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March 14, 2013

Developers, lenders cautious without anchor tenants

  • To get more cranes in the air, office developers will have to build on spec or a large tenant will have to rent at above-market rates.
    Wallace Properties


    As a guy who has been doing business on both sides of the lake for decades, I am always amused by the number of Seattle’s luminaries who view Bellevue as the 17th century British viewed the Colonies. It’s a perspective that hasn’t changed in a long time.

    When my parents announced to our Magnolia neighbors in 1958 that we were moving to the Eastside, they reacted with the same perplexity that I must confess when someone from Bellevue says he’s moving to the Plateau. Who on earth would want to visit, let alone live there?

    That same snobbery exists in reverse. Tens of thousands of Eastside residents and workers take a certain pride in rarely, if ever, crossing the bridge to Seattle. We have the best shopping, free parking, superior schools, biggest churches, safest neighborhoods, most open space, and generally, sanest politics. Who on earth would want to visit, let alone live there?

    All that parochialism on both sides is a shame, because both areas contribute to the strength of the region. In most cases, what’s good for Seattle is good for Bellevue, and vice versa. We wouldn’t have the quality of life we enjoy on the Eastside were it not for Sea-Tac International Airport, the county seat, cultural and sports venues, universities and businesses of Seattle. Likewise, Seattle would still be a bit of a backwater nationally were it not for the economic powerhouses and future potential of the Eastside.

    It’s that future potential on both sides of the lake that should interest us all. Any community either grows or atrophies, and there isn’t a region in the U.S. that wouldn’t kill to have some of the dynamics that exist in this area.

    Throughout the Puget Sound region, aerospace, biotech, finance, law, software, education, real estate, gaming, construction, health care, retail and more are at the top of their game and growing like crazy. These are all industries of the future, and it’s this fact that has made greater Puget Sound one of the most targeted real estate investment markets in the U.S.

    Urban tech workers

    While these economic trends are affecting the region, demographic trends are also having a major impact. The reality is that knowledge workers are exhibiting a preference for urban living and working. Employers competing for the brightest and best have concluded that commuting by elevator rather than shuttle bus makes sense, and this is driving their facilities choices to places like Pioneer Square, South Lake Union and downtown Bellevue. Thanks to Amazon’s incredible growth, South Lake Union is on fire.

    Thanks to technology companies like Microsoft, Expedia and a host of game developers, as well as numerous mainline firms like Paccar, Clark Nuber, Symetra, Eddie Bauer, Perkins Coie, CH2M Hill and more, downtown Bellevue is full.

    If you need 50,000 square feet in downtown Bellevue, you’re basically out of luck. So, with occupancy rates so high, when is the next office development likely to happen?

    Ask those who control the land. They all say they’re ready to go. Each has the best location, best architect, best plan, fastest delivery and so on. But, unlike in earlier cycles, developers and lenders are reluctant to proceed absent anchor tenants.

    There appears to exist about a $5-$10 per-square-foot discrepancy between today’s market and what it takes to justify new development. So, what it will take to see new cranes in the air is one of two things: a developer who has the financial capacity and intestinal fortitude to build on spec; or a tenant who needs enough space that doesn’t exist who is willing to make a forward commitment at a rate that’s a little more painful than current market.

    Bellevue has become a market for the titans, and it is dominated by some of the biggest players in the industry: Rockefeller, Beacon, United Dominion, Kemper, Bentall, Wallace (just kidding).

    Most of the sites in the permit pipeline would require 200,000-300,000 square feet of anchor commitment to launch under traditional standards. So the real question is, where is that commitment expected to come from? Not likely from a traditional enterprise. Paccar seems pretty stable in its decrepit headquarters, Boeing isn’t likely to move to downtown Bellevue, and insurance giant Symetra has renewed at the Symetra Financial Center.

    Uncharacteristic restraint

    The reality for Bellevue is the same as for Seattle. It’s going to take a strong developer willing to gamble on the speculative market or a strong tenant willing to sign up in advance for a premier product to catalyze the next wave of development in either market.

    What is interesting about this situation is that everyone seems to be exhibiting prudence. In earlier periods, the old saw “give a developer the money and he’ll build whether there’s any demand for his product or not” would have prevailed. That’s why in every other cycle, we saw see-through buildings.

    Today, it appears that developers, investors and lenders are exhibiting uncharacteristic restraint. Likely lessons learned from the recession, likely prudent, likely good for the industry — but, not necessarily good for the market.

    Markets can’t grow if they don’t have space. Some of Bellevue’s most remarkable growth resulted from an inventory of surplus space. In the early ’80s, the downtown needed an additional 100,000 to 200,000 square feet of space. Developers built six or seven times that amount, and it resulted in a lot of empty buildings. While the investors suffered, the vacant space represented a vacuum that attracted countless businesses that helped grow our economy in succeeding decades.

    Decisions on when to pull the trigger on new development aren’t based on what’s good for the local economy; they’re based on what makes economic sense for the developer and his investors. Based on that, who is likely to pull the trigger first? Beats me. Real estate deals are based on both capacity and motivation.

    Does the player have the financial capacity and expertise to proceed as well as the motivation to do it? And is the risk-reward ratio attractive?

    Most of the entities that control feasible sites in downtown Bellevue have the financial capacity to do whatever they want. Beacon could probably build a 500,000-square-foot building and let it sit empty for five years and consider the loss a rounding error. But, the opportunity-cost loss likely represents a deterrent.

    My bet is on Bentall and Kemper Development. Both control premier sites, have unlimited financial capacity, and are local players fleet-footed enough to know all the likely tenants and be able to respond to their needs. However, both have exhibited restraint in shelving projects when the economics didn’t make sense.

    The good news is that Bellevue is thriving, demand is exceeding supply, and the area can expect the return of the construction crane soon.

    Bob Wallace is CEO of Wallace Properties, a commercial real estate investment, development, brokerage and property management firm based in Bellevue. He is past chair of both the Bellevue and Seattle chambers of commerce, and has been active in business and civic affairs on both sides of the lake for 40 years.

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