millennium in Midtown project, a 410,000 sq. ft. development under construction. The PWC lease, plus an 85,000 sq. ft. lease by the Federal Deposit Insurance Corp. announced earlier this year, raises the project to more than 50% leased.

The positive news comes none too soon. Atlanta, like most of the country, has been hit hard by the one-two punch of a declining economy and technology slowdown that is resulting in thousands of layoffs and thousands of feet of new sublet space pouring into the open market.

“Tenants are becoming more cautious on square footage needs and are reluctant to make long-term space commitments,” said Jim Ledbetter, managing director in the Atlanta office of Insignia/ESG. “At the same time, landlords are becoming more conservative in their negotiations. 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 subleases by traditional companies such as Coke and bankrupt dot-coms.”

It's no secret by now that earlier this year Merrill Lynch put the Midtown market on its list of “markets that will be especially hit hard” by the real estate correction. And despite the encouraging news of Holder's project, there is still nearly 1 million sq. ft. of space under construction in the market.

As of mid-year 2001, vacancy rates in Midtown, including space available direct from the landlord, as well as space available through sublease, was a staggering 17.5%, up from only 5.7% one year ago, according to Ledbetter.

Robert Bach, national director of research at Skokie, Ill.-based Grubb & Ellis, said Midtown continues to show its resiliency. “Despite the naysayers, Midtown is one of the city's most active submarkets,” Bach said. “With 1.5 million sq. ft. of speculative office space coming on line, the pent-up need for large, contiguous spaces is demonstrating the demand for this market. In addition to office activity, there are 5,500 new residential units on the way and several retail complexes.”

According to Duke Doubleday, executive vice president of CRESA Partners/Atlanta, there are three key drivers behind Atlanta's Midtown corporate real estate market — the growth of BellSouth and its business units, the continued growth of Georgia Tech, and the influx of successful technology firms moving to be near Georgia Tech's research components. Additionally, the explosion of residential dwellings (apartments and condos) allows corporations to locate where staff can find quality housing at a reasonable price.

Midtown competes with two big markets — downtown and Buckhead. But while it historically was home to professional services firms such as law firms, accounting, consulting, architectural firms and ad agencies, in the late-1990s it became the market of choice for high-tech companies such as Earthlink and Macquarium.

“Today, supply is outpacing demand, but the long-term outlook remains positive with the central mass of residential, retail and cultural/entertainment options,” Ledbetter said.

But according to Bach, the technology slump has had a significant impact on the market. “The technology fallout has affected the Atlanta market in several ways. The most noticeable effect is the form of available sublease space. Eighteen months ago, there was 1.5 million sq. ft. of sublease space, now that figure is approaching 5 million sq. ft., which equates to 4% of the total market,” Bach said. Landlords have to contend with an increasing number of defaulting tenants, prompting them to be more conservative in assessing the credit standing of prospective tenants, Bach said. “Despite increasing vacancy rates, we have yet to see decreases in the asking rental rates. However, there has been a significant increase in incentives offered by landlords, which has resulted in lowering the effective rental rates in the Atlanta market,” Bach added.

Many local observers aren't so sure the technology falloff is as bleak as it may seem. “The impact of the technology fallout in Atlanta/Midtown is grossly overblown,” Doubleday said. Basically, he contends that much of the space gobbled up by dot-coms during the technology wave was non-traditional space that was never considered part of the mainstream market in the first place, including abandoned warehouses and meatpacking plants in obscure areas.

“The truth is that the true mainstream sublet space with reasonable terms is getting relet reasonably quickly at fair market value, often without significant discount,” Doubleday said.

According to Ledbetter, the hottest tenant base in Midtown is traditional Fortune 500 firms. Companies with solid business plans and established revenue streams are back in vogue, he said.

For years, locals have touted Midtown as a viable 24/7 live-work-play environment, but is it grounded in reality?

“Only time will tell if that part of town will become Atlanta's own Greenwich Village or Soho district,” Ledbetter said.

“Midtown's fundamentals are strong. The density of office, residential, retail, cultural/entertainment options is unmatched anywhere else in Atlanta. It is fast becoming our newest 24-hour neighborhood,” Ledbetter continued. “Also, the plan by Georgia Tech to expand across the interstate and the bridge that will link Jacoby Development's massive Atlantic Station mixed-use project will only enhance Midtown.”

Queen City shines, for now

Known as the “Queen City,” the seven-county Charlotte metro area, which extends into South Carolina, grew by an astounding 29% during the 1990s, to just short of 1.5 million people, according to the 2000 Census.

The city also has cemented its rightful place as the financial capital of the Southeast. “There are two factors that are clearly driving the Charlotte market: Bank of America and First Union,” said Patrick Duffy, senior vice president and branch manager for Julien J. Studley's Atlanta office. “Right now, the First Union/Wachovia merger is the most critical decision that's affecting the market.”

Duffy predicts that because the First Union merger has received Wachovia shareholder approval, it's likely that the coupling will increase net absorption downtown significantly. “As far as Bank of America, it certainly is going to continue to grow, but the question becomes: Can it continue to grow at the same pace?” he asked.

According to Steven D. Garrett, senior office specialist for Grubb & Ellis/Bissell Patrick in Charlotte, financial tenants dominate the suburban landscape as well. “Bank of America and First Union/Wachovia dominate the downtown, but in suburban Charlotte tenants such as Royal Insurance, TIAA/CREF, Vanguard, Equitable and Allstate are major players,” Garrett said.

For the past few years, Charlotte's financial bent has served its office market well, but with the slowing economy and potential mergers of financial services firms in the offing, the bloom has come slightly off this rose.

Class-A CBD office vacancies have remained low through the first half of 2001, while Class-A suburban vacancies reached 10.4% in the second quarter, according to The Stephens Co., an affiliate of CRESA/Charlotte. But the company warns, “With a higher vacancy and a softer market than the first quarter, office space in Charlotte has had a considerable slowdown in terms of activity. Deals are taking longer to complete and are not as large. Accordingly, landlords are more aggressive in luring tenants to their buildings. What started as one month's free rent last quarter has escalated into three to six months of free rent on longer-term commitments.”

Carolinas Real Data, a local market analyst firm, points to a decline in office vacancy figures from the fourth quarter of 2000 to the first quarter of 2001. The entire market posted an 8.5% vacancy rate, down slightly from the 8.9% posted during the fourth quarter of 2000.

Charlotte still has a lot going for it, including availability of labor, quality of life and good convenient air transportation, thanks to its USAir hub at Charlotte Douglas International Airport.

Thankfully, most agree that Charlotte was not as deeply affected by the tech slowdown as other cities. “When the technology boom hit in late 1999 and 2000, we felt left out in Charlotte. Now we are glad that we were left out,” Garrett said.

Among the city's hottest submarkets is Ballantyne Country Club, a master-planned community located south of the city center, which combines major interstate access with neighborhoods of high quality. Also, downtown continues to be a big draw. “Despite the lack of activity by major banks in downtown Charlotte, the Class-A vacancy rate remains just above 1%,” Garrett said.

A number of non-office projects continue to keep the focus on downtown, including construction of the convention center hotel, continued residential redevelopment of the city's uptown district First Ward, extension of the trolley line into downtown, expansion of the city jail and an anticipated new county courthouse, Garrett added.

Several growth spots are on tenants' radar screens:

  • I-77/Southwest — The largest suburban submarket in Charlotte still has plenty of land left for growth, and access to the Interstate and the airport are still major draws for tenants.

  • South Charlotte — The success of Ballantyne will draw competitors to the South Charlotte market, but limited land options zoned for office development will place a ceiling on growth in this submarket.

  • North Charlotte — The congestion of I-77 North that generated demand in this submarket will continue, and as the market reaches critical mass it will begin to become a destination for tenants.

Latin influence boosts Miami market

This South Florida city moves to a decidedly Latin beat, boosting its office market. Many Fortune 500 companies have set up their Latin American headquarters here, and the economy is also blessed with banking, finance, international trade, tourism and foreign investment playing key roles.

“Miami's geographical position in the extreme south of the continental United States, and hence proximity to Latin America, is a major advantage the city has been able to capitalize on,” said Donna Williams, research services manager for Grubb & Ellis, Miami.

Miami's large seaport as well as the Miami International Airport rank among the top in the country in international trade and tourism, pumping billions of dollars into the local economy.

“Miami's importance to Latin America cannot be overstated. In fact, the network of airlines through Miami International Airport is so extensive that it is often easier to travel from one Latin American country to another via Miami, than directly from country to country,” Williams said. “All of this has a major impact on the local real estate market.”

In fact, the Airport West market has become the area's largest office center, with some 8.6 million sq. ft. of space compared with downtown Miami's 6.8 million sq. ft. According to CB Richard Ellis, the airport market registered an 11% vacancy rate at the end of the first quarter, while downtown checked in with an 8.1% vacancy rate.

Robert G. Orban, vice president in Trammell Crow Co.'s Miami office, said one reason for the strong showing is the investment made by Latin American companies “using Miami as a beachhead to the U.S. market.”

Williams agrees. “Miami has attracted foreign investors, in particular from South America, who view investment in Miami's real estate as safer and more stable than those in their own countries.”

Recent office performance bears this out. According to CB Richard Ellis' Office Market Index for the first quarter of 2001, “The nation's current economic slowdown has not and does not appear to affect Miami's rapid commercial growth.”

Still, there are some warning signs. “Collectively, the South Florida office markets are holding their breath to see if the new construction/absorption balance will remain at equilibrium or tip to oversupply,” said David Preve of New York-based CRESA Partners.

“The completion of new construction, combined with the contraction of companies has caused vacancy rates to increase. Developers still voice optimism that this is a short-term phenomenon, mainly due to the meltdown of the high-tech facility market. We believe the current economy may cause a continuation of the slowdown in South Florida markets,” Preve said.

There are pockets of health and growth all around, though. “The Coconut Grove submarket has historically been one of the region's tightest, with vacancy consistently less than 5%. This submarket has had little new construction over the past decade and the amenities of the market keep tenants and attract new ones when applicable,” said Orban of Trammell Crow.

Jonathan Kingsley, managing director in the South Florida office of Julien J. Studley, points to a few other growth spots. “The next growth areas will be the downtown markets, which include the Airport West submarket and Coral Gables. Again, this has to do with their access to labor. Additionally, both submarkets have the most business energy and history,” Kingsley said.

Miami has experienced its share of tech woes, too, pushing an abundance of sublease space on to the market in almost all sectors, said Orban. “Landlords are now more weary of upstart companies.”

Williams of Grubb & Ellis agrees. “There was a 200% increase in sublease space between year-end 2000 and second quarter 2001. Among the more notable was Telefonica, which downsized considerably in the process dumping 80,000 sq. ft. on the market.”

Williams also sees another problem. In downtown Miami, plans calling for the development of more than 2 million sq. ft. of telecom space have been brought to a screeching halt. “Only one building, the Technology Center of the Americas, has been completed and its two tenants, NAP of the Americas and Global Crossing, were signed about a year ago,” Williams said. Projects that were formerly marketed strictly to telecom users are now being marketed to regular office users. For example, Doral eCommerce Park in Airport West has changed its marketing plan to include traditional warehouse users.

Still, the future looks promising. As the economy rebounds locally, and eventually in Latin America, telecommunications companies will be able to forge ahead with plans to expand Internet access into Latin America.

Richmond's struggles

According to a report published by research firm Reis Inc., Richmond's office market is solid but will not have a good year because construction is on the rise. Reis points to an average vacancy rate of 7.1% in the first quarter of 2001, up from 6.8% in the fourth quarter of 2000. “The relatively large gap between asking and effective rents indicates that rental concessions continue to play a major role in leasing transactions,” according to Reis. Over the next three years, Reis expects rental rate growth to return to positive territory, while the vacancy rate should reach 9%.

Richmond-based Morton G. Thalhimer Inc. reports that Richmond's suburban office markets actually recorded negative absorption in the first quarter of 2001. “This number is the direct result of the subleasing of space due to corporate downsizing,” the report states. Thalhimer is now tracking some 265,000 sq. ft. of sublease space in the suburban markets. Combining the new construction pipeline with vacant blocks of space and the sublease space available, there is in excess of 1.2 million sq. ft. of vacant space in the suburbs.

Downtown, the situation is not a lot better, with a slow start to 2001. Thalhimer expects several Government Services Administration (GSA) leases to move downtown from the suburbs by the fourth quarter of 2001, pumping more positive absorption into the CBD market later this year.

While Richmond's downtown market is fairly stagnant right now, the majority of the leasing activity continues to take place in the suburbs. “Innsbrook and areas surrounding it are the location of choice for many companies,” said Carlton S. Jones, senior vice president in Trammell Crow's Richmond office. “Glen Forest and Stony Point are also desirable submarkets because both are centrally located and feature easy commutes from a variety of directions.”

Overall, Richmond is blessed with a fairly diverse tenant base, including a number of Old Economy and New Economy firms. “While several of the Old Economy corporate entities are struggling — AMF, Heilig Meyers — there are others based in Richmond, including HRH Insurance, Dominion Resources and Landamerica Financial, that are performing well,” Jones said.

But one tenant seems to stand out above the others. “The greatest single driver behind the office market is probably still Capital One because of the amount of space they control, and total employees on staff,” Jones said. “While expansion projections have been adjusted downward somewhat, the fundamentals for the company remain strong.”

If any one sector has dragged the market down, it has to be technology. “The primary effect [of the tech slowdown] has been the marketing and availability of more sublease space in certain submarkets, because entities are downsizing, moving employees out of Richmond and/or closing offices,” said Jones.

The submarket that has been impacted the most is Innsbrook, where the vacancy rate (including sublease space) has climbed from 2% last fall to 9% today, according to Jones. Asking rents and achievable deal terms have deteriorated slightly as a result.

Richmond's growth looks as if it will be outward rather than inward toward downtown. Local veterans point to West Creek in eastern Goochland County, the new home of Capital One's corporate campus. Capital One bought 318 acres in fall 2000, and the first two buildings, totaling 310,000 rentable sq. ft., will be completed in early 2002.

Performance Food Group has also completed a build-to-suit in West Creek on a land parcel it owns. In addition, the completion of the new Route 288 in December 2003 will increase the accessibility of West Creek from Chesterfield County and other points south and west. This route will give employers access to an expanded labor pool, as well as an easy commute for employees.

Ben Johnson is an Atlanta-based writer.

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