Optimism in the St. Louis office market is as palpable as the energy that enveloped the city when the Cardinals won the 2006 World Series. Riding that wave of euphoria, THF Realty last September sold the 16-story Plaza in Clayton building to KBS Real Estate Investment Trust for $93.2 million. The deal set a record of $290 per sq. ft. for a Class-A building in the St. Louis market.
The whopper of a deal occurred in the midst of a 12-month period ending March 31 in which the market tallied a robust $829 million in office investment sales, according to New York-based Real Capital Analytics. “A lot of owners of real estate are trying to capitalize on this level of activity,” observes Chris Fox, who is managing director of brokerage for Gateway Commercial/Cushman & Wakefield. “They recognize that at some point, it has to come to an end.”
But perhaps the run isn't over just yet. The Gateway to the West is generally insulated from the more severe ebbs and flows seen in the larger markets, explains Fox, who brokered the Plaza sale for its owner, THF Realty, a St. Louis developer. “What's really pushed investors to such a high level in St. Louis is the competition for properties in markets like Chicago, New York or Los Angeles.” The downtown office market, which has lagged behind the rest of the metro area, is starting to see signs of a resurgence, with new residential, restaurants, retail and office.
The largest buyers of office properties in St. Louis are private investors that raise both public and private capital to invest in real estate as well as pension funds. KBS REIT of Newport Beach, Calif., for example, is a non-traded REIT that taps into the wealth of private investors. “There's a lot of institutional investment going on as those entities continue to allocate a substantial amount of funds to commercial real estate, which is a big driver in St. Louis,” says Fox.
The increased activity occurred despite limited demand for office space and weak rents in the first quarter of 2007, according to Reis, which reported a metro vacancy rate of 15.2%, down 130 basis points from the first quarter of 2006.
As cap rates compress across the nation, investors are turning to the Gateway City for higher returns. “It's not a growing city like Vegas or Phoenix, but it is steady,” says Danny Prosky, managing director of healthcare properties for Santa Ana, Calif.-based Triple Net Properties LLC.
In June, Triple Net Properties purchased a 315,000 sq. ft. headquarters building for Express Scripts from Northpark Partners ESI for an undisclosed amount. The build-to-suit facility, located on the campus of the University of Missouri-St. Louis, is leased to Express Scripts, a Fortune 1000 healthcare company.
Triple Net's cap rate on the transaction was 7.3% — on par with St. Louis' average office cap rate for the first quarter of 7.4%, but high compared with the U.S. average of 6.9%, reports Real Capital Analytics. Prosky says if Express Scripts opts to move forward with a second building on the site as planned, Triple Net will seek to snap up that property as well. “Because of cap-rate compression elsewhere, places like St. Louis are nice to invest,” Prosky says.
The downtown St. Louis office market had slipped considerably in the past few decades. Office tenants left in droves for space in the city's western submarkets, including Chesterfield and Clayton, where land was abundant and in closer proximity to housing for executives and employees. Tens of thousands of square feet of commercial space, primarily former warehouses, sat vacant through the 1990s.
Also in recent decades, warehouse closures in the former garment district left the city with dozens of vacant buildings. Those vacancies, combined with the growth of the suburbs, emptied the CBD of vitality after office hours.
The exodus saddled downtown St. Louis with the highest vacancy rate in the metro area — 17.6% on 6.7 million sq. ft. of Class-A office space, according to Colliers Turley Martin Tucker. Asking rents for Class-A space downtown were $19.43 per sq. ft. in the first quarter of 2007, compared with $18.50 per sq. ft. in the first quarter of 2006.
The trend of office tenants migrating westward in the area hasn't stopped completely, but recent lease renewals indicate the tide may be turning. In the past year, several office tenants have renewed their leases, including law firms Blackwell Sanders LLP, which renewed 77,652 sq. ft. downtown, and Greensfelder, Hemker & Gale, which expanded to 116,000 sq. ft. Representatives from several major law firms on the lookout for new or expanded space say they're keeping downtown among their options.
Revitalization efforts pay off
Downtown is poised for a comeback, bolstered by revitalization efforts and the addition of 3,000 residential units since 2000. The CBD has also benefited from nearly $4 billion in investment since 1999 from local and national developers, reports non-profit Downtown St. Louis Partnership. Much of that has been sunk into the redevelopment of former warehouse and Class-B office space, which has boosted the CBD's population to about 10,000 people, an increase of 4,000 since 1999, and the addition of 100,000 sq. ft. of new restaurants and retail last year.
Two of the largest commercial developments planned downtown are the $650 million Ballpark Village (see sidebar, p. 48) and the $475 million Lumiere Place, a casino and hotel project on 20 acres of riverfront property just north of the CBD, and slated for completion this fall.
Lumiere Place includes a 75,000 sq. ft. barge casino on the Mississippi River and a 24-story tower with two planned restaurants and a 200-room Four Seasons hotel. Later phases of Pinnacle's development proposal call for the addition of eight residential buildings with 375 condos and 220,810 sq. ft. of retail space.
“The resurgence of the residential downtown and with Pinnacle's new casino has made investors take an optimistic look at downtown office properties, which will improve over the next two to four years,” says Kevin Bittmann, senior vice president at CB Richard Ellis.
St. Louis' tallest building at 42 stories, Metropolitan Square, was put on the market in late June by Metropolitan Square LLC, an entity formed by a New York-based private investment partnership led by Mark Karasick. Sources estimate the office tower could sell for as much as $200 million. Karasick bought the property in mid-2005 for $165 million.
Several buildings have also changed hands or have been placed on the market in the past year. In December 2006, Inland Real Estate of Chicago bought AT&T's largest office building in Missouri, One AT&T Center for $205 million.
St. Louis' Big Dig
A wildcard in the office market is the reconstruction of Interstate 64, known as Highway 40, the major artery into downtown. St. Louis will face its version of the Big Dig when Highway 40 shuts down completely for part of 2008 and 2009 in a $535 million reconstruction.
“In the short term, the Highway 40 project will definitely impede some of the progress that's been made downtown,” says Fox. “My impression from the investment side is that it's a non-factor,” adds Paul Hilton, senior vice president for Colliers Turley Martin Tucker. “The leases of most major tenants won't expire in that two-year timeframe. People will adjust.”
Some investors are looking to make major investments to capitalize on downtown's long-term prospects like Parmenter Realty Partners based in Miami. The company, led by Darryl Parmenter, bought the 433,533 sq. ft. One Financial Center downtown earlier this year for $46.25 million with plans to sink at least $2 million into upgrades and to reposition the 12-story building. Parmenter Realty noted the purchase price was 36% below replacement cost and the firm is now scouting for similar investments.
Class-B properties are also attracting out-of-town investors. At the end of 2006, Los Angeles-based JMF Development, led by Jeffrey Fish, bought the 215,000 sq. ft. Millennium Center office building downtown for $3.5 million. “The improvements in downtown are there, with Ballpark Village coming and all the new restaurants that are opening,” Fish says. “When the Highway 40 project is completed in a couple years, the leasing will pick up. I'm trying to get in the market, and hopefully my risk will pay off.”
Development pipeline grows
Few speculative office buildings have been developed in the St. Louis metro area in recent years. There were no office buildings delivered in the first quarter of 2007 throughout the region, but that's about to change. Building owners and developers are making the bet that the St. Louis tenants are ready to pay higher rental costs for new construction. Some real estate brokers say planned office space could push rental rates past the $30 per sq. ft. mark, setting a new bar for St. Louis. Developers say they expect the buildings to be leased primarily by local tenants looking to expand or relocate.
In the past few months, several spec office projects have been announced totaling more than 420,000 sq. ft. Duke Realty Corp. has set a June 2008 completion date for a 127,000 sq. ft. spec office building it's developing in the Lakeside Crossing Business Park in Maryland Heights, located in central St. Louis County.
Whitaker Varley, senior leasing director for Duke Realty, says the developer already has proposals out from tenants seeking a combined 400,000 sq. ft. of space. “We have had a tremendous amount of activity before we've even broken ground.”
In St. Louis' strongest submarket, Clayton, a new office building hasn't been completed since 2001. But with the Class-A vacancy rate of 10%, that situation is likely to change. Several developers are already starting to make plans, including the development arm of Montgomery Bank, which has announced plans for a 25- to 30-story, $100 million office tower.
Joel Montgomery, managing partner in Webster Groves-based Montgomery Development, says plans are still preliminary but construction could begin in 18 months. A Montgomery Bank branch would be located on the ground floor and a few floors in the building would house Montgomery Bank's offices.
Reis forecasts rents in Clayton will grow significantly from $23.08 per sq. ft. in the first quarter of 2007 to $26.49 by the end of 2011. “We'll see more spec buildings get under way in submarkets like West St. Louis County and Clayton in the second half of 2007,” predicts Tripp Hardin, senior vice president of CB Richard Ellis. “I think there will be at least one or two more on the Highway 40 corridor. Larger users are going to need more space.”
Colliers' Hilton projects a significant hike in rental rates in St. Louis over the next year due to increasing construction costs limiting plans for large office buildings in the short term. “Historically in St. Louis, rental rates have moved up and down moderately,” Hilton says. “This is the first time in my 20-year career that we've seen a big spike in rental rates. Higher rental rates leading to increased revenue for owners will have a big impact on office investment sales.”
Investors recognize the opportunity to buy now with the expectation that rental rates can't stay at the levels they are now for much longer. “That allows investors to be more aggressive on underwriting existing buildings,” Hilton says. “They're willing to buy at lower yields initially because they believe the rents will go up.”
Lisa R. Brown is a St. Louis-based writer.
ST. louis - BY THE NUMBERS
Source: U.S. Census Bureau
UNEMPLOYMENT RATE: 5.5%
Source: U.S. Bureau of Labor Statistics
LARGEST PRIVATE EMPLOYERS:
Boeing Integrated Defense Systems
Scott Air Force Base
Source: The St. Louis Business Journal
METRO AREA VITAL SIGNS
12.5% vacancy, 1Q 2007
14.2% vacancy, 1Q 2006
$18.62 rent per sq. ft., 1Q 2007
$18.22 rent per sq. ft., 1Q 2006
Source: Colliers Turley Martin Tucker
8.0% vacancy, 1Q 2007
8.6% vacancy, 1Q 2006
$705 monthly gross rent, 1Q 2007
$688 monthly gross rent, 1Q 2006
10.3% vacancy, 1Q 2007
9.8% vacancy, 1Q 2006
$14.71 rent per sq. ft., 1Q 2007
$14.98 rent per sq. ft., 1Q 2006
6.7% vacancy, 1Q 2007
6.4% vacancy, 1Q 2006
$4.83 rent per sq. ft., 1Q 2007
$4.78 rent per sq. ft., 1Q 2006
Source: Gateway Commercial/Cushman & Wakefield
50.4% occupancy, 1Q 2007
48.6% occupancy, 1Q 2006
$108.41 average daily rate, 1Q 2007
$102.01 average daily rate, 1Q 2006
Source: Smith Travel Research
Lumiere Place, a new casino resort rising in downtown St. Louis, will include a 200-room Four Seasons hotel and two restaurants in a 24-story tower. The project will feature a 75,000 sq. ft. barge casino on the Mississippi River. The second phase of the project will include eight residential buildings with 375 condos and 220,810 sq. ft. of retail.
Developer: Pinnacle Entertainment Inc.
Completion: Fall 2007
Cost: $475 million
SkyHouse, a glass and steel 22-story tower to be located in the Washington Avenue loft district, will have 166 condos with prices starting in the mid- $200,000s. Metropolitan Development Enterprises, embarking on its first St. Louis project, is partnering with local developers Brad Waldrop and Ben Riley to meet downtown condo demand.
Developer: Metropolitan Development Enterprises
Completion: Fall 2009
Cost: $475 million
Mixed-use project swings for the fences
For decades the sidewalks rolled up in downtown St. Louis a little after 5 p.m. when office employees left for the day with few residential and entertainment choices to hold their attention. These days, however, new development is rising to break the silence.
Part of that revival can be attributed to the new Busch Stadium, a $344 million baseball park that opened in April 2006 for the St. Louis Cardinals. Next door, on the site of the old Busch Stadium, a massive $650 million mixed-use development, Ballpark Village, is planned. The first phase of the project is slated to open in time for the Major League Baseball All-Star Game in 2009.
Construction will commence this fall on the project pending approval from the state of Missouri. It is being developed jointly by the Cordish Co. of Baltimore and the St. Louis Cardinals. The joint venture is being funded by $115 million in subsidies from the city and state, including tax increment financing, which enables cities to borrow against future tax revenue to help fund projects in blighted areas.
The cost for the first development phase of Ballpark Village totals $387 million. In addition to 324,000 sq. ft. of retail and restaurant space, Cordish is considering the inclusion of 250 condos.
The amount of office development is still undetermined but could increase, according to Blake Cordish, vice president of development for Cordish, who notes that demand for office has been strong. The project originally called for 100,000 sq. ft. of office space to be completed in 2010, with 200,000 sq. ft. of office space to be added in a later phase.
The new space will be the first added downtown since the 1.1 million sq. ft. 42-story Metropolitan Square building, the tallest in St. Louis, was built in 1989.
No tenants have been announced to date, but interest in the development is mounting. “The interest is reflective of a growing demand downtown,” says Cordish.
“But perhaps more importantly is the uniqueness of the amenities we offer such as ballpark and river views, outdoor balconies, diverse restaurant and retail offerings and parking.”
— Lisa Brown