Seattle has endured a humbling reversal of fortune since the high-tech bubble burst, but its economic slide appears to have ended. With spring approaching, signs of recovery in the city's real estate market are budding.

Office vacancy rates in the region stabilized in 2003, ending the year at 16.6%, and downtown Seattle's office market is experiencing a pick-up in activity. In addition, warehouse development in the industrial Kent Valley south of the city is on the rise: seven distribution/warehouse projects totaling nearly 1.3 million sq. ft. are under way in the small town of Sumner, spurred by its proximity to the fast-growing Port of Tacoma.

Institutional investors also have remained active. Real estate investment firm RREEF paid $290 per sq. ft. for Seattle's 22-story One Convention Place, one of three significant Seattle-area purchases in 2003, totaling nearly $152 million. Meanwhile, Metzler North America paid $325 per sq. ft. for the office and retail portion of Millennium Tower. It's a handsome price, but well below the record $483.48 per sq. ft. Paccar Inc. paid for an office building during the boom.

While these signs are encouraging, the regional economy is expected to lag behind the national recovery by more than a year, slowed by continued softness in the aerospace sector. In addition, the state's unemployment rate remains among the highest in the nation. The Office of the Forecast Council predicts that Seattle's unemployment rate will hit 7.57% by year-end 2004, compared with a projected nationwide unemployment rate of 6.08%. The state will continue to lag the nation in 2005 with an unemployment rate of 7.07%, compared with a national rate of 5.88%, the Forecast Council predicts.

That sluggish turnaround will slow the recuperation of the suburban office market east of Lake Washington while sharply limiting multifamily development in most areas until jobs increase. “Historically low rental rates continue to be the major influencer in tenant decisions (rather than growth plans) and that will continue through this year,” says Rob Aigner, executive managing director in the Seattle office of Colliers International.

The Seattle CBD Bounces Back

With office vacancies in the low teens in the Seattle CBD, that submarket is expected to be among the first in the office sector to regain its strength. “We are looking at one to two years and it still really is based on job growth,” says Tom Abbott, head of broker services in the Seattle office of Trammell Crow Co.

Abbott predicts office rents in downtown Seattle will begin rising again in 2005. But don't expect rents to bounce back to the level reached during the Internet boom, says Jim Bowles, head of the Seattle office of CB Richard Ellis. “I do not know if we will ever see rates like that again,” Bowles says. “Hopefully the real estate community will be a little more prudent in the future.” Asking Class-A office rents in Seattle in December 2000 were $38.05 per sq. ft. By the end of 2003, rents had fallen to $28.83.

During the height of the Internet boom, downtown Bellevue, the largest of the suburban cities, was the tightest Class-A office market in the country, with less than 1% vacancy. When the tech sector crashed, few anticipated the speed and depth of the market reversal. By the second half of 2002, office vacancies in Bellevue topped 28%.

Since then, the market has stabilized and begun to improve with the vacancy rate at 22.5% at year's end.

The road to recovery will have some bumps. The nation's largest thrift, Washington Mutual Inc., is consolidating its operations in a new office tower that will be completed in 2005. When the thrift moves into its new headquarters, the space it leaves behind — nearly 1 million sq. ft. in 11 office buildings — could tug at the recovery of the Seattle office market. But an ambitious plan to redevelop an aging neighborhood just north of downtown as a biotech hub promises to spur new development.

Mr. Allen's Neighborhood

Microsoft co-founder Paul Allen's Vulcan Inc. has assembled 52 acres of land in South Lake Union, a rundown neighborhood just north of downtown. Presently, Vulcan has the capacity to develop about 10 million sq. ft. of mainly biotech office and research space in the area. So far, about 2 million sq. ft. has either been completed or is in the planning and development stage, according to Ada Healey, vice president of real estate for Vulcan.

Plans include some 10,000 additional residential units in the area. Such a life sciences hub could create 6,409 new jobs by 2007, swelling to 23,710 new jobs by 2020, according to a report by Paul Sommers, a senior research fellow at the University of Washington.

The nation can support five to 10 such biotech hubs, according to Healey, and she believes South Lake Union will rank in the top five. “What will differentiate South Lake Union is that it is much more than a life sciences center,” Healey says. “We are looking to support that life sciences with housing and with amenities such as retail.”

The concept is working. Fast-growing upscale clothier Tommy Bahama recently selected the area for its new headquarters as did NBBJ, a leading national architectural firm.

Developer Doug Howe, a principal at Seattle's Touchstone Corp., also has several projects in the area. Howe cites several factors that attracted him to South Lake Union, including the University of Washington's academic reputation and the fact that it is one of the largest recipients of grants from the National Institutes of Health.

In addition, other attractive factors include major investment in biotech and health care research by Microsoft co-founders Bill Gates and Paul Allen, Puget Sound's reputation as one of the best areas to live in the country and a highly educated workforce.

“Most cities in the country do not have those attributes and they can't catch up,” says Howe. “Not that we don't have high taxes, a highly regulated environment and high costs. We have challenges, but if we continue to work on these problems we can keep this industry here competitive.” Howe expects the Seattle CBD office market to post single-digit vacancy rates and be well into recovery by 2006.

The news is not so good elsewhere in the Puget Sound area. Even as Bellevue was hard hit by the dot-com collapse, the cities at the south end of Lake Washington were equally bruised by Boeing's decision to downsize and relocate its headquarters to Chicago, throwing hundreds of thousands of square feet of office space onto the market.

But two office submarkets will lag the general recovery significantly. The Seattle CBD and the Kent Valley industrial market will lead the recovery over the next 12 to 18 months, says Abbott of Trammell Crow. “That will be followed by suburban Bellevue in two or three years,” says Abbott. “Then I see the Bellevue CBD and te Southend market recovering.”

Positive Impact of the 7E7

Boeing has delivered a bit of good news with its decision to assemble the 7E7 passenger jet aircraft in Everett, north of Seattle. The 7E7 is expected to add about 1,200 jobs directly and as many as 17,000 jobs indirectly to the market. Colliers International broker Derek Heed expects Boeing suppliers to relocate near Everett to take advantage of work generated by the production of the 7E7. Some may even come from Europe to take advantage of less stringent labor laws in the U.S., according to Heed.

South of the city, six developers have significant buildings either completed or under construction in the industrial Kent Valley submarket. The vacancy rate, at 9.7%, has remained essentially flat through 2003 but is expected to decline over the next six months as net absorption increases.

Investment also is continuing. San Francisco-based AMB Property Corp. is buying eight buildings at International Airport Center in the Kent Valley for an estimated $53 million while RREEF, along with Capstone Development, recently paid $9.5 million for a 3-acre tract in nearby Renton with plans to develop a 600,000 sq. ft.-plus industrial park.

Is Retail Immune from Recession?

At the end of 2003, about 1.1 million sq. ft. of retail space was under construction in the Puget Sound area. Nearly half of that space — 453,000 sq. ft. — consisted of the expansion of Alderwood and Everett malls north of Seattle. At year's end, the retail vacancy rate registered 6.2%, with the average asking rents per square foot up 10 cents over the prior year to $18.24 per sq. ft.

“The one property type that has never shown any effect of the recession but continues to appreciate is retail, especially well-anchored retail,” says Andy Lakha, general manager of Bellevue-based Lakha Investment Group LLC. Lakha recently sold one shopping center anchored by Bed Bath & Beyond, REI and the Guitar Center in February 2004 for $17.1 million, pocketing a $3.6 million gain on his 2001 purchase price.

Because so little land is available for retail construction, developers are turning to urban mixed-use retail projects. Seattle-based Milliken Development Corp. has completed several successful grocery-anchored, mixed-use projects in Seattle with various grocers and is planning additional projects in South Lake Union and Bellevue.

After months in mothballs, one of the nation's largest mixed-use projects, Bellevue's Lincoln Square, is moving forward again as a phased project. Shopping center magnate and developer Kemper Freeman Jr. bought the property this summer after Opus Northwest LLC let its option lapse.

The $360 million project is in a prime location between Freeman's Bellevue Square regional shopping mall and his Bellevue Place mixed-use office project. Freeman will begin work on the reconfigured 330,000 sq. ft. retail portion of the project, and also plans to expand the Bellevue Hyatt Regency in Bellevue Place and connect all three properties via a skybridge.

Meanwhile, Schnitzer Northwest is finalizing plans for a phased development of a rival mixed-use project with two hotels near the city's convention center. The underachieving Totem Lake Mall in Kirkland just changed hands and could also be redeveloped into a major mixed-use property under its new ownership.

Multifamily Sector Rebalances

Greg Laycock, a senior director of the apartment group at Cushman & Wakefield of Washington Inc., describes the Seattle apartment sector as an “emerging recovery market.” Supply is coming into balance with demand — just 1,300 units are scheduled for delivery in 2004, compared with 2,600 units in 2003 and more than 4,000 units in 2002. Rents are expected to creep up 0.9% by the end of 2004 as excess inventory is slowly absorbed.

In the meantime, a record 70% of apartment owners are offering concessions, according to the Seattle office of CB Richard Ellis. Hardest hit: newer complexes built during the dot-com boom in expectation of higher rents. “This market has seen concessions as high as one-month free rent on a six-month lease in certain submarkets,” Laycock says.

Hotel Developers Cautious

The hotel industry continues to suffer from low occupancy and room rates. The occupancy rate hovered around 65% in 2003, with the average room rate at about $96 — essentially flat when compared with 2002.

Lenders are requiring hotel developers to put up as much as 40% to 50% of the cost of new full-service projects, which has quashed all but a few of the area's proposed projects. Survivors tend to be part of mixed-use projects with other components such as condominiums that offer faster payback.

The choppy recovery is keeping a lid on demand for all types of space in the Seattle area. “What we all are watching for, more than anything,” says Bowles of CB Richard Ellis, “is the return of jobs.”

Jeanne Lang Jones is a Seattle-based writer.

SEATTLE - BY THE NUMBERS

POPULATION OF METRO AREA: 3.3 million

UNEMPLOYMENT RATE: 6.8%

LARGEST EMPLOYERS:

  • Costco Wholesale Corp.
  • Microsoft Corp.
  • Washington Mutual Inc.
  • Weyerhaeuser Co.
  • AT&T Wireless Services


METRO AREA STATS

Office:

16.3% vacancy, 4Q 2002

16.6% vacancy, 4Q 2003

Rent per sq. ft.: $21.70 4Q 2003

Source: Cushman & Wakefield of Washington Inc.

Multifamily:

7.1% vacancy, 4Q 2002

7.3% vacancy, 4Q 2003

Monthly rent: $801 4Q 2003

Source: Dupre & Scott Apartment Advisors for 5-county area

Retail:

6% vacancy, 4Q 2002

6.2% vacancy, 4Q 2003

Rent per sq. ft: $19.01 4Q 2003

Source: Marcus & Millichap

Industrial:

11% vacancy, 4Q 2002

11.8% vacancy, 4Q 2003

Monthly rent per sq. ft.: $0.62 4Q 2003

Source: Cushman & Wakefield of Washington Inc.

Hotel:

65.1% occupancy, as of Nov. 2002

65.6% occupancy, as of Nov. 2003

Room rates: $95.58 as of Nov. 2003

Source: Wolfgang Rood Hospitality Consulting

MAJOR PROJECTS UNDER CONSTRUCTION:

Lincoln Square, a mixed-use project in Bellevue that will include 330,000 sq. ft. of retail in its first phase of construction

Cost: $360 million

Developer: Kemper Development

Completion: First phase, Fall 2005

Summit Building/Sumner Corporate Park, a 492,000 sq. ft. warehouse

Cost: $18 million

Developer: Knapp Development

Completion: March 2004

Ninth & Stewart Life Sciences Building, a 207,000 sq. ft. biotech office and research building

Cost: $60 million

Developer: Touchstone Corp.

Completion: Spring 2004

401 Broadway Building, a 158,000 sq. ft. medical office building

Cost: $62.5 million

Developer: Opus NW

Completion: June 2004