Faced with swelling vacancy rates and tepid demand from Corporate America, office owners are trimming expansion plans. Duke Realty Corp., No. 5 on NREI's top office owner's ranking this year, is a typical example. The Indianapolis-based owner has cut itsactivity by more than 50% since the building boom of the late 1990s. At the same time, the company is sticking to its core strength — the suburban office market.
Amid the seemingly endless demand for office space in the late 1990s, Duke Realty was building between 2.5 million sq. ft. and 3 million sq. ft. of new space per year. Today, the company has slashed that amount to about 900,000 sq. ft.
Specis but a distant memory. With the nationwide vacancy rate for Class-A office space approaching 17%, according to CoStar Group, those projects are far too risky. “Now, pretty much all the development we're doing is build-to-suit or substantially pre-leased buildings,” says Denny Oklak, president and COO of Duke Realty. “We're still very aggressive and are looking hard to find companies that want to move into a building right off the bat.”
Focusing On The 'Burbs
Duke, a real estatetrust (REIT) that went public in 1993, also continues to focus its development activity in the suburbs. Aside from a few office buildings in downtown Indianapolis and Cincinnati, Duke's portfolio is made up predominantly of suburban properties in the Midwest and Southeast. “We think the risk profile in the CBD markets is greater — they're generally larger buildings with more turnover,” Oklak says. “We have really shied away from the downtown markets and believe you can do just as well long-term in the suburban market.”
As of Dec. 31, 2002, Duke's office portfolio totalled 25.6 million sq. ft., up from 25 million sq. ft. the previous year. Although the company's industrial portfolio — which at 81.7 million sq. ft. is one of the nation's largest — far outweighs its office holdings, Oklak notes that the $5 billion value of its portfolio is split roughly 50-50 between the two property types.
As of June 20, the stock price for Duke Realty (NYSE:DRE) registered $26.97, down from the 52-week high of $29.30, but well above the 52-week low of $21.40.
Still Eyeing Growth
The office portfolio grew at breakneck speed in the 1990s through acquisitions and new development. After purchasing its first office property in its hometown of Indianapolis in the late 1970s, Duke's office portfolio shot up to 7.2 million sq. ft. in 1993 and 16.2 million sq. ft. in 1997.
Oklak says the company's current goal is to expand its office holdings in Atlanta, Nashville, Raleigh/Durham, N.C., and the Central Florida markets of Tampa and Orlando. Duke entered those markets in 1999 when it acquired a portfolio of mainly industrial properties from Atlanta-based Weeks Corp.
However, before the company can make a major push in those cities, it will have to wait for vacancy rates to subside. The first-quarter 2003 vacancy rate for Class-A space registered 21.2% in Atlanta and a whopping 24.5% in Raleigh/Durham, according to Bethesda, Md-based CoStar Group.
Duke's biggest office project under development is a 225,000 sq. ft. build-to-suit project for Community Insurance in the northeast suburbs of Cincinnati. The project will cost approximately $27 million and be completed in the fourth quarter of this year.
Vacancy rates in Duke's portfolio increased from 14.7% in the first quarter of 2002 to 14.9% in the first quarter of this year. During that same period, the national vacancy rate for Class-A office space rose from 14.4% to 16.7%, and vacancies for all classes of space rose from 13% to 14.7%, according to CoStar.
Despite the heightened competition from institutional investors, acquisitions at the company rose from 258,000 sq. ft. in 2001 to 928,00 sq. ft. in 2002. The company's lone acquisition in the first quarter of 2003 was a two-building, 301,000 sq. ft. office complex in the Northern Perimeter submarket of Atlanta. Duke paid approximately $40 million for the property in a sale-leasebackwith Lucent Technologies Inc.
Although Duke has scaled back new development in the past two years, it is in a good position to pick up the pace because it owns plenty of land in each of its major markets. Duke's undeveloped land holdings can support about 62 million sq. ft. of future development, with about 20% of that property set aside for office space.
Emphasizes Oklak, “We really believe that once things turn around, we're poised to grow our revenue stream and our earnings through new development.”