COVER STORY, JUNE 2009

OFFICE SECTOR STAYS ACTIVE
Brokers see movement despite crippling recession.
Jon Ross

Measuring the health of a region’s office market is difficult in the current environment, but lending power is generally an effective measure. Markets that have strong regional banks willing to refinance existing loans are doing well in the current economy, and owners who can’t find willing lenders are hurting. Conversely, developers are still building smaller properties and brokers are signing a small amount of leases no matter what the banks are doing. Market geography and the existence of non-office drivers also play a huge role in determining the strength of a city’s office sector.

In an era of penny pinching, lenders in the Washington, D.C., area are loaning money to developers who present quality proposals for new properties. These local and regional banks might be a little slower to act than they were 1 year ago, but cash is still entering the market. “If they have a relationship with the buyer and the buyer’s well capitalized and can demonstrate they have a plan for the property and are willing to put some skin in the game, lenders are more than willing to do a deal,” says Cole Spalding of Marcus & Millichap’s Washington, D.C., office.

Spalding sees Washington as a market that is doing relatively well compared to the rest of the Southeast. There are fewer deals getting done than before the recession, but the presence of the federal government and legions of private contractors means that office transactions are at least still happening. “If you’re an owner, it’s hard to rival being in the Washington, D.C., area,” he says. “Even with all the things that are going on right now, it’s still a pretty good place to be as far as jobs and economics.”

The Washington market is still facing some of the same problems that have popped up all over the Southeast. Landlords are offering large tenant concessions, and tenants are taking longer to make decisions, poking around for the best deal. It’s anyone’s guess as to when this trend reverses itself, Spalding says. He expects to see a slow turnaround once the market hits bottom. “I don’t know if there’s going to be a huge industry catalyst or driver,” he says. “It could be an organic, slow painful growth, but any growth is better than going in the opposite direction.”

An hour to the north, landlords and tenants in the Baltimore area are locked in a recessionary tango. Owners don’t want to hand out too many concessions and are asking for short leases, while tenants assume that a weak economy means more deals for those seeking office space. In most cases, the tenants are winning. “Landlords are very nervous right now about retaining some of their larger tenants,” says Matthew Haas of Manekin’s Baltimore office. “They’re really trying to incentivize their credit-worthy tenants with renewing early, rolling rents back. They’re really trying to be as accommodating as they can to secure their rent rolls.”

The Baltimore area is populated by healthcare and defense-oriented businesses. The University of Maryland Medical Center and Johns Hopkins University attract a large amount of medical office users, and two area military bases will help generate interest from office users as the Base Realignment and Closure campaign gains momentum. “Those businesses are fairing better as opposed to some of the other service-oriented industries that our market really doesn’t have,” Haas says. The Baltimore market is fairing better than its neighbors to the north primarily because of its two main industries. “Our vacancy rates are soft, but they’re not declining at a brisk pace like some of our competing markets,” he says.

One submarket of Baltimore that’s not seeing benefits from the healthcare and defense sectors is downtown. Haas says tenants in the downtown market are focusing on cost-cutting measures and are looking to the suburbs as a money saver. For one thing, parking is included in suburban office rents. “If you end up parking downtown, that could increase your rates anywhere from $3 to $5 per foot,” he says. “The downtown market is really the area that’s going to be glaring, and the vacancies are really going to hit in the 20 to 25 percent range pretty soon.”

Ken Morris of Morris Southeast Group/CORFAC International in Miami hears echoes of the dot-com era in the current downturn. When the bubble burst, a large amount of Class A office space came onto the market in Miami, and Class B and Class C users moved into better offices. These users took space off the market, albeit at lower rents than the landlords thought it was worth. The same thing is happening today. Compounding the current flight to quality is the recessionary downturn experienced by Latin American corporations, Miami’s bread and butter. “The Latin American economies are suffering right now, and that directly affects how Miami is doing,” Morris says. “Miami has prided itself on being the business gateway to Latin America, and we know that Latin America is suffering just as much as Europe and Asia and certainly North America.”

Miami banks, unlike regional and local institutions in Washington, D.C., are reluctant to refinance existing loans. This lack of capital is the key problem facing Miami’s office market. Without the ability to refinance, owners that used short-term capital to buy their buildings are faced with no way to stay in the market. “[The capital markets] are going to be a factor in how long it’s going to take the market to recover and ultimately what kind of concessions the tenants are able to negotiate while we’re in this down cycle,” Morris says. To further illustrate the problem, he conjures up the image of a train crash. The train, which represents office properties in Miami, is speeding toward a cliff. “We’re at the early part of the train crash, where the cars are just about to go over the abyss.”

Delivery of 1450 Brickell in downtown Miami is slated for January.

On top of the tight lending market, Miami will soon have an abundance of office space on its hands. Three LEED-certified office buildings are set to deliver in the next year, bringing more than 1.84 million square feet into the market. Rilea Group’s 1450 Brickell is a 586,000-square-foot Class A highrise on Brickell Avenue. The development will deliver in January and is currently 7.2 percent pre-leased. Down the street at 600 Brickell Ave., Foram Group is expected to complete the 605,886-square-foot first phase of the Brickell Financial Centre by next June. Current occupancy stands at 1.8 percent. On Avenue of the Americas, MDM Development Group is working to complete the 750,000-square-foot Met 2 office tower by May. The property is currently 33.3 percent leased. A 376-room Miami Met Marquis Hotel will be attached to the building.

One positive note that can be taken from the construction of the three Miami buildings is a commitment to green construction. Morris says this is more than just a trend; building an environmentally friendly office property is the new status quo. Government agencies and other corporate tenants have started demanding energy-efficiency and green materials in their buildings, Morris says. “That doesn’t mean they’re willing to pay extra for it, but it’s something that’s a criteria for making a decision,” he adds.

A lack of capital combined with the downturn and an imminent influx of office space means that developers in Miami are sitting on the sidelines. Instead of waiting for work to pick back up, however, companies are combining their construction development and realty divisions together and looking for ways to assist owners with distressed assets. In a trend spread throughout the Southeast, developers are also lending a hand to bankers who suddenly have a wealth of foreclosed office space with no idea how to maintain it. “Development’s not going to die,” Morris says, “but it’s on hold for the time being because there’s little or no capital out there and there’s little to no demand for development.”

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