Just outside developer Dan Ivanoff's office door last spring hung a mock license plate that read “MR 462.” The fake vanity plate, given to Ivanoff as a gag by staffers at Bellevue-based Schnitzer Northwest LLC, celebrates the record-setting sale of the firm's flagship Civica Office Commons. Investcorp paid $462 per sq. ft., or just over $140 million, for the two-building Bellevue office complex last March, the company's first investment in the Seattle area.
The Civica sale topped the previous record for the Puget Sound area of $411 per sq. ft. set by Hines when it sold Seattle's IDX Tower to TIAA-CREF for $340 million in 2004. Local real estate professionals were startled to find a suburban mid-rise complex fetching a substantially higher price than a sleek downtown Seattle high-rise — especially in a-busting year that set records for the total number of sales and sheer volume of dollars spent. The sale was a testament to the increasing institutional interest in the area.
“We've seen a lot of national investors target Seattle as one of their top five or six markets,” says Bob Mooney, president of the Seattle office of Staubach Co. During 2005, there were a total of 35 office transactions above $10 million in the Puget Sound region with total sales for the year of $1.95 billion, according to Lou Senini, first vice president in the Seattle office of CB Richard Ellis. The year's sales volume compares to $1.25 billion in sales in 2004 on 19 transactions.
What's driving record sales? A strong local economy fueled by technology and business services that is outperforming the national average.
According to The Puget Sound Economic Forecaster newsletter, the state payroll grew 2.7% for the 12-month period ending in November 2005. That compares to a national average of 1.5%. Additionally, the state economy is expected to remain strong through 2010, with job growth increasing 2.7% this year and 2.4% in 2007.
Rob Hollister, vice president in the Seattle office of Houston-based Hines Interests LP, says his firm likes the Puget Sound area because the region offers the sort of lifestyle and educational opportunity that attracts a talented workforce.
Because of the strengthening economy, vacancy rates and rents are improving in the Puget Sound's two largest office submarkets — Seattle and Bellevue, a suburban city located on the east side of Lake Washington about a 30-minute drive from downtown Seattle.
During 2005, Class-A office vacancies in Seattle continued to drop, sliding from 14.81% in the first quarter to 14.01% in the fourth quarter, according to a year-end report from CB Richard Ellis. Class-A office asking rents meanwhile increased modestly, rising from $24.15 in the first quarter of 2005 to $24.45 in the fourth quarter.
With just 105,000 sq. ft. of new office space delivered in 2005, downtown Seattle office tenants absorbed a total of 413,467 sq. ft. of space. Several of the most desirable office buildings, such as Two Union Square and the U.S. Bank Centre, are nearing full occupancy. In mid-January, the occupancy rate at Two Union was 91.8% with U.S. Bank Centre at 93%, according to OfficeSpace.com.
Casting a shadow over the recovery of the downtown Seattle office market is Washington Mutual Inc. The nation's largest thrift will be vacating hundreds of thousands of square feet in the central business district later this year when it relocates to its new 42-story headquarters office tower in downtown Seattle.
Other tenants, however, have stepped up to claim a substantial portion of the 1.2 million sq. ft. of space Washington Mutual plans to vacate. The thrift is expected to retain as much as 500,000 sq. ft. of the space it currently occupies.
Meanwhile on the suburban Eastside, which includes the downtown Bellevue office market, CBRE reported the vacancy rate dropped from 12.65% to 9.65% from the first quarter of 2005 to year's end as rents rose to $24.14 from $22.48 during the same period. New construction brought 239,082 sq. ft. of new office space to the Eastside market, as office tenants absorbed 1.1 million sq. ft. of space.
Just a few years ago Bellevue posted a vacancy rate nearing 30%. The market was badly stung by the sudden tech crash after a robust period during the dot-com era in which it was one of the healthiest markets in the nation.
Notable large leases in 2005 included Symetra Financial's lease of 289,000 sq. ft. in two of Equity Office Properties Trust's Bellevue office towers, Puget Sound Energy's move into its newly constructed 235,000 sq. ft. headquarters a few blocks south, and Amazon.com's agreement to take 180,000 sq. ft. in Equity Office Properties Trust's Columbia Center in downtown Seattle. EOP is the Puget Sound area's largest landlord, controlling approximately 10 million sq. ft., split equally in half between Seattle and Bellevue.
Class-A office rents are expected to increase between 10% to 15% in downtown Seattle and could increase between 15% to 20% in downtown Bellevue before the year ends, with the biggest hikes for premium view space,say. Industry leaders, including EOP regional senior vice president Pat Callahan, expect double-digit rent increases in 2006 for Class-A office space.
“Í think it is clear that the Seattle area is perceived as a market that will have strong growth in the future and positive dynamics in the office sector,” says EOP senior vice president of investments Michael Lynch. “It feels like a lot of assets have been very fully priced. I'm not sure there is a tremendous amount of room for cap rates to move down.”
Many local investors sidelined
Of the 10 largest sales last year, only one was to a local investor. Metzler North America, a wholly owned subsidiary of Germany's oldest private investment bank, Bankhaus Metzler, kicked off the year with its $55.1 million purchase of the 5th & Pine Building.
The firm is one of the few international institutional investors competing in the Puget Sound area. Despite the Port of Seattle's substantial trade with Asia, Seattle hasn't attracted many Pacific-Rim investors.
“We bid on a lot of properties from Vancouver to San Diego, and very infrequently do you see an Asian institution being an aggressive bidder,” says Bankhaus Metzler's managing director for investments Kyle O'Connor. “We compete more frequently with other European capital sources that are Irish, English or German.”
Even though Metzler North America is headquartered in Seattle, the Puget Sound area remains a second-tier market for the investor, which is currently more focused on.
But Seattle has been high on the list for Chicago-based Walton Street Capital LLC. In February, Walton Street sold Seattle's historic Exchange Building to Fort Worth-based Crescent Real Estate Equities for $52 million. Eight months later, Walton Street followed with an off-market, paying Seattle developer Larry Benaroya, a principal of The Benaroya Cos., $345 million for four downtown Seattle office buildings. In two sales on the same day in May, Hines paid $162 million for the 1001 Fourth Avenue building while California-based Spear Street Capital paid $41.9 million for Waterfront Place. Two months later, local developer John Goodman paid $38.5 million for the 509 Olive building.
The year ended with a flurry of deals. RREEF and partner CalPERS paid TIAA-CREF $110 million for the 41-acre Westpark Business Park in Redmond, and Seattle's Portage Bay Partners sold its Roosevelt Commons office complex to a client of RREEF for $94.5 million. Meanwhile, ING paid $117.5 million to buy 401 Elliot West in Seattle.
That the Civica sale topped the 2005 list in price paid per square foot is a testament to an appealing design that has attracted a roster of tenants willing to pay above-market rates and to the growing stature of the Bellevue office market.
Once a rural town surrounded by strawberry fields, Bellevue has moved beyond being a suburban bedroom community servicing Seattle. Bellevue has been chosen to be the headquarters for Symetra Financial, retailer Eddie Bauer, Puget Sound Energy and a bevy of high-tech and telecom companies.
“While the market has traditionally been a little more high-tech software and telecom oriented, I think the Bellevue CBD is starting to evolve and pick up more traditional businesses like law firms, banks and insurance companies,” said Lynch. One result, says Callahan, is that “most serious investors today certainly look at both sides of the lake.”
Tee up in Bellevue
Besides buying existing buildings, institutional investors also are active in development. Five developers have announced plans for new office construction in downtown Bellevue, two of which are national players. At 2.5 million sq. ft., the combined square footage proposed is roughly equal to half of the existing Class-A office space in the Bellevue CBD.
Bellevue-based Kemper Development breaks ground this February on a 550,000 sq. ft. office tower at Lincoln Square where Eddie Bauer has signed a 15-year lease for roughly 220,000 sq. ft. of space, according to leasing broker Jim Kinerk of Bellevue-based Broderick Group. In June, Hines plans to start building a 400,000 sq. ft. office tower on a mothballed construction site whose previous owner ran into financial difficulty. Meanwhile, EOP's board has approved moving ahead on a speculative basis with a 559,000 sq. ft. office tower on its City Center campus.
Also in the works: Canadian developer Bentall Capital plans to add a 311,000 sq. ft. office tower — the third — to its Summit office campus while Schnitzer Northwest will include two office towers totaling 745,000 sq. ft. in its proposed mixed-use project, the Bravern.
Thanks to strong institutional interest in the office market, landlords aren't holding onto their properties for as long. “Holding periods have shrunk partly because the market is rebounding so quickly,” says Dale Sperling, chief executive of Unico Properties Inc. in Seattle. “It used to be a long-term hold was 10 years, then it was five to seven years, now it's two to three.”
Seller's market through 2006
Already the market has improved enough that there are not many properties out there for value-added investors to buy, says Andy Miller, senior vice president at GVA Kidder Mathews. “Toward the tail-end of last year, a lot of property owners saw pricing they may not see again for a long time, or have never seen before, and they viewed it as an opportunity to sell at what may be the peak in the market,” says Miller.
One example is Redmond Woods, a 145,000 sq. ft. office campus near Microsoft Corp. Miller says Spear Street bought the property several years ago when the market was very soft, made improvements that cost between $40 to $60 per sq. ft. and likely will sell it for between $180 to $200 per sq. ft. — a roughly $40 per sq. ft. gain.
Colliers International senior vice president Reynolds Haas expects the Puget Sound area will remain a seller's market through 2006. “Have we reached the top of the market? We're sure approaching it,” says Haas. “But I'm not seeing a slide. We will maintain the values we experienced in 2005.”
That opinion is seconded by Scott Eshelman, a senior director at Cushman & Wakefield in Seattle. Eshelman sees sales volume continuing strong while prices “may not be as high but will be pretty close.” The continued demand may also spur some property owners who've been sitting on the sidelines to get in the game, he says.
Miller also expects 2006 will be another strong year for investment in the Puget Sound area with one possible exception. “There could be some pricing gap problems with unrealistic sellers getting too greedy,” says Miller. “I don't see anything to stop the demand side over the next 12 months as long as we do not give off the perception that the market is being overbuilt.”
Jeanne Lang Jones is a Seattle-based writer.
SEATTLE - BY THE NUMBERS
POPULATION OF METRO AREA:
Source: Puget Sound Regional Council
UNEMPLOYMENT RATE: 4.9%
Source: Washington State Employment Security Dept.
Costco Wholesale Corp.
Washington Mutual Inc.
Source: Puget Sound Business Journal 2006 Book of Lists
METRO AREA VACANCY RATES
Seattle CBD Office:
14.01% vacancy, 4Q 2005
14.87% vacancy, 4Q 2004
$24.45 rent per sq. ft., 4Q 2005
$24.62 rent per sq. ft., 4Q 2004
Source: CB Richard Ellis
9.45% vacancy, 4Q 2005
13.16% vacancy, 4Q 2004
$24.14 rent per sq. ft., 4Q 2005
$22.11 rent per sq. ft., 4Q 2004
Source: CB Richard Ellis
6.5% vacancy, 3Q 2005
8.78% vacancy, 3Q 2004
$0.37/$0.65 monthly per sq. ft., 3Q 2005
$0.34/$0.65 monthly per sq. ft., 3Q 2004
Sources: Colliers International
7% vacancy, year-end 2005
$818 rent per unit, year-end 2005
7.7% vacancy, year-end 2004
$805 rent per unit, year-end 2004
Source: Marcus & Millichap
2.63% vacancy, 4Q 2005
1.61% vacancy, 4Q 2004
$21.29 per sq. ft., 4Q 2005
$19.53 per sq. ft., 4Q 2004
Source: CB Richard Ellis
76.8% occupancy YTD thru Nov. 2005
73.8% occupancy YTD thru Nov. 2004
$137.84 average daily rate, 2005
$129.21 average daily rate, 2004
Source: Wolfgang Rood Hospitality Consulting
The 1.4 million sq. ft. mixed-use project, the largest now under construction in the U.S., will include a 27-story office tower, a three-story retail podium and a 42-story hotel condominium tower.
Cost: $500 million
Developer: Kemper Development Co.
Washington Mutual/SAM Tower
A 42-story, mixed-use development with Washington Mutual Inc. occupying about 890,000 sq. ft. and the Seattle Art Museum taking up 335,000 sq. ft.
Cost: $300 million
Developer: Pine Street Group LLC, Seneca Real Estate Group
Completion: Late 2006