December 10, 2009

Bellevue’s office market more ‘fit’ than Seattle’s

  • Unlike Bellevue, Seattle is dealing with a record level of speculative construction.
    Cushman & Wakefield


    When Herbert Spence first coined the phrase, “Survival of the Fittest” in 1851, he was referring to the process of natural selection, and certainly not to the office markets in the Puget Sound region.

    The term now commonly refers to the continued existence or the rise of a prevailing entity or individual. Using this theory, it wouldn’t take a 19th century philosopher to understand that Bellevue has emerged from the worst global economic downturn as the “fittest” of our two largest office markets.

    As many other markets in the country grappled with ongoing recessionary concerns during the latter part of 2007 and 2008, Seattle and Bellevue were two of the fittest markets in the country, following historical trends and lagging the nation by a year. In fact, after slight gains in job growth in 2008, economists were predicting that employment would level off by the end of the year, and could potentially post only modest losses in 2009.

    In the 12 months ending in September, however, the region lost approximately 65,680 jobs, or about 47 percent of the jobs that were created from 2005 through mid-2008. Also, it is predicted that a total of more than 83,000 regional employees will lose their jobs by the second quarter 2010, with more than 24,000 of which attributed to office-using industries.

    As we all know, the health of our real estate markets is predicated on jobs. Yet, continued layoffs throughout the region, where the unemployment rate has reached 9.3 percent, are contributing to growing vacancies for both the Bellevue and Seattle office markets.

    Consider the challenges that even our most stable employers faced in 2009. Microsoft, long thought to be recession-proof, laid off employees for the first time in company history. The failure of Washington Mutual resulted in the loss of nearly 3,400 jobs at its downtown Seattle headquarters.

    Boeing, still the region’s largest employer, has been faced with setbacks of its own. The company had approximately 5,000 layoffs this year and the eight-week strike in late 2008 pushed the roll-out date of the new 787 Dreamliner further into 2010. Adding fuel to the fire is the recent announcement that Boeing selected South Carolina as the site for its second production line for the jetliner.

    Tough markets

    Images courtesy of Cushman & Wakefield [enlarge]
    Bellevue’s office vacancy rate will level off before Seattle’s.

    Downtown Seattle is in one of the toughest real estate climates it has ever faced. Landlords are drastically reducing rental rates in response to a record level of speculative construction and rising vacancies, and tenants are delaying decisions about relocating in hopes of seeing further rent reductions and concessions.

    Negative absorption is at unparalleled levels at 1.9 million square feet, and vacancy is at an all-time high at 18.5 percent, compared to the previous high of 16.5 percent in 2003. Additionally, average rental rates in the Seattle CBD are down 20 percent at $28.75 per square foot from the same period a year ago.

    Unlike Seattle, Bellevue is not faced with the unprecedented level of speculative construction activity, and that has resulted in rents remaining somewhat elevated in comparison to Seattle. However, Bellevue has seen its share of decline over the last 12 months.

    Overall vacancy in the Bellevue CBD was at 14.8 percent in the third quarter of 2009. That compares to 10.8 percent at year-end 2008 and 9.5 percent over the previous 12 months. Average rental rates in the Bellevue CBD were at $34.24 per square foot for all classes in the third quarter of 2009, compared to $39.96 per square foot one year ago, which accounts for a 13 percent drop.

    Despite the decline, year-to-date absorption was at positive 337,900 square feet by the end of 2009. The primary contributing factor for this positive trend was the delivery of 748,000 square feet at The Bravern, which was fully pre-leased to Microsoft.

    Market trends

    The economic decline is resulting in a growing number of subleases around the region, though the impact is thus far less severe than during the bust earlier in the decade. More than 2.2 million square feet of sublease space was available in the region by the end of the third quarter. This compares to a peak of more than 4 million square feet in the third quarter of 2001.

    Also on a positive note, deal velocity is picking up, largely in the form of lease renewals, which is being driven by the high cost of relocation and landlords’ motivation to retain existing tenants. Also, thanks to the recent surge in new deals, approximately 1.4 million square feet of leasing activity was recorded by the end of third quarter (excluding renewals), compared to 1.5 million square feet in the first three quarters of 2008.

    A surplus of office space in the Seattle market means rental rates will be more volatile on the down side.

    Those tenants that are moving from one space to another seem to be doing so because of lease expirations and often involve moving into smaller spaces. More tenants are working with their brokers to negotiate early lease renewals, and are frequently able to blend their current higher-priced rates into more aggressively priced lease extensions.

    2010 outlook

    There are modest signs that the regional economy is beginning to stabilize. Job losses seem to have peaked and, according to Moody’s, employers should begin to add jobs to the region beginning in mid-2010. Although, annualized growth is not expected until 2011.

    The housing market is also gaining momentum, buoyed by the homebuyer tax credit, and prices appear to be leveling off. While foreclosures were up 38 percent during the third quarter from the same time in 2008, the number has dropped substantially in 2009. Real estate fundamentals generally lag the overall economy and, even when employers begin to increase payrolls next year, it is unlikely many will be in the position for expansion.

    Unfortunately, the vacancy for downtown Seattle is expected to climb to around 21.2 percent by the end of 2009 and could further increase to 23.1 percent in 2010. With higher vacancy, rental rates naturally should continue to deteriorate through the balance of the year and into 2010. We estimate another 3.2 percent decline in rents by the end of the year, followed by another 4.7 percent drop in 2010.

    Conversely, the Bellevue market should begin to flatten during the next 12-16 months. Vacancy will likely reach around 15.7 percent by year-end and flatten for all of 2010. The same will be true for rents, which we expect to decline slightly by the end of the year, but show modest gains by the end of 2010.

    In comparison, the amount of new product coming onto the Seattle market with minimal pre-leasing simply cannot be overlooked. Although the region will survive this cycle like every other in the past, we will see a continued slide in 2010 with Bellevue continuing to be a much more “fit” office market than Seattle.

    John Miller has been involved in the Puget Sound real estate market for 17 years and is the senior managing director of the Pacific Northwest offices for Cushman & Wakefield.

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