Tidbits from the Commercial Real Estate Forum

Earlier this week you might have known, or seen a brief summary in the paper, about the annual commercial real estate forum. It's heavy on the Chamber and the popular "axis of evil," as it were, but that doesn't make its observations about the economy trivial in any way. These are important things to observe, and if we might disagree with some of the framing or the interpretation, many of the underlying facts are sound and important to understand.

So here are some excerpts. If you have more expertise on the local economy or real estate, chime in!

As we talk about the kinds and forms of development we want to see, the ideal is constrained by actual market effects, and this is an important reality check.

But it is also interesting to compare the actual to our plans and policies. The City should formally comment on these things to complete the feedback loop: As we structure municipal-level incentives in our code and statutes, is the market responding as we would like? If not, how do we need to change the incentive structure? Is, for example, all that activity on Kuebler mentioned below really what we want? If not, what should we change? Do we need more incentives for downtown housing? How does the market actually respond to plans, policies, and ideas?

(An excerpt on multi-family housing will be separate, as there might be more to say on it. Update - part 2, here.)

Industry

For commercial real estate, vacancies are down, and rents are up. The chart's axes don't start from zero, so the scale of things might be a little manipulated - but still, the narrative implied by that crossing in 2014 is a good thing. That means business activity is growing.

(It is a shortcoming of the brochure that each sector isn't graphed the same way! So if you aren't an expert already, it is hard to interpret the relative importance of things.)

I think this is for industrial property only

From the piece. The news about the cannery seems quite good, as that has been a real void in the neighborhood.

2014 and 2015 combined to see more than 1,300,000 sq. ft. of leasing activity according to CoStar – more than the previous five years combined.

The 410,000 sq. ft. former Seneca Cannery at 1745 Oxford St. SE saw the most activity as it was successfully leased to two tenants in 2015. Diamond Foods, the parent company of Salem-based Kettle Chips, leased 63% of the building to combine two local distribution centers under one roof. Kettle took full occupancy in the third quarter. In August, Salem-based Northwest Distribution and Storage, Inc. leased the remainder of the building - also for a storage and distribution center. Salem Watumull, LLC, the Landlord, is investing millions in retrofitting the former cannery building whose origins date back to 1940....

In spring 2016, the Oregon State Police will relocate from Portland Road to occupy 119,700 sq. ft. in three buildings currently under construction on Trelstad Ave SE for its headquarters, State Fire Marshall, ID and fleet services....

With recreational marijuana use legalized in 2015, the hurdles surrounding the allowance of that use in buildings financed by federally chartered banks and credit unions have surprisingly kept that industry from flourishing in the local market. At present, only a few commercial cannabis operations have successfully located operations in the mid-valley but we are confident more will follow as the supply allows. [link to Oxford St. property added]

Turning to the outlook for 2016, there is a fascinating anxiousness about the Mill Creek Industrial Park:

Probably the most notable news affecting industrial development and growth in the greater Salem area didn’t even come from Salem. On December 14, 2015, the City of Woodburn and Marion County approved a remanded version of the Woodburn Urban Growth Boundary (UGB) which includes 190 acres of industrially-zoned land to be developed adjacent to Winco Foods at the SW Corner of the Woodburn interchange. The land is to be developed by Specht Properties of Portland and is estimated to be able to accommodate up to two million square feet of industrial space.

This news may have a dramatic and far-reaching effect on viability of Salem’s Mill Creek Corporate Center, the 488 acre development site owned by the State of Oregon in SE Salem, once the Woodburn site comes online in 2017. It is widely believed within the brokerage and development industries that most corporate and development buyers will likely prefer the Woodburn property over Mill Creek due to its proximity to Portland. Mill Creek is considered Salem’s best chance to lure companies paying family-wage jobs to the area. Officials say they are close to a deal on 56 acres for a food-processing company and are hoping to be on the short list for a distribution center user looking at 90 acres. The coming eighteen months are vital to the success of this park to secure users before Woodburn comes on line....[italics and Mill Creek link added]

This was in 2013; Sanyo/Panasonic just announced more

Maybe we would actually be better off if Woodburn swooped in and took this problem off our hands.

Despite $42 million in incentives, nearby Sanyo Solar just announced a second round of lay-offs. In May of 2013 they eliminated about 50 jobs, and this month they announced the elimination of about 50 more. From a high of about 200 employees, they now have about 85.

These office parks on the edges of cities require a lot of subsidy, and while they may enrich individual investors or developers, in totality, including municipal and other governmental subsidies and infrastructure, too often they cost more to service than they actually return to the community. In a memorable metaphor, they are like "dumping all [the] fertilizer on the weeds." (Via Happy City and Salon.)

Maybe we should focus instead on fertilizing our downtown and closer-in areas that already have infrastructure, meaningful adjacencies, and don't cost so much to maintain over their lifetime.

As with roads, so with industry and commercial real estate: Fix it first! It's that same old chestnut: Shouldn't we maintain and reinvest in what we already have instead of chasing after something new and shiny and expensive?

Office Space

From the piece:

The market for office buildings continues its rebound from the depths of post-recession markets that saw vacancy rates close to 20% and quality properties selling for 50%, or less, of construction costs. In our survey of 538 non-owner occupied buildings totaling 7.22 million sq. ft. the vacancy factor finished the year at just 9.1%. This is down from more than 17% in 2012. Rent growth averaged 3.8% in all property classes. Lease concessions (free rent, etc.) are minimal as the market continues to improve.

2015 leasing activity was greater than any year in the past decade with more than 335,000 square feet leased in 67 transactions for an average lease size of 5,000 sq. ft., the largest on record. Conversely, sales volume plunged to its lowest level in years with $7.5M in transactions.

2015 brought the third consecutive year of positive absorption of office space and our largest year of leasing activity in the past decade, lowering the vacancy rate. No new construction correlates into higher market rents for existing properties and fewer, if any, concessions being granted in current lease negotiations. Capitalization rates for office buildings, used to calculate investment returns on leased investment properties, fell from an average of 9.4% in 2013 to sub-7% in late 2014. The slight rise in interest rates pulled the current average rate to 7.75%.

The average sales price, per sq. ft, has risen from a low of $78 per sq. ft. in 2011-12 to $132 per sq. ft. at year end.

New construction continues to be medical related with only a few new office projects on the drawing board for 2016-17

And for 2016:

While the market continues to show considerable improvement, it lags behind the growth we have seen in the retail and industrial markets largely because of no new construction. Rents will continue to climb, and vacancy rates drop, until this is addressed. Absorption will remain positive and demand for quality space will continue even though we are now facing a shortage of quality availabilities.

At present there is only one office vacancy of any quality in excess of 20,000 sq. ft. in the market and just eight between 10,000 and 20,000 sq. ft. This will make it difficult for larger companies to locate or expand within the market in the coming year.

Look for the State of Oregon to relocate the Department of Energy (DOE) into the former Public Utility Commission building at Capitol and Marion in 2016 and the current DOE building downtown to be back filled by a consortium of non-profits.

That's interesting about the DOE move and the non-profit consortium.

One tidbit looks like it involves the vacant auto-glass shop on the northwest corner of 12th and Mission:

The planned Deepwood Medical Arts Building at Mission & 12th Streets, anchored by Mission Medical Imaging, has stalled and negotiations are underway with new partners in hopes of materializing in 2017.

Retail

From the piece, with a digest of city quadrants. It is interesting to see in this take that Kuebler is hot, and Lancaster is not:

In 2015, there was virtually no change in the vacancy rate, currently at 9.6%. However, the amount of vacant square footage increased from 419,000 sq. ft. at the end of 2014 to 433,000 sq. ft. at the end of 2015. This can be attributed to the modifications to the survey and the addition of new construction to the survey. In spite of a level vacancy rate, the overall market absorption was a positive 44,000SF because the market added almost 55,000 sq. ft. in the form of new construction in 2015. This absorption continues to be well below the normal range of 75,000-90,000 sq. ft. each of the past ten years.

South Salem continues to be the market darling, with over 80,000 sq. ft. of positive absorption, about half through new construction and half through existing space. Current vacancy is 4.4%. Expect some infill development in 2016 and pressure to develop south of Kuebler following adequate preleasing.

In 2015, the vacancy downtown increased to 8.6% as it really couldn’t better last year’s 5.2%. 8,000 sq. ft. was added to the market with South Block and 440 State, which was not marketed last year. The new vacancies at Ferry/Liberty and Church/Marion make up the bulk of the remaining increase in vacancy.

Increased leasing the former Blockbuster and at Edgewater Crossing positively affected this submarket, with its current vacancy of 2.5%. Goodwill should be constructed in 2016 and there are plans in the works for development at SW corner of Glen Creek and Wallace Road.

The Lancaster Drive corridor continues to languish. For there to only be a change of 11,000 sq. ft. to the vacancy in a market of over 1.6 million sq. ft. is remarkable. All positive absorption in small shop leasing has been erased with vacancy of Kelly’s Design Center and the former pet supply store on Market Street.

With the closing of Haggen Foods, the vacancy in this area [of Keizer] increased to 13.7%. If the Keizer Schoolhouse Square and the Haggen vacancies were filled, the market vacancy would be 4.2%, so the bulk of the “problem” in the market is targeted in these two properties.

Looking to 2016, the preference for "big box" is a little alarming!

Last year’s prediction of slowed absorption was realized. Areas of town with the highest vacancies have the least amount of demand. For 2016, I am a bit stumped. There is not a lot of high-quality space to backfill. There will be continued redevelopment in South Salem, and with the ownership change at Keizer Schoolhouse Square, hopefully the Keizer market will see some positive absorption in 2016. There are a number of projects on the drawing board for South Salem as that area continues to be in high demand. There is a continued lack of existing mid-large box spaces in Salem which will impact growth in the market for the time being.

Currently, there are four existing opportunities for retailers looking for over 20,000 sq. ft. Three of them are in Keizer (former Office Depot, Roths and Haggen) and one on Lancaster (former St. Vincent de Paul). There are no existing opportunities for retailers looking for more than 45,000 sq. ft., forcing newcomers to the market to look to new development to support expansion.

There are currently seven projects in South Salem, ALL along Kuebler or south of Kuebler, in various stages of feasibility, preleasing, or development. This would bring over 500,000 sq. ft. of new product to the market, which is similar in size to all of Keizer Station. It remains to be seen what sort of pre-leasing will happen during this market cycle that will allow these projects to take shape and deliver to market.

The amount of square feet constructed in 2015 for retail use...is great news and a testament to the feasibility of new construction in the market. However, please remember that ALL except about 4,000 sq. ft. was leased prior to the start of construction. Speculative development has not yet returned to this market.

As "the establishment" talks about the "continued lack of existing mid-large box spaces in Salem," we also need to consider how inefficient they are at generating value.

This is a central piece of the Strong Towns analysis. Downtown mid-rise, even neighborhood main street two-story development, is much more efficient at generating value/acre. Big box is wasteful!

Mid-rise downtown development generates 10x
property tax/acre over suburban big box sprawl
(see here for discussion and image credit)

Chasing after new big box construction on the edges of the city is counter-productive and depletes the city overall. And is all this development along Kuebler what we really want?

The latest Kuebler Station concept
with Morningside NA comments
(from the Staff Report for Planning Commission)

There will be a zoning hearing for the proposed "Kuebler Station" at the Planning Commission on the 1st, by the way. The Staff Recommendation is for approval. (Why is it so easy to convert land zoned "residential agriculture" to "commercial retail" for a strip mall?)

The efficiency of main street development is an important point also for the State Street Study! Two- and three-story projects there will likely be much more efficient than single-story boxes on the edges of the city.

One other tantalizing item was in the paper, but not the brochure:

[Jennifer] Martin said she was excited to see the redevelopment of the recently closed Barrick Funeral Home. She wouldn't disclose any further details, but said she was nervous that the proposed use of the building would be met with "mixed emotions" by the community. [link added]

It's hard to know how to read this. Is this a comment about NIMBYism in Salem? Or is this a comment about a project that's actually not very good? Hard to say, but it will be interesting to watch!

Anyway, do you see any interesting patterns in the 2015/2016 overview from the brochure that is worth more comment?