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November 10, 2008
Seattle was recently picked as the top commercial real estate investment market for 2009, but the Emerging Trends in Real Estate report that made the prediction also said the Emerald City will see rising office vacancies, flat office rents and a dramatic drop in condo sales and presales next year.
Clearly, this area isn't immune from the national economic troubles and the global credit meltdown.
The Seattle Daily Journal of Commerce talked to several local players about their views on the greater Seattle market. Here's what they said:
Dan Ivanoff, Schnitzer West's managing investment partner, said the Seattle office market won't be oversupplied in the next two years, despite a number of spec buildings coming on line, because jobs, wages and population are still growing.
Ivanoff said some mid-level brokers quoted recently in the press “pontificate about space coming on line, not fundamentals. My opinion is (those) brokers don't do their homework when they're out there flapping their mouths.”
His firm factored into its models a year ago that Washington Mutual may give back a sizeable chunk of its downtown Seattle office space. WaMu, which was recently acquired by JPMorgan Chase, leases or owns 1.6 million square feet downtown.
Ivanoff said Schnitzer West expects to lease half its 660,000-square-foot 1918 Eighth office project in Seattle by early next year, and has rented 75 percent of its 238,000-square-foot 818 Stewart.
Ivanoff said developers are looking at “every arrow in the quiver” to attract tenants. “(Tenants) are paying close attention to what they're taking down because of all this economic crisis.”
Schnitzer West won't decide until next year when to start another office project — the 750,000-square-foot M5 Commerce Centre at 505 Madison St. — and won't move forward without a big prelease, Ivanoff said.
“There won't be a lot of new buildings built that aren't financed right now,” he said, but the Puget Sound region won't suffer like other areas of the country.
Ivanoff said the “real bugaboo (is) if the lending community continues to horde cash.” If they don't reopen borrowing to businesses that need short-term money, that will hurt tenant demand.
Tight lending policies are good because they constrain supply, said Ivanoff. And even now, well-capitalized players can get buildings constructed with their own money or with partners, he said.
“Larry Benaroya can get something built,” he said. “I guarantee you we can get something built. Vulcan can get something built ... Tarragon can get things built, Opus can get things built.”
For mid-level developers, “I think it's tough. I think it's very tough, (but) there's banks that are still in the game.”
On the residential side, he said the Seattle condo market has softened. Sales at his firm's projects are slower than a year ago, though interest is strong, but there won't be an increase in demand for at least a year, he predicts.
Potential buyers at Schnitzer West's The Bravern condos in Bellevue are attracted by the retail and restaurants, he said, but some are waiting to see the effects of the bailout before signing on. Since mid-February, 25 percent of the 455 The Bravern units have pre-sold, he said.
But he said other downtown Bellevue condo projects may not be faring well.
“We have heard some very disturbing stuff about some of some of those high-rises,” he said. ... “We have been told by people in the selling community, the brokerage crowd, that there are properties in the Bellevue CBD that have not sold stuff since December.”
Wright Runstad & Co.
Greg Johnson, president of Wright Runstad & Co., predicts some unannounced big users will lease office space in Seattle. “Microsoft is the one that's rumored the most and I think that's a pretty good rumor.”
But more space is being added to the sublease market, and downtown is feeling the effects of the Heller Ehrman law firm dissolution and Starbucks reductions, and will face the “inevitable further reductions” of Washington Mutual and Safeco employees, he said.
“It was the law firms and corporations and financial institutions driving demand,” he said. “Now none of those are in the expansion modes.”
“When there isn't job growth, office buildings don't get full,” he said. “They get more vacant and when they're getting more vacant, the rents go down.”
“The only hope,” he said, is a big user from outside the market.”
Still, Johnson said, “I am not in the camp that says the sky is falling, because we don't have massive overbuilding.”
“We're definitely not in the boat of the dot.com blowup (but) there will be a better balance between landlords and tenants,” he said.
Conservative, well-capitalized companies, like Wright Runstad & Co., will win in this market, Johnson said, while over-leveraged firms with lots of un-leased office space are most exposed. Compared to past downturns, however, developers in the Seattle area with projects under way are better capitalized, he said.
Microsoft's voracious demand for office space has saved the Eastside, he said, leaving Bellevue better positioned to weather a downturn than Seattle. “The more Microsoft we see in Seattle, the better it is for Seattle.”
Now, he said nobody can get a loan to buy office properties locally, he said. “Once the credit crunch eases up we're going to be in a better shape than most.”
Office buildings won't sell for as much as they did last year for the foreseeable future, he said. “Just like our stocks weren't as valuable six months ago, our buildings aren't as valuable as they were six months ago.”
On the residential said, Johnson said the Bellevue condo market is suffering like Seattle's, but there haven't been big discounts.
Kevin Daniels, president of Daniels Development Co., is monitoring the office, financial and credit markets to determine whether to re-start in March its 43-story, 798,000-square-foot office tower slated for the former First United Methodist Church site at Columbia Street and Fifth Avenue in downtown Seattle.
“I couldn't say that we are and I couldn't say that we aren't,” he said. “If there was one significant event that really caused us to pause and reflect it is what's going to happen with WaMu.” If WaMu gives up substantial lease space downtown or lays off a lot of people, Daniels said construction may be delayed.
Daniels said his firm and its partners had “great terms” on the project, but had to put in significantly more equity than they anticipated. However, he said that wasn't a big deal and “it didn't stall the project.”
On another front, Daniels Development and Opus Northwest could start building the Qwest Field north lot project late next summer, he said, but that is dependant on market conditions. Seattle's commercial real estate market is holding up better than many, he said, and its large, well-funded institutional owners “don't get panicky.”
“They have the money and experience to know what goes up comes back down and what goes down comes back up over time,” he said.
Daniels sees the local office market improving by early 2010, but if WaMu has big layoffs “all bets are off.”
Daniels said Bellevue's condo market is slow because buyers can't get financing and speculators have left. “I certainly would not want to be in Bellevue.”
Larry Benaroya, Benaroya Co. principal, said few big deals are getting done today because lenders are being careful and high-leverage is out. “This market just needs to stabilize.”
Prices are dropping for less desirable assets in smaller markets, including in areas like Yakima or for Federal Way retail space, but he doesn't anticipate prices declines for “really good stuff,” like downtown Seattle retail.
“Down the road I think the good stuff will sell for what sellers are asking for it and the not-so-good stuff will sell for what buyers want to pay for it,” he said.
Benaroya said apartments will still get built because of demand, but condo development will be very tough.
His firm is offering seller financing on commercial buildings, such as the former King County Journal building in Kent, which Benroya revamped for LA Fitness, and three office buildings in its Park Place Plaza development in Everett.
“I haven't really seen other people offering seller financing, but they certainly could,” he said.
Kemper Freeman Jr.
Kemper Freeman Jr., chairman and CEO of Kemper Development Co., said, “The only thing more scary than being in trouble with your lender is to have your lender be in trouble when you need them. What's different about right now is the borrower's OK and the lender isn't. That's spooky.”
The greater Seattle and Eastside commercial real estate market is “as good as it gets in the country,” Kemper said, but it's not immune to financial/credit market problems. He predicts erosion through 2009, stabilization in 2010, and he hopes for a turnaround in 2010 and 2011. “Even though we may be the best in the country, you can't have this stuff go on and not affect us, too.”
Freeman predicts the local condo market won't pick up for two to three years. “That's a long time to sit there sucking your thumb with a building that's designed to be condos.”
Some developers may rent their condos as apartments, which likely will put them “under water” and perhaps in danger of losing a project to the lenders, he said.
“If you're building condos and are highly leveraged, you're not sleeping too well,” he said.
Consumers are putting off purchases, which is hurting Kemper Development's Bellevue Collection with its 300 retailers. So far in 2008, sales are slightly under last year, but quite good relative to other shopping centers, he said.
“You just can't have every newscast full of ‘the world's coming to an end' and people going about their business,” he said.
Kemper Development has built about 4 million square feet of space over 60 years and has about 2.5 million on the drawing boards, he said. It will wait for a better market to move forward with more development.
“I am thankful every day that I am not starting something right now or in the middle of something right now,” he said.
Real Capital Analytics
Dan Fasulo, managing director of Real Capital Analytics, a New York-based real estate research and consulting firm, said every major market has been affected by the credit meltdown and poor economy.
While $2 million to $20 million transactions are getting done in the Puget Sound region, “the type of trophy deals you were reporting on last year in Seattle are just basically non-existent,” he said. “The easy money that was there for the plucking is gone.”
Almost all the Equity Office Properties' deals were financed by commercial mortgage backed securities, which are not available anymore. “Tens of billions of liquidity disappeared.” Many investors have to go to insurance companies or regional banks, and they're saying “those numbers don't make sense any more,” Fasulo said.
Through September, there were $2.4 billion of commercial property sales in King, Pierce, Thurston, Kitsap and Snohomish counties, 90 percent of them in King, he said. In all of last year, there were $18.1 billion, but that's inflated by the EOP sales and subsequent spin-offs, Fasulo said. In 2006, there were $7.7 billion.
“Investors are really confused,” he said. “When investors are confused they shut down. They don't buy. They hang on until the sky is clear. And that's what we're seeing now.”
The Emerald City is helped by its expanding companies and lack of domination by housing and finance industries, Fasulo said. “On relative terms, I would definitely conclude that Seattle is holding up better than many of its peer markets across the country.”
The strong tenant base helps, although downsizing by Washington Mutual would hurt, he said. That the buyers of the EOP spin-off office buildings are very well-capitalized also is good, he said. But Fasulo expects no office buildings to get built without signed tenants in the greater Seattle area in the foreseeable future.
“If Microsoft comes to a developer and says ‘build me a building' that might happen,” he said. “Besides that, there's going to be no speculative development.”
Matthew Gardner, principal with the land-use economics firm Gardner Johnson, said banks aren't lending any money for development.
“The only light that were seeing now is in the apartment world” where there is funding via Fannie Mae and Freddie Mac, “but they're mandated to pull back on their lending by 2010,” he said.
Developers today have to put down a lot more equity. Gardner said the 90 percent/10 percent debt-to-equity ratios are gone. Now it's 60/40.
In Seattle and Bellevue, commercial and residential projects are getting entitled, but developers don't have the money to build, Gardner said.
“Very few of the condominium projects in the Puget Sound region have financing in place and that is why we've seen no projects break ground for several months,” he said.
In Seattle, there's concern about the amount of speculative office space set to be delivered in the next couple of years, he said, but in Bellevue it's a different story. Boston-based Beacon Capital Partners is “showing extreme confidence” in the market by proposing adding a high-rise to its plans downtown, he said.
“The necessity of having a downtown Seattle presence doesn't apply anymore,” he said.
In real estate in general, “cash is king right now,” he said. Investors are looking for distressed properties in Southern California and Oregon, but not yet in Seattle, he said. “We're not seeing sufficient distress in this marketplace.”
CBRE Melody Co.
Michal Makar, executive vice president of CBRE Melody Co.'s Seattle office, said it's very difficult to get construction loans for commercial buildings. Even developers with well-conceived projects must provide 30 to 35 percent cash equity, while a year ago it was 20 percent, he said.
A year ago about 15 lenders would consider the loan. Now there's two or three and they say, “These are our terms. Hope you like them because I can't guarantee they'll be there tomorrow,” Makar said.
His said his firm recently was doing a loan “and a particular institution got hit with bad news and had to withdraw their proposals even though we were way downstream on the closing process.”
Now borrowers are questioning the viability of lenders. “What happens if your lender is such that in the middle of construction he can't get the funds to give you funds?”
Banks worry about having too much exposure to real estate and are trying to conserve cash, “and they're getting encouragement from regulators to reduce that exposure to real estate,” he said. “Selected banks are getting that kind of pressure.”
Makar said real estate equity funds are buying real estate-related loans from distressed financial institutions as there's better returns doing that than development deals.
“It's harder and harder to get money for development deals,” he said.
He said he's seeing people with land who can't get construction loans for development projects, “and the banks are saying ‘pay off my land loan.”'
Business Growth Consulting
Julie Benezet, principal Business Growth Consulting, a management consulting firm with a large number of real estate clients, said, “We're not totally frozen, (but) the whole pace is slow.”
Few loans are being made and only to credit-worthy, cash-rich borrowers, she said, and few leases are being signed. Design firms, engineering, development, property management are laying off employees, but not on a large scale.
“There's hardly a company that is escaping that,” she said.
“Seattle was the golden-haired child of the country,” she said, but with unemployment rising, it won't remain untouched.
In the acquisition of Washington Mutual by JPMorgan Chase, “the big question is how much (leased) space is going to be vacated.”
Given the economic environment, area real estate companies have their heads down and are continuing to get development permits. She said the people who are going to win are those who understand real estate and have “a big stack of cash sitting by.”
Brian O'Connor, principal with Seattle-based O'Connor Consulting, called Bellevue the one to watch in terms of condos sales: “It's bad.” The three major projects downtown have about 800 unsold expensive high-rise units, he said.
Recently, each project was preselling about one unit every two months. He said if the economic climate improves, and “optimistically” each building could sell four units a month, it would take 68 months to run through the inventory.
In 2005, “when these buildings were conceptualized,” everything was pre-selling, he said. “You just announced a project and you were done.”
“I think something's got to give in Bellevue,” he said.
In the downtown Seattle market, condo sales figures don't look as bad, he said. The project with the biggest “overhang” is Escala, which he said was the last to get under way and is the biggest.
Anthony Gibbons, principal of Re-Solve, a Bainbridge Island appraisal company, said if you don't need to sell or refinance commercial property investments now, you are doing very well. But if you're involved in sales or mortgage transactions where people are relying on debt to finance or refinance “it's a big negative” because lenders are requiring more value to loan ratio, he said.
Two years ago they might have loaned on 75 percent of the price, now it's 55 percent. And if rents don't rise on the more risky loans that rely on future performance, those investors/developers have a problem, he said. “Now we're coming back to real fundamentals: How is the property operating today?”
Gibbons said that there are a lot more seller-financed deals. “It's better than trying to put your money in the stock market.”