CBDs Sizzle

Hot Downtown Office Properties Offer Value and Opportunities Nationwide.

Thriving. Hot. Exciting. Dynamic. Charged.

These are the kinds of words that real estate brokers and analysts are using to describe today’s central business district office markets. While brokers overwhelmingly term their own market as very strong, those with an overview of the bigger picture affirm that urban office properties nationwide offer among the best, if not the best, real estate investment value today.

"CBD office is the most underpriced property today," declares Janice Stanton, director of investment research for Cushman & Wakefield in New York. "The CBD markets are hot. They’re just thriving now."

Many real estate professionals are saying that 1999 will be known as "the year of the CBD," according to Skylines magazine. A more accurate prediction might be that 1999 will be known as the first year of the decade of the CBD, according to Hessam Nadji, national director of research in the San Francisco office of Marcus & Millichap Real Estate Investment Co.

City vs. Suburbs
This is the beginning of a long-term reversal of fortune between the suburbs and downtown, Nadji continues. Whereas cities have suffered a general decline in influence over the last several decades, today they are regaining lost stature, he says.

However reversal may be a slightly misleading term, for in fact, urban office is not rising so much to the detriment of suburban markets as simply rising along with them. Companies continue to move from the tight confines of inner-city mid- and high-rise office buildings to spacious suburban campuses with parklike settings, comparative quiet, and lots of parking.

But while previously this led to spiraling vacancies downtown, today other companies — particularly those involved in multimedia, entertainment, communications, and financial services — are following a reverse course, moving into the heart of the city from outlying locations. For example, Sega of America recently moved from suburban Redwood City, Calif., into a 200,000-square-foot space in San Francisco.

More importantly, new in-city firms and established companies — particularly those in the above fields — are expanding to take over vacant space. They even are moving into class B and C buildings and in many locales are transforming industrial and warehouse space into offices, increasing the office market through conversion of existing properties rather than new construction.

City Trends
Several trends indicate that downtown markets are heading toward lower vacancies, higher rents, and a concomitant increase in value, according to many analysts and brokers. Market watchers point to several factors at play. Among them are a robust economy producing a rising tide that lifts all boats, whether in urban harbors or suburban bays, and a declining spread between urban and suburban rents. Also, a fair number of new speculative suburban office projects are being built or are in development as opposed to a comparatively small amount of new downtown development. According to CB Richard Ellis, 14.6 million sf of suburban office space was completed in first-quarter 1999, with an additional 50 million sf under construction. The comparable CBD figures were 1.6 million sf completed and less than 10 million sf under construction.

The number of new speculative suburban offices being built could lead to overbuilding and declining rents in outlying markets, while the relative lack of downtown office construction should ensure steady or declining vacancies and steady or rising rents in CBDs.

In addition, changing perceptions about quality of life in the city vs. the suburbs have affected the CBD market. These include:

  • a general return-to-the-cities movement leading to significant urban residential and retail growth;
  • increasing levels of suburban crime, pollution, and traffic congestion coupled with decreasing levels of urban ills, depriving the suburbs of many of their former advantages; and
  • stricter growth controls that make suburban development more difficult, time-consuming, and costlier than in the past.

The fact that cities have had higher vacancies has worked to their advantage in the past couple years. Immediately available space and lower rents made them an attractive alternative for many companies that previously might have skipped over the CBD entirely. For example, says Nadji, "Manhattan has captured a lot of occupancy that 10 years ago would clearly have left for the suburbs or other regions."

The effect of all these factors coming together is a leveling of the playing field, enabling cities to compete with the suburbs on a more or less equal basis.

Regional Roundup
In some cities, the change has been dramatic. In the early 1990s, downtown San Jose, Calif., had a vacancy rate close to 30 percent, according to Mark Ritchie, president of Ritchie Commercial Real Estate in San Jose. Today, he says, vacancies are running about 4 percent, despite a jump in inventory due to several build-to-suit developments. And this does not tell the whole story, he adds: "There are virtually no chunks of space larger than 20,000 sf."

What perhaps is most remarkable is that the trend is affecting small and midsize cities as well. For instance, Monroe, La., has an office vacancy rate of 1 percent, while Sioux City, Iowa, checks in at 2.3 percent vacant, according to CB Richard Ellis. Columbus, Ohio, Harrisburg, Pa., and Jackson, Miss., all report vacancies in the 3 percent range, according to the company.

Of course, not all cities report low vacancy levels. The 1999 National Real Estate Forecast from Grubb & Ellis reveals noticeably high vacancies in some urban downtowns, such as 32.9 percent in Dallas, 19.9 percent in Los Angeles, and 19.2 percent in Detroit. But on average, CBDs enjoy lower vacancy levels than the suburbs, according to a first-quarter report from CB Richard Ellis, which pegs CBD vacancy levels at 10.8 percent compared with 12 percent for the suburbs.

However, the pattern of CBD revival appears not to be geographic. For example, the major markets in Texas present very different pictures, says Helen Jobes, CCIM, of SynerMark Commercial Real Estate Co. in Austin. She calls Austin’s CBD "booming," with a vacancy rate of 6 percent and falling and an average rent of $23.52 per square foot, up 15 percent from two years ago. In contrast, she says, Houston and Dallas have comparatively high vacancy levels, with high levels of speculative construction making the suburbs attractive to tenants. She puts San Antonio in the middle, its relatively small downtown market characterized by a stable vacancy rate that tends to stay in the 8 percent to 10 percent range.

The East Coast shows the same lack of geographic patterning, according to Grubb & Ellis data, which reports a 14.6 percent vacancy level in Philadelphia but only 8.6 percent in Washington, D.C. Similarly, Atlanta registers an 18.9 percent downtown vacancy rate, while Charlotte, N.C., boasts 3.9 percent. As noted, large, midsize, and small cities all report a wide range of market conditions.

One category, however, does appear to correlate more closely with the market. Cities that combine office, residential, retail, and entertainment uses in their downtowns tend to be doing better than those that do not, according to many observers. "People have rediscovered the CBDs and want to be there," Stanton says. "It’s the 24-hour lifestyle, which is why those that are not 24-hour CBDs are not doing as well."

San Antonio brokers Andres Andujar, senior vice president with 3D International, and Rob Sult, CCIM, director of leasing for Grubb & Ellis Property Management Services, both identified planned residential and retail development as the key to future office market growth in their city’s downtown.

In St. Louis, Helena Hartig and Don Woehle, vice presidents with Grubb & Ellis/Krombach Partners, listed an inadequate residential and retail base as an obstacle to a stronger downtown office market. "Downtown has 9,000 residents, but it should have at least 17,000," Hartig says.

She pegs downtown vacancies at about 16 percent, compared with only 6 percent in the suburbs. The CBD is improving, however, Woehle adds, noting that class A rents, now about $20 psf, rose 25 percent over the past two to three years.

John Stirek, national director of development and investment in the Portland, Ore., office of Trammell Crow Real Estate Services, contrasts Portland’s situation with that of his company’s home base in Dallas. Portland, he notes, made a concerted effort over the past two decades to bolster the city’s downtown as the heart of the 1.5 million-resident metropolitan area. City officials encouraged and partially underwrote residential, retail, entertainment, cultural, and recreational development; built public parking garages; invested in light-rail transit; landscaped streets; and created a new riverfront park. Today, its office vacancy stands at about 3.5 percent, he says, with at least a million sf added since 1990. Dallas, on the other hand, let its downtown languish, he says, and the vacancy level stays high because companies feel no particular commitment to the CBD.

Software, multimedia, and Internet firms are having similar impacts on Austin, Boston, Manhattan, and North Carolina’s Research Triangle area, brokers say. To a lesser extent, they are contributing to CBD strength in Portland, Seattle, Denver, Minneapolis, and several other midsize markets with reputations for high-quality urban living.

In Los Angeles, various facets of the entertainment industry are fueling a resurgence of office activity in Santa Monica, West Los Angeles, and Marina del Ray, though they have had minimal effect on the city’s traditional downtown.

In Miami, entertainment and telecommunications companies that target a Spanish-speaking audience have located in Dade County’s densest centers — downtown Miami, Miami Beach, and Coconut Grove.

Government is also making significant contributions to the returning strength of CBDs. Many state and local governments have adopted urban-first development policies as part of a strategy to bolster cities against decline. And calls for downsizing notwithstanding, state and local governments are growing to match economic and population growth. In Ohio, the state has some $70 million of office development in progress in downtown Columbus, while the city and county are spending $323 million on public projects, according to the city’s Web site. In Pittsburgh, a coalition of public, quasi-public, and educational organizations plan to convert a large industrial area adjacent to downtown into a technology business center with close to 2 million sf of office and research and development space.

The impact of government development on the private market is both direct and indirect. Direct benefits come from growing government reliance on leased and build-to-suit space. Indirectly it benefits the market by increasing the numbers of lawyers, accountants, consultants, lobbyists, and other office users that interact with government agencies.

CBD Development and Investment Opportunities
Many observers agree that urban investment makes a great deal of sense right now. The CBD markets with the greatest investment potential include Orange County, Calif., Orlando, Fla., Seattle, Phoenix, and Denver, according to Valuation International in Atlanta.

In these and other cities, prices will continue to rise, Nadji forecasts, because little new construction is in the pipeline while demand continues to grow. Because demand is not growing fast enough in most markets to push rents to replacement levels, minimal speculative development is likely to occur in the near future.

On the other hand, brokers report a fairly high level of new suburban construction, which should halt rent increases and possibly lead to rent decreases outside center-city markets. As Nadji points out, barriers to development almost always will be greater downtown than in the suburbs, even with suburban approvals becoming more difficult to obtain. Few large downtown projects can be brought to completion in less than 18 months, while 12 months is not atypical in the suburbs.

Nonetheless, serious construction has begun in some cities. Several observers express particular caution about San Francisco, where rents for offices with panoramic views have spiraled to the $70 psf per year range and new and rehab construction totaling some 4 million sf is set to come on line beginning late next year.

"The market has peaked. The engine is at full tilt," declares Christian W. Lustic, CCIM, senior vice president and manager of leasing and sales for the San Francisco regional office of GVA Beitler, a Los Angeles-based real estate services firm. "Tenants whose leases are expiring find themselves with rents double and triple what they have been paying. They are beginning to rebel."

Lustic cites a small law firm he relocated from San Francisco’s Embarcadero Center, one of the city’s premier addresses. "They had 10,000 sf they had been renting for $28 psf. The landlord was asking $58 psf for renewal. I found them space across the bay in Emeryville for about the same rate they had been paying," he reports.

Lustic marvels at Boston Properties’ recent $1.2 billion purchase of the six-building, 4 million-sf Embarcadero Center, one of the largest office property sales in the country last year, according to the National Association of Real Estate Investment Trusts in Washington, D.C. "From what I understand, they have to average $55 psf for the deal to make sense," he continues. "They’re getting that now on smaller deals, but when the larger spaces start turning around, they’re not going to find users willing to pay that."

Nadji and Stanton agree San Francisco is near if not at peak and suggest that only the savviest buyers should attempt that market right now. Stanton also expresses reservations about Portland and Seattle, which have been harder hit than many cities by the Asian economic crisis. On the other hand, Bill Palmer, a senior vice president in the Sacramento office of Grubb & Ellis and managing director of the firm’s Western region institutional properties group, gives solid recommendations on investment in both cities.

Palmer reports that Portland’s One Main Place sold last year to Lowe Enterprises for about $150 psf, while Ben Franklin Plaza sold to Spieker Properties for about $180 psf. "That’s about 20 percent higher than two years ago," he says.

Oncor International reports that the markets seeing the most construction (both speculative and build-to-suit) include Washington, D.C., Dallas, Houston, Manhattan, Chicago, Atlanta, Phoenix, Minneapolis, and Sacramento, Calif.

Nadji cautions about downtown Atlanta due to the area’s inability to hold public and investor interest after the 1996 Olympics. "It has never recovered momentum," he says.

Stanton and Nadji both believe Manhattan has good investment potential with a fair amount of room for rents to move up. Class A asking rents average about $52 psf in Midtown and $38 psf in Lower Manhattan, according to commercial real estate advisers and brokers Julien J. Studley. Stanton named Boston, Washington, D.C., and Chicago as other markets with good upside. Studley, however, predicts that Chicago rents will level this year after a 22 percent rise over the past two years. The company puts overall levels at about $24 psf, with class A approaching $30 psf.

Stanton offers a prioritized list of the best CBD investments, beginning with large properties in large metropolitan areas. "I think these are the surest moves," she says, acknowledging that only real estate investment trusts and institutional investors likely will have the resources to accomplish these deals. Next on her list are upgradable buildings in these same top markets, followed by either property type in midsize markets. She urges care in smaller-city markets because most tend to be single-industry towns tied to the fortunes of that industry. If there is a downturn, investors may find themselves unable to lease or sell their property. "Buyers must be sure they have an exit strategy," she advises.

Other commentators concur that buildings that can be converted from other uses or substantially upgraded to pull in higher rents make good bets. Studley’s year-end Report & Spacedata notes that the lack of new construction is forcing class A tenants to consider class B buildings, but only if they are rehabbed substantially. Others point out that rehabs can be brought on line much quicker than new construction, putting them in good position to capture tenants as markets move toward peak — and perhaps relieving enough pressure to further postpone new construction, ensuring value is sustained.

Stanton suggests the growing market for sale-leaseback transactions involving corporate property as another avenue for CBD investment. Many companies took advantage of the real estate downturn to acquire buildings for their own use at bargain rates. With values back up, they now see opportunity for profits to invest back in the business. She notes that Amoco sold its Manhattan headquarters in a sale-leaseback arrangement and CBS is contemplating a similar move. In April, PP&G sold and leased back its headquarters in downtown Pittsburgh.

"It’s really not profitable [for companies] to own real estate and tie up their own dollars. They can invest in their own business and get a much higher return," says C. Frederick Wehba, chairman of Bentley Forbes Group in Los Angeles, which has specialized in this type of transaction for 20 years. The company recently paid $30 million for a Bank of America building in Sacramento, which it then leased back to the bank for 12 years.

Although there is a far greater number of corporate-owned buildings in the suburbs than downtown, CBDs have a good supply of properties owned by lawyers, doctors, and various small local companies. The problem, several experts point out, is that brokers may need to apprise them of the sale-leaseback option and its advantages.

Other opportunities coming up include REIT disposals, Stanton says. Because most REIT purchases involve multiproperty transactions, she predicts that trusts soon will begin culling their portfolios to eliminate buildings that do not fit their overall strategies. With Wall Street still somewhat cool to REITs, this also will provide capital for continued investment.

Nadji estimates that investors have approximately two years to take advantage of urban opportunities. By 2002, he says, most CBD markets will have peaked. The exceptions will be those cities that have initiated downtown revitalization only recently, which will take longer to reach maturity, he notes. However, the latter group has a drawback in that there is no guarantee that downtown revival will advance.

But in general, Nadji continues, "The only thing that threatens downtown is the retraction of the financial services sector," in which the continued merging of financial services companies, brokerage downsizing due to the shift of stock investing to the Internet, and possible global economic shocks have the potential to shrink the traditional CBD tenant base. Otherwise, he and other analysts foresee a bright outlook for urban centers for the next decade and beyond.

John McCloud

John McCloud is a San Francisco-based freelance business writer. His articles for CIRE have covered topics such as suburban office markets, auctions, and marketing techniques.Inbound or Outbound?Call centers fall into two basic categories, inbound and outbound, and each has slightly different labor and facilities requirements.Inbound centers handle calls initiated by customers seeking technical assistance, product or account information, or help with other queries. Mostly these are corporate-owned or overseen. These facilities are built out to a very high standard to attract high-caliber employees, says Marc Schiff, principal in charge of DCSW Architects in Albuquerque, N.M.Because inbound telephone representatives face complicated, often challenging demands requiring a fairly high level of education, site selectors generally look for middle-class university or college towns, says Susan Arledge, SIOR, a principal with Arledge/Power Real Estate Group in Dallas.Outbound centers most often are involved in telemarketing, where personality and enthusiasm are more important than education level. Consequently, more location options are available. Because outbound representatives generally use fewer resources than inbound ones, they need less desk space for manuals, calculators, and other tools, according to Mary Ryder, director of operations support for Valic in Houston. As a result, a greater number of employees can be housed in any given space.Outbound call centers rarely operate after 11 p.m. Eastern time, because reps cannot call people in the middle of the night. Inbound centers, on the other hand, may work around the clock. For example, the telephone sales force for some companies may be on hand 24 hours a day to take calls made in response to late-night infomercials on television.Security is a significantly bigger issue for round-the-clock operations, Arledge points out. So is access to 24-hour restaurants and shopping for employees coming to or leaving work, she adds.


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