Events NAREIT Investors Forum June 6-8, 2007 New York Commercial Mortgage Securities Association Annual Conference June 11-13, 2007 New York Real Estate Roundtable Annual Meeting June 20-21, 2007 Washington D.C.

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Going Coastal

Portland enjoys growing interest from institutional investors

While international buyers have yet to make a significant entrée into the West Coast stronghold of Portland, Ore., out-of-state buyers have begun to recognize opportunities in the market. Healthy fundamentals and high barriers to entry, along with affordability, are generating plenty of investor interest.

"The region has long been ignored due to its remoteness and size," says Michael D. Coen, regional director of GE Real Estate in San Francisco. "The buyers and sellers in the past have been almost totally regional and local, but lately the landscape has changed with the Equity Office Properties portfolio being sold to Blackstone and then to Shorenstein."

In March, Shorenstein Properties LLC purchased 4 million square feet of former Equity Office assets in the greater Portland area, catapulting the San Francisco-based investment company overnight from an outsider into the largest local landlord.

With a population of 562,690 residents, Portland is considerably smaller than top tier markets. Why, then, are investors looking to buy here? One reason is attractive pricing. Increasing asset prices across all commercial property types in California cities and the Puget Sound have made Portland assets a bargain by comparison, Coen says.

The job market, driven by a strong presence of high tech and health care employers, is another lure to investors. Job growth may be tapering across the nation, but Portland continued to add office-using jobs at an annualized rate of 1.7 percent through the first quarter of 2007.

Like other markets that flourished in the technology boom, Portland now boasts a dynamic night life, scenic landscape and plenty of fun lifestyle elements that help to attract and retain young workers. That livability factor is a key to the city's future growth, according to Pam Baker, an investment specialist and senior vice president at Colliers International in Portland.

"The lifestyle here is attracting and retaining the creative workforce that is so critical to the knowledge-based economy of the future," she says. "Portland is very conscious of wanting to attract and retain that workforce, and has a very eclectic approach to development that keeps it lively."

Bound to Please

Steve Wells, managing director at the Trammell Crow Co.'s Portland office, sees local demand and opportunity for almost every product type. The challenge for developers, he says, is finding land within the Urban Growth Boundary (UGB).

Every metropolitan area in the state sets an UGB that is intended to provide a 20-year supply of land for development. In practice, however, the boundary leaves few desirable tracts available for greenfield development.

Love it or hate it, the UGB largely contains sprawl and encourages infill development to maximize the use of existing roads and other infrastructure. For investors, the boundary serves as a barrier that keeps competitors at bay while holding the pipeline of new space in check.

Office investors appreciate the boundary's constraining influence, which is reflected in construction totals. The market grew by 152,000 square feet in 2005 and another 416,000 square feet last year, well below the 1.2 million square feet that developers cranked out at the tail end of the tech boom in 2003, according to CBRE.

The boundary's limiting effect on construction was one of the factors that attracted the city's largest office landlord to look for acquisitions there, says Andy Friedman, managing director at Shorenstein's San Francisco headquarters. "We feel pretty good about the prospects for additional supply relative to the demand we think is going to be coming in Portland over the long term," he adds.

Shorenstein also liked being able to pay less than $300 per square foot for high quality assets in a portfolio large enough to provide a variety of leasing options to tenants. The purchase included 17 of 20 buildings in Kruse Way, the hottest submarket in the area with rents reaching $28 per square foot.

Office is by far the most active investment sector by dollar volume. The Shorenstein deal, which was valued at approximately $1 billion, drove Portland's office investment volume to $2.02 billion in the first quarter. In 2006, office investments totaled a more modest $650 million, according to New York-based Real Capital Analytics (RCA), which tracks deals of $5 million or more.

Investors are increasingly focused on Portland's office real estate because it offers slightly better returns than in top tier cities like San Francisco, according to Chris Johnson, an executive vice president at NAI Norris Beggs and Simpson who specializes in office and investments.

Office caps average 7 percent in Portland compared with 6.2 percent in San Francisco and 6.5 percent in Los Angeles, RCA found. In the first quarter, local office properties sold for an average of $210 per square foot compared with $287 in Los Angeles and $293 in San Diego.

In a market with 45 million square feet of office, however, there simply aren't enough deals in the $30 million-plus range to meet the growing demand, Johnson says. "The number of institutional players looking at Portland continues to amaze me," he adds.

The CBD is particularly attractive to investors, says GE Real Estate's Coen. "The last Class A CBD office building delivery was in 2000 and the earliest a new one could enter would be 2010," he says. "As a result, Class A (vacancies) are south of 8 percent, rents are increasing and it has become a landlord's market."

Only a few sites offer potential for new downtown construction. Locally based TNT Development is obtaining permits to construct a mixed-use tower that would provide 215,000 square feet of office space as well as some residential units. Shorenstein will likely beat TNT's office space to the punch with its own 15-story office tower at First and Main, expected to break ground around the end of 2007.

Whichever project goes up first will likely lease quickly due to pent-up demand. Class A vacancy in the CBD was 6.4 percent in the first quarter, with few options larger than 30,000 square feet, according to Grubb & Ellis. Vacancy is projected to drop below 4 percent in early 2008, an all-time low. The scarcity of space has empowered some landlords to market the highest quality space downtown for as much as $30 per square foot.

In the coming months, Shorenstein plans to build two new, speculative projects of 100,000 square feet each in Kruse Way. "We feel good about the prospects of keeping our buildings full," Friedman says.

To lease Shorenstein's planned downtown tower, the company has retained Johnson of NAI Norris Beggs and Simpson. Johnson says core investors should focus on the CBD to find fully leased properties. The high-dollar Kruse Way submarket is unlikely to offer acquisition plays, since Shorenstein just acquired most of those properties.

Beyond office

The difficulty of bringing on new space helps to keep occupancy rates healthy for all property types, according to Gary Griff, senior director of the capital markets group at Portland-based Cushman & Wakefield of Oregon Inc.

While the average industrial vacancy rate of about 5 percent suggests strong demand for distribution space, chiefly associated with the city's port, it's difficult to amass industrial portfolios large enough to interest institutional investors in a market with less than 170 million square feet of total inventory, Griff says.

One exception to that rule will be a 2.5 million square-foot industrial project planned for development on 113 acres by the port. The Trammell Crow Co., now the development arm of CBRE, is about to begin the first phase of construction to deliver Rivergate Corporate Center III, which will provide 573,000 square feet of speculative space on land leased from the Port of Portland.

"We've got strong interest already in that building and will kick off the plans on the second phase almost immediately," Wells says. Crow is also handling land, hotel, office and some retail development at Cascade Station, an Ikea-anchored mixed-use project under construction on 117 acres by the airport.

Retail is a lucrative property type, with strong sales driven in part by the absence of sales tax, says Coen of GE Real Estate. "Additionally, national retailers still view Portland as being underserved, and many national retailers such as IKEA and Kohl's have made their first entrance into the market."

Few commercial real estate assets in Portland have sold to international buyers, but Mark Fitkin, CBRE's local managing director, believes that is about to change. "Institutional money is here in a big way, and there is a higher level of interest internationally than we've seen in the past," he notes.

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