[Commercial Marketplace]
March 12, 1998

Seattle real estate is climbing the charts

The Norman Company

If the commercial real estate market across the United States is red-hot, then color Seattle and its surrounding commercial sub-markets as white. As in white-hot. Blazing. Number four or five on the national hit parade, and climbing.

The Seattle CBD's vacancy rate hovers just below five percent, nearly five percentage points better than the national average in other downtown markets. Vacancies in some of the surrounding sub-markets -- most notably, Bellevue -- are even tighter.

Yes, Seattle's office sector is on every major investor's radar screen, and over the past several months we have experienced first-hand the insatiable appetite of national commercial real estate players. Quality Class A office product, when available in the Seattle market, sells fast.

Who's buying? Publicly traded real estates investment trusts, or REITs; major international developers; foreign buyers and local buyers. They're all lined up, waiting for their opportunity to enter the Seattle market.

US Bank Centre

Bentall's purchase of U.S. Bank Centre for $237 million set a new record at almost $260 per square foot.

Perception is reality, and these investors' perception of the long-term potential of this market is reflected in the record prices being paid after fierce bidding competitions. Evidence is scattered throughout Puget Sound's Class A markets.

  • Bentall, a Canadian developer and investment company, purchased the US Bank Centre for $237 million and Vysis Portfolio for $187 million.

  • Sam Zell's Equity Office, the nations largest REIT, bought a portfolio of 10 office properties from Wright Runstad & Co. for $610 million, including high-profile Class A properties like First Interstate Center, Rainier Plaza, 1111 Third and Second and Seneca.

  • Spieker Properties, the regions most active REIT, snapped up US Bank Plaza and Plaza Center in Bellevue for a lofty $80.5 million.

With its lean vacancies, soaring rents and lack of new speculative supply in the foreseeable future, Seattle is a microcosm of national trends. Thanks to a strong economy and an expanding corporate America, office properties in most commercial real estate markets are selling below replacement cost while fundamentals steadily improve. Development has returned to many markets, largely suburban, where demand for quality office space is outpacing supply.

Seattle is experiencing heavy interest from outside Washington's borders, and the main attraction seems to be the region's raging economy. Seattle boasts a steadily rising job market, solid growing companies such as Boeing, Microsoft, Starbucks and REI, and an expanding population base. In addition, the region is experiencing a record number of new business openings, especially in the high tech and biotech industry.

All sectors are rockin'

As a result, every sector of the region's commercial real estate market is positively affected. Need a barometer to underscore the point? Look no further than the retail sector. Historically, retail expansion only occurs in cities with strong local economies that can support the businesses. In Seattle, Nordstrom, Nike, Banana Republic, Planet Hollywood and a host of other well-known local and national retailers have made it known that downtown Seattle is the place to be.

In addition to retail, virtually every other sector of Seattle's real estate economy is rockin' including hotels, sports, residential and cultural projects.

Seattle's commercial market is one of the darlings of the nation's investment community, and prospective suitors are lined up to woo its limited Class A properties. Those who are spurned turn away to look for alternative opportunities before the market and its favorable fundamentals vanish.

The money is there as capital markets across the U.S. shift into high gear, and creative business plans are beginning to surface. Properties ripe for redevelopment are being purchased. New build-to-suit projects are being proposed. Class A properties in less desirable markets just outside of Seattle are being combed for opportunities.

For the first time in years, investors are putting money into deteriorated and poorly managed properties. Downtown observers are kibitzing as properties with large vacancies and significant redevelopment challenges are being snapped up. It can be a risky business, but these properties provide experienced developers the opportunity to make deals at values below replacement cost and earn substantial returns commensurate with the increased risk.

Examples of redevelopment are abundant: Smith Tower and its surrounding blocks; the Seattle Trade Center along the waterfront, the Seattle City Light Building, the Seattle Steam Plant and the Seaboard Building block. If this trend continues, which it should, the Seattle market will only get hotter.

New development is coming

The prospect of new office product coming online in the next few years is now a reality. Although development has been flat since the boom of the late 1980s, the availability of capital and the tight supply have combined to create new opportunities for build-to-suit developers.

Most of the projects announced, however, will require a major tenant to kick things off. Expect internally financed REITs, such as Carr America, to take on more speculative projects because pre-leasing is unnecessary.

In fact, any well-capitalized firm with strong local contacts can secure large tenants for build-to-suit projects. Again, evidence of this growing market niche includes Trammell Crow's 288,000 square foot One Convention Center project, Quadrant's 300,000-plus-square-foot campus for Adobe in Fremont, Wright Runstad's 180,000 square foot World Trade Center, Nordstrom's 550,000 square foot corporate headquarters and King County's 310,000 square foot build-to-suit at King Street Station.

Although the purchase of existing product or redevelopment and its associated risk seem to be the most publicized methods of entering the Puget Sound markets, other players are taking a road less traveled.

Their strategy is buying property in outlying markets, such as Tacoma, and hoping that the favorable market dynamics will spill across into the perimeter markets.

Unico Properties recently fired off a barrage of purchase offers in outlying markets including Tacoma and Renton. Long a sleeping giant in the region's commercial market, Unico currently manages the University of Washington tract in the heart of downtown Seattle and is restricted from purchasing properties that compete with those buildings.

As a result, their strategy for growth in the region's hot market seems to be to buy in perimeter markets and wait for values to increase. Will this strategy work? Time will tell.

So the market looks great, doesn't it?

Well, not for everyone. Life is becoming a bit more complicated for tenants, particularly large users who will face moves or renewals in the foreseeable future. They will see significant rental rate appreciation.

Look for rates to soon crack the $30 per square foot barrier, setting new records for rates in the market and sending shudders of sticker shock through companies used to paying $20 a foot or less in Seattle's most prestigious addresses.

So what's ahead? The future of Seattle commercial markets is very bright but it's hard to say for how long without a reliable crystal ball.

Michael Allmon is an investment specialist with The Norman Co. in Seattle.

Copyright © 1998 Seattle Daily Journal of Commerce.