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September 10, 2009
A few years ago an out-of-town real estate investor, examining an aerial photograph of downtown Bellevue, asked in jest, “Is this Bellevue … or Shanghai?”
We laughed, but in truth the large number of construction cranes dominating the photo indicated that an explosion of growth was indeed transforming the city. Perhaps not to the same degree of volume that Shanghai was experiencing at the time, however the sheer diversity of projects represented by those cranes was unprecedented in Bellevue’s history and was certain to have a profound impact on the city.
Fast forward to today and the city skyline reflects the addition of new hotels, high-end condominiums and apartments, luxury retail and several new Class A office towers.
Today Bellevue possesses a vibe it never had in the past, when it was better known as a place where the sidewalks rolled up after 5 p.m. and people got in their cars to travel half a block. The sidewalks are now alive with pedestrians in both the daytime and evening, and it has clearly evolved into a sophisticated regional entertainment and retail destination as well as a leading center for business.
Photo courtesy of Pacific Real Estate Partners
Bellevue’s skyline, shown here in 2007, has seen the addition of new hotels, residential towers and several office buildings.
Looking specifically at the office sector, four new towers have been completed in the past 14 months, adding roughly 1.8 million square feet to the office base, which now totals over 9 million square feet, according to CoStar. These include the Expedia Building, Bravern I and II, and City Center Plaza.
Demand for this new office space can be summed up in a word: Microsoft. The seemingly ever-expanding software giant leased the entirety of the office component of The Bravern and City Center Plaza. So despite a 20 percent increase in the amount of office inventory and a severe economic recession, the overall vacancy rate in Bellevue currently stands at a relatively healthy 11.8 percent, and there is no additional office construction on the immediate horizon.
Compare this with downtown Seattle where the vacancy rate is 11.0 percent but over 4 million square feet of new office space is currently under construction with no significant pre-leasing. It is anticipated that the vacancy rate in Seattle could near 20 percent in the foreseeable future.
While the office market in Bellevue appears to have a more optimistic near-term outlook than its larger counterpart across the lake, the economic downturn has nonetheless taken its toll.
Apart from the new towers, leasing activity in 2009 has been sluggish at best, with tenants fearful of committing to new lease obligations. Rental rates are on the decline and quoted asking rates have fallen approximately 10 percent, or over $3 per square foot, since last September.
Unfortunately, this trend is not likely to reverse itself until our region starts to see a drop in unemployment, which was at 8.9 percent as of June. According to the Puget Sound Economic Forecaster’s latest update, employment is not predicted to improve before the middle of 2010.
While the investment market in Bellevue had been red hot, the credit freeze that started in late 2007 caused property transactions to come to a skidding halt, and it has remained at a standstill ever since.
Eight major central business district office buildings sold in 2007, and several of those traded hands multiple times within the year, representing a significant diversification in the ownership base. In 2008, only one major property transaction closed the $47 million sale of Pacific First Plaza. Thus far in 2009, not a single office transaction for more than $10 million has occurred throughout the entire Puget Sound Region.
During the peak volume years of 2006 and 2007, pricing for office assets in Bellevue was on an upward trajectory, with per-square-foot prices averaging $405 and exceeding $500 in some instances. Meanwhile, capitalization rates annual net operating income divided by the sales price tumbled into the 5 percent to 6 percent range.
The current lack of transaction volume makes it difficult to quantify the impact of the recession and credit market turmoil on property values; however the unofficial consensus within the investor community is that office values have dropped at least 25 percent and possibly as much as 50 percent. The validity of that sentiment is yet unproven with hard data points, however multiple curtailed attempts by owners to sell office assets over the past 18 months indicate that a vast bid-ask spread on pricing between buyers and sellers persists.
The economic experts are now stating that the national economic recovery has begun, but that it will be slow. The first signs of real growth are not expected until the middle of 2010, and the Puget Sound Economic Forecaster predicts that our region will lag the rest of the county slightly in recovery, just as it did going into the downturn.
Assuming that is true, the Bellevue office market should experience further weakening in vacancy and rental rates over the next three to four quarters before stabilizing. Although rental rates have thus far backslid to 2007 levels, market vacancy is not expected to reach anywhere near the levels witnessed during the tech bust in 2001-2002 when vacancy in downtown Bellevue surpassed 20 percent.
Immediate market discomfort aside, there is no doubt that ultimately the recent building boom is to the long-term benefit of the city. Bellevue’s transformation from a sleepy bedroom community into a vibrant live-work urban environment will better position it to complete in the global business community. It certainly has become a much more interesting place to work and play!
Lori Hill is a principal with Pacific Real Estate Partners, where she specializes in the disposition of retail, industrial and office properties in the Puget Sound and Portland markets.
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