Hurricane Wilma blew apart Miami's monster residential growth in October 2005. Home and condo listings tripled with storm-weary citizens ready to move. In the months that followed, as insurance companies began dropping homeowner policies, more residents joined the exodus.

Since then, the “slowdown” — deemed such by anxious real estate agents hoping to revive investor interest — has only intensified as home foreclosure rates spike and sales volumes slump. Yet, as residential falters, commercial real estate flourishes.

For more than a decade, developers didn't build speculative office buildings in downtown Miami. Now, about 1.9 million sq. ft. in proposed new construction readies for 2009 delivery among three high-profile projects. That space will be spread out between Met2, Brickell Financial Centre and 1450 Brickell.

The total square footage of new office space will be more than the total that has been completed in the city in 17 years, according to CB Richard Ellis. No major tenant announcements have been made, but observers argue that the fundamentals are in place for success.

“Miami has finally evolved into a top-tier city for office,” says CBRE Senior Vice President Randy Olen. “Occupancy is as high as it's been in the last 15 years. Vacancy is the lowest in 15 years.” Ironically, the residential boom deserves credit for the commercial upswing.

Leveraging its gateway status

Miami has long leveraged its location as the gateway to the Americas and insulated itself from downturns in the domestic economy. Tourism and real estate typically outperform manufacturing and farming. Headquarters for Fortune 500 companies are few and far between in Miami, but more than 500 multinational corporations have a regional hub there.

Because of the blessings of geography and its Spanish-friendly culture, Miami has been the place of business for anyone interested in penetrating markets in Central and South America. Increasingly, that includes countries in Asia, particularly China.

Rather than competing with New York, Chicago or Los Angeles, Miami's rivals are Buenos Aires, Panama City and Sao Paulo. Indeed, trading with Latin America increased by 9% to $72 billion in 2006, according to Grubb & Ellis. The Greater Miami Chamber of Commerce estimates that 60% of all U.S. trade with Central America moves through Miami, as does 27% of trade with South America and 46% with the Caribbean island nations.

Merchandise trade in Florida hit a record $110 billion in 2006, according to Enterprise Florida, a state economic agency. The Washington Economics Group (WEG), a Coral Gables-based business think tank, says that trade has benefited from the 4% to 5% annual expansion of Latin American economies.

WEG expects the top markets for export in 2007 to be Venezuela, Colombia, Brazil and Peru. Trade activity should continue to rise thanks to the Central American-Dominican Republic Free Trade Agreement. Already nearly one out of eight jobs in Florida is connected to international business, the bulk of which operates out of Miami.

Irrational exuberance over condos

Just five years ago, however, Miami gained a different type of notoriety as a city where luxury condos reigned over the skyline. Historically low interest rates fed the phenomenon as lenders threw billions of dollars toward these projects.

Extravagant real estate parties stocked with free liquor, fancy hors d'oeuvres and fabulous models — paid to stand around — were nearly nightly occurrences by 2003. Residential development exploded in Miami as short-term investors dreamed of easy profits and reassigned contracts to the next speculator in line.

The dynamics had decidedly shifted in favor of high-rise, high-end condo construction, often starting at $400,000 a unit for waterfront views. Escalating land values and the demands on labor and building materials made most commercial development outside of mixed-use projects unrealistic.

Bidding wars were waged over parcels once considered undesirable. Properties slated for future office projects were rezoned to residential. Longtime industrial sites along the Miami River were torn down to make way for waterfront vertical dwellings.

Meanwhile, multifamily properties gained record premiums as converters quickly devoured the existing apartment supply to the tune of 20,433 units in two years. Even Class-B and Class-C office buildings were broken up into commercial condos for sale in a money play to squeeze easy dollars rather than long-term holds from leasing.

Demand for office, industrial and multifamily grew with the new population, yet inventory actually decreased and available land vanished. The result was a perfect storm.

Building on a virtual island

Miami-Dade County exists as a virtual island, with the Atlantic Ocean to the east and south. To the west lie the Florida Everglades, a protected ecosystem that is vital to the area's water supply and seafood industry.

Hence, development has nowhere to go but up — and prices have followed. In the heated Miami office market, concessions today are non-existent and deposits are in growing demand by landlords. Rents are already breaking the $40 per sq. ft. barrier in the central business district. At 701 Brickell, full-service quotes are $42 per sq. ft. Courvoisier Center, recently acquired by Tishman Speyer for $150 million, is commanding rents of $45 per sq. ft., reports Jones Lang LaSalle.

Flagler Real Estate Services brokers are asking for $46 per sq. ft. in advance of the 2009 opening for the Met2 office tower under construction in downtown Miami. That's well above the average Class-A asking price of $35.74. Top floors at the Wachovia Financial Center rent for $40 to $45, according to Jones Lang LaSalle.

Within 24 months, the overall downtown vacancy rate fell to 8.3% from 16.4%, according to CBRE's first-quarter report. In 12 months, asking rates for Class-A offices increased 18% to $35.71 per sq. ft. from $30.11 along Brickell Avenue, the city's financial corridor and home to the highest concentration of international banks in the nation outside of New York.

Tenants beware, landlords too

Studley Senior Vice President Bob Orban cautions that landlords will try to tie down tenants to long-term contracts while options are slim and before new deliveries make the market competitive again. “We've been getting a lot of calls from tenants with sticker shock. They see all the construction cranes, but none of them are office buildings,” says Orban, also co-branch manager of the South Florida office. Studley exclusively represents tenants. “We're trying to position folks for what should be an oversupply of space by 2010 and 2011.”

Tenants who have leases expiring now could see new contracts increase by $5 per sq. ft. or more, Orban warns. CBRE estimates that some Miami CBD leases could hit $50 per sq. ft. by 2009; office rates across the county could hike 25% within two years.

But don't expect owners to record stronger margins. Heftier insurance premiums, increased taxes and utility surcharges have eroded any gains; institutional investors with national portfolios are better positioned to operate with lower overheads.

Jones Lang LaSalle reports insurance rates as high as $6 per sq. ft. for operators without “significant buying power.” Only the largest investors are able to keep insurance costs at $1 or less per sq. ft. and operating expenses in downtown Miami and along Brickell Avenue were more than $20 per sq. ft. in the first quarter of 2007.

Post-hurricane inflation

Jacked-up operating expenses can be attributed to Hurricane Wilma, which altered the commercial landscape just as it turned the residential market inside out.

For the nation, the impact of Wilma paled in comparison to the death and devastation wrought by Hurricane Katrina, which struck the Gulf Coast less than two months earlier, causing a record $75 billion in damage.

But for South Florida, Wilma, a Category 5 hurricane, was the worst storm since Hurricane Andrew left $25.5 billion in damage in 1992. It was also the fifth in 14 months to strike the state. Damage was estimated at $16.8 billion and commercial insurance premiums skyrocketed in its wake.

As a result of increased premiums, higher occupancy costs are expected for every property type. At the same time, Miami office space has seen a 46.5% increase in value to $214 per sq. ft. in 2006 from $146 in 2004, according to CBRE. Landlords are moving away from the customary full-service quotes on leases in favor of triple-net rates so they can pass on increases. At least 15 Class-A offices have adopted the change.

Billions chasing industrial

Industrial parks are also switching over to triple-net leases including Miami-Dade's biggest landlords: AMB Properties, ProLogis, PS Business Parks and RREEF. Miami-Dade's industrial market registers among the lowest vacancy rates in the nation at 4.2%, reports CBRE.

Yet, there too, cap rates have “gone by the wayside,” observes Ernesto Casal, principal of Miami-based Capital Commercial Group, which provides full-service commercial brokerage for private client groups and multi-national corporations. Operating expenses have doubled to $3 per sq. ft. in two years, according to CBRE. Still, institutional buyers are eyeing the long-term promise of increased leases.

Marcus & Millichap ranked the Miami industrial market sixth in the nation, up two slots, in its 2007 national report. CBRE noted that from 2004 to 2006, the price jumped from $62 per sq. ft. to $89.

“[Industrial] supply and demand is a critical problem,” says Casal. “Any available land is very expensive. Major institutional players are blocking control and it's a problem for certain brokers.”

Casal estimates as much as $2 billion in capital chasing industrial properties in Miami-Dade, including quasi-private equity and pension fund money. The reason is international.

A boom and bust town

Total construction currently underway in Miami including hotels, office and retail is $9.15 billion. Yet as construction cranes begin to fly away, payroll employment growth in the construction sector suffers. WEG notes that the recent increase in unemployment to 3.3% from 3.1% was tied to a reduction in building projects.

The impact of the correcting condo market is still to come. History shows that all of South Florida has suffered from manic boom and bust cycles since the first attempts to drain the swamp at the turn of the 20th century.

Less than 10,000 units had been completed in the City of Miami from 1995 to 2005. A 12-month span from September 2005 to September 2006 saw the delivery of 6,600 units, largely condo and mostly high-end. By the beginning of October 2006, an unprecedented 22,254 more units were being built in the city.

Another 60,232 more multifamily units — overwhelmingly condo — are in the planning pipeline, though a growing chorus of analysts question if those projects can secure the lending to break ground.

Most condo developers find themselves at a standstill these days. As of May, the City of Miami had no major projects added to its “under construction” database since last fall.

Tens of thousands of condo units have yet to hit the market, however. In many cases, these projects are up to 80% investor-driven. Closing time is still months away as most towers are now only topping out. The number of buyers who will walk away from units is anyone's guess, but the current trend is alarming.

Pending foreclosure litigation cases increased from about 600 in August 2006 to nearly 1,600 in March 2007, according to Metrostudy, a housing market research firm with offices in West Palm Beach. Metrostudy notes that Miami was the first market in Florida to register a glut in inventory, and that was by 2003. The Florida Association of Realtors reported a 40% drop in existing condo sales for Miami for the first quarter of 2007.

Condo silk purse

A market of condo owners offering their investment condos to tenants in competition with traditional multifamily operators has emerged. Number crunchers are in a tizzy because of the difficulties in tracking the newly emerging tier of apartments scattered within for-sale condo buildings.

Many apartment properties that were split up for sale are now reverting back to hybrids, with some units sold to individual owners, rendering them unfit for the conventional multifamily market. But the market to buy multifamily has resurged. In fact, the market to buy all types of commercial real estate — including retail — is stronger than ever in Miami, says John Bell, managing director of DTZ Rockwood's Miami office.

Real estate investment trusts have become more aggressive in Miami, a recent CBRE report trumpeted, as have equity funds. As a result, current acquisitions require hard money up front and short closing periods. Expect a “feeding frenzy” if any of Miami's trophy office towers become available, Bell adds.

The industrial areas around Miami International Airport have become highly coveted and some institutions are willing to do smaller deals under $25 million “just to get into the game.”

But for all the excitement, properties in Miami remain considerably less expensive compared with Manhattan, San Francisco and other top U.S. cities.

“This all looks sky-high for those of us who have lived and breathed the real estate market in Miami for the last 30 years,” Bell says. “But we're still viewed as very reasonable by investors, and that's why they're not shy about coming here to buy.”

Susan Stabley is a Miami-based writer.

MIAMI - BY THE NUMBERS

METRO POPULATION:
2.4 million

Source: U.S. Census, 2006 estimate

UNEMPLOYMENT RATE: 3.1%

Source: Bureau of Labor Statistics, March 2007

LARGEST PRIVATE EMPLOYERS:

  1. Baptist Health South Florida
    10,300 employees

  2. University of Miami
    9,367 employees

  3. American Airlines
    9,000 employees

  4. United Parcel Service
    5,000 employees

Source: Greater Miami Chamber of Commerce

METRO AREA VITAL SIGNS

Office:

6.9% vacancy, 2Q 2007

7.7% vacancy, 2Q 2006

$27.40 rent per sq. ft., 2Q 2007

$26.29 rent per sq. ft., 2Q 2006

Source: CB Richard Ellis

Multifamily:

97.6% vacancy, 4Q 2006

98.8% vacancy, 4Q 2005

$1,006 avg. effective rent, 4Q 2006

$971 avg. effective rent, 4Q 2005

Source: CB Richard Ellis

Retail:

2.9% vacancy, 4Q 2006

3.4% vacancy, 4Q 2005

$30.45 rent per sq. ft., 4Q 2006

$21.52 rent per sq. ft., 4Q 2005

Source: CB Richard Ellis

Industrial:

4.8% vacancy, 1Q 2007

4.1% vacancy, 1Q 2006

$5.61 rent per sq. ft., 1Q 2007

$5.95 rent per sq. ft., 1Q 2006

Source: Marcus & Millichap

Hotel:

79.8% occupancy, 1Q 2007

83.0% occupancy, 1Q 2006

$199.86 average daily rate, 1Q 2007

$176.54 average daily rate, 1Q 2006

Source: Smith Travel Research

MAJOR PROJECTS:

Met2 will be a 700,000 sq. ft. office building that connects to a 376-room Marriott hotel. The 47-story building at 200 Southeast Third Street is part of the $1 billion, four-building Metropolitan Miami development.

Developer: MDM Development Group

Completion: second-quarter 2009

Cost: $335.9 million

Brickell Financial Centre aims to become the first “green” office tower in Miami. Its developers seek a minimum silver LEED rating from the U.S. Green Building Council. The entire development at 600 Brickell Avenue proposes more than 1 million sq. ft. built in two phases and includes a hotel, condos, retail and a public plaza. The first phase is 602,000 sq. ft. of office with 18,030 sq. ft. of shops and dining in a 40-story structure.

Developer: Foram Group

Completion: second-quarter 2009

Cost: $722.6 million