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“Nabbefeld”
Joe Nabbefeld
Real Estate Editor

October 19, 2000

Real Estate Buzz: Overbuilt? Locals dispute FDIC report

The FDIC's recent inclusion of Seattle on its list of cities potentially heading into a painful overbuilt condition rankles some locals who think the bank regulators didn't measure all the data.

As downtown Seattle developer and investor Greg Smith put it, "I don't think they looked very deep."

Said seasoned developer Jon Runstad, a survivor of past over-builds: "I'm not sure how they got their conclusion."

Bob Filley has fewer reasons to insist the outlook remains sunny. Filley, director of the University of Washington's Center for Community Development and Real Estate, agreed to read the FDIC's full report and give The Buzz his feedback.

In short, he disagreed with the FDIC too.

"After reading the report? No," Filley said. "My gut feeling is a lot of space is going to turn over (during the Internet company shakeout). But it won't be the same (as the desultory early '90s). It won't be that bad."

We'll know sooner rather than later, too, Filley said.

"Oh, I think this is going to happen pretty quickly, because capital (for dot-com companies) has dried up pretty quickly. We should have a better feel for this in the next 12 months."

The FDIC's main concern was with rising numbers of loans on commercial buildings made by banks that the FDIC insures and regulates.

The FDIC calls this "exposure," the risk that loans won't get paid back to the banks, which would mean the FDIC takes the losses.

For this year's first quarter, Seattle-area community banks (those with fewer than $1 billion in assets) had increased their exposure to a level of 36 percent of their loan portfolios in commercial real estate, the FDIC found.

Local developers wondered if the FDIC had looked solely at the high volume of office construction activity throughout the Seattle area, which by itself can be misleading. The developers point out that because so many tenants want space, we are seeing record rates of absorption, with space snapped up as soon as it becomes available.

Vacancy rates remain at extremely low levels, indicating tenants still demand more space, they said.

The FDIC report includes this information. The key appears to be the FDIC's forecast, produced with the help of Torto Wheaton Research, that the area's stunningly high absorption rate will plummet this year.

Absorption not only soared in 1997 to more than 3 million square feet, according to the FDIC. It also outstripped the supply of newly leasable space, which totaled about 700,000 square feet for 1997.

Absorption rose to about 3.2 million for 1998, while new space hit about 3.1 million.

For 1999, both absorption and new construction came in at 4 million.

The FDIC projects new space to soar to about 6.5 million square feet for this year while absorption drops to less than 3 million.

Absorption would rise again for 2001 to almost 6 million square feet, with another roughly 6.1 million square feet of new space coming online, by the FDIC's forecast.

The prediction for this year would seem likely to widely miss the mark.

The brokerage firm Kidder Mathews & Segner calculated that absorption in King, Pierce and Snohomish counties totaled 3.5 million square feet for just this year's first half. CB Richard Ellis tabulated another 2.3 million square feet of absorption for the third quarter. Thus, with a quarter to go, the area roughly doubled the FDIC's prediction.

Developers and brokers argue that much of the space under construction is pre-leased, so when that space comes on the market as part of the new space total, it will come on as absorbed.

This suggests a plunge in absorption likely won't happen next year either.

The pivotal question, Filley said, is how much space currently considered absorbed will be vacated during the dot-com shake-out. For now, dot-coms haven't given back enough to throw off the market.

Filley would like to see a survey of how much space dot-coms and other "new economy" tenants actually occupy in this market. "We don't really know the proportion of dot-coms to the market."

That said, Filley's not disappointed that the FDIC spoke up and received so much attention, whether the report hit the mark or not.

"Anything we do to try to understand markets better and warn of potential overbuilding and imbalances is a good idea," he said.

After all, every development cycle so far has ended in overbuilding to one extent or another. No one disputes that. Generally the question is when and by how much, not whether it will happen.

Runstad said the FDIC may even have reduced the severity when it hits.

"I would never say that it couldn't happen," Runstad said. "I think the FDIC's action probably reduces the chance that it will happen because it causes lenders and investors to be more cautious, and we welcome that."


On a lighter note

What a great restaurant space the large and ornate mezzanine of the Dexter Horton Building would make.

But for now, brokers Dan Dahl and David Gurry think it may become an office supply store or a dining-and-relaxation open area leased by a tech company that would also take offices upstairs.

The space, at the base of the historic building near Pioneer Square in downtown Seattle, currently houses the city of Seattle's Department of Design, Construction and Land Use.

The CB Richard Ellis brokers have begun marketing parts of the building, including the roughly 18,000-square-foot mezzanine, that will soon become available as city agencies move into Key Tower. Investor John Goodman and the Carlyle Group bought the Dexter Horton from the city earlier this year.



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