To many real estate investors, Atlanta's office market remains an enigma. Despite a vacancy rate hovering near 20%, 2.4 million sq. ft. of new office space was under construction in the third quarter of 2006, according to locally based Dorey Market Analysis Group. While that's not a significant amount of development by historical standards, any increase in new supply in a market already burdened by double-digit vacancies hampers efforts to raise rents.

Even so, investors continue to gobble up office towers at record prices. Case in point: Hines Interests recently sold its newly constructed 1180 Peachtree Tower for $268 million to General Electric's pension fund. At $400 per sq. ft., the deal was a record for a metro Atlanta commercial property. Then Hines turned around and reinvested through its core fund back into the city, buying One Atlantic Center, a 50-story, 1.1 million sq. ft. tower. The price tag: $307 million.

“The vacancy rate isn't really shifting because as soon as it's absorbed, we're developing comparable amounts,” says Keith Pierce, a senior research coordinator with CB Richard Ellis Group Inc. “Demand is outpacing supply, but not by much.” In fact, absorption through the third quarter of 2006 totaled approximately 2 million sq. ft., slightly less than the amount of space under construction.

Overall, that's a good sign for tenants. Although New York-based research firm Reis Inc. reports that effective rents rose 1% from the third quarter of 2005 to the same period in 2006, concessions have occurred throughout the market. Current average asking rates are $20.21 per sq. ft., or nearly $5 per sq. ft. lower than the national average, reports Reis.

For this reason, Atlanta has been ranked as one of the country's most affordable office markets for tenants, but with little prospect for any strong rental rate gains for landlords in the near future, according to Marcus & Millichap. And economist Sam Chandan of Reis says some 40% of landlords are reporting rental rate declines.

“This is a pretty respectable [office absorption] recovery, but the degree of development adds some question marks,” says CBRE's Pierce. “To put it another way, if nobody were building anything, we'd be looking at a completely different market.”

In spite of the tendency for developers to kill the golden goose, investors view Atlanta as a growth market with opportunities, says Ross Ford, president and CEO of TCN Worldwide, a nationwide commercial real estate brokerage network.

“This market is on fire because there are so few opportunity markets, and none in the same caliber and class as Atlanta,” Ford says. “If I have investment dollars targeted for top-tier Class-A markets, my best opportunities are in Atlanta.”

Barriers welcome

Many local real estate experts believe that the current development wave is not enough to derail the office recovery. Many developers require significant pre-leasing at their projects, and it's becoming more difficult to find prime spots in the central business district (CBD), where a majority of the new office development has taken place. Further, they argue, banks haven't been willy-nilly in their lending because construction costs are at all-time highs.

John Whitaker, managing director at AIG Global Real Estate, says that the cost of construction and the need for pre-leasing should keep many developers' plans for new office projects on hold in the near future. “Developers that are pursuing any new projects will be required to have pre-leasing to start them. That certainly takes out an element of risk,” Whitaker says.

But there's still a lot of office space in the pipeline that could turn this recovery sour. Matt Bronfman, managing director of Jamestown, an Atlanta-based real estate investment and management company with more than $6 billion in investments in the U.S., still sees one major Achilles heel to the city: few barriers to entry.

Atlanta has no real geographic barriers to prevent new development, or a lack of potential sites, even inside the CBD. As Bronfman points out, as long as there are surface parking lots, that's another site that potentially could see a new office tower.

Measurable uptick in demand

While far below the heady days of employment growth between 1995 and 2000 when the market added as many as 100,000 jobs per year, Atlanta has posted impressive gains overall. More than 69,000 new jobs were created in 2005, of which roughly 12,000 were in professional and financial services industries, jobs that often require office space.

Even more encouraging is that Atlanta's unemployment rate registered 4.4% in September 2006, down from 5.5% the year before, according to Reis. And while many economists predict that job growth won't continue along the lines of last year, healthy job gains are still expected in the metro area.

An improving local economy coupled with strong absorption has brightened the long-term outlook. Dorey Market Analysis Group reports that 3.47 million sq. ft. of office space was absorbed in metro Atlanta in 2005 with Class-A space accounting for 2.3 million sq. ft. of that total. And of the nearly 2 million sq. ft. of office space absorbed during the first three quarters of 2006, more than half that total was Class-A space.

Many experts say that the significant rise in office absorption within the city is largely due to the growth of small and mid-sized firms. In what may be the biggest office deal of 2006, CompuCredit Corp., a credit card processor, leased more than 400,000 sq. ft. at Concourse Corporate Center, an office tower in the Central Perimeter submarket. Other major office deals include The American Cancer Society, which took 260,000 sq. ft. at the Inforum Building in Atlanta.

Of course, one key factor that made Atlanta such a darling office market in the 1990s is still true today — a diverse economy. That said, the capital of the Southeast is not impervious to the vicissitudes of market forces as evidenced by the highly publicized bankruptcy of Delta Air Lines and a possible hostile takeover by US Airways. But by all accounts, Atlanta remains a resilient economy.

Many financial institutions have increased their presence in the city, and others have entered the market in recent years such as RBC Centura and Flagstar Bancorp. The market also plays host to several corporate headquarters, including Newell Rubbermaid, Intercontinental Hotels, The Home Depot, and numerous technology incubator companies spawned by the Georgia Institute of Technology.

Some historical context

One hallmark of the Atlanta commercial real estate industry is that when things look up, developers race to break ground on new product. “[Still], the exuberance this time is more managed than it was in the past,” says Tad Leithead, senior vice president at Cousins Properties, a diversified REIT. Cousins is developing the Terminus 100 office tower in Buckhead, a 650,000 sq. ft. building that is already two-thirds leased, and has plans for a second building next door.

“If you take the new development as a whole, there is a significant amount of pre-leasing in these projects and [companies are absorbing more space] then just churning the market,” Leithead says. As major tenants jump from older towers to newer towers, they tend to take bigger chunks of additional space.

Cousins spotted the recovery trend in Buckhead, the financial district north of downtown. And the numbers corroborate the firm's intuition. Research firm Dorey considers the Buckhead submarket to be much healthier than the rest of the metro Atlanta office market with a 15.8% vacancy rate in the third quarter of 2006 compared with nearly 20% for the metro area.

Much of the office development activity, however, has occurred in the CBD. Regent Partners, for example, is constructing a 50-story, mixed-use tower scheduled for delivery by April 2008. Developers hope that several other projects in the planning stages will break ground in the future.

Lending restraint?

Along with significant pre-leasing, some lenders say developers are also coming to the table with 5% more equity on average than in the past. The added protection has enabled banks to finance many of the new office projects in Atlanta.

Melissa Frawley, the Georgia market manager for real estate services with Wachovia Corp., one of the largest commercial lenders in the state, says there is not yet an oversupply to dissuade lenders from financing new projects. But the pipeline of potential projects could throw a wrench into that balance.

“I tend to hope, and I believe, the developers are watching. From our side, we haven't seen this rush of new loan requests,” Frawley says. “If there is that better self-control in the marketplace, we probably won't have an issue.”

But Atlanta commercial real estate firm Childress Klein Properties Inc., an investment, development and management company, is not participating thus far in this round. “We've run numbers and we can't figure out how you can make a new building work without $30-plus rents,” says Connie Engel, a partner with the firm. “I need to be full-up here — 90% in every building — before we start looking at more office development.” According to Reis, the average metro Atlanta effective office rental rate registered $16.82 per sq. ft. in the third quarter of 2006.

Buy, hold

More than $1.8 billion in office buildings changed hands in Atlanta during the first three quarters of 2006, with an average capitalization rate of 7.6%, according to Reis. Although it was unclear in early December whether the deal volume would surpass the $2.6 billion worth of investment sales recorded in 2005, the $1.8 billion sum still ranked among the highest annual totals ever.

The prices paid for Atlanta office properties are bargains compared with prices in New York, Chicago and Washington, D.C., but they are higher than average locally. That coupled with the prospective struggle to raise rental rates in light of new product means many institutional investors will likely sit on their Atlanta investments for some time, says Justin Parsonnet, senior vice president at CBRE in Atlanta.

BentleyForbes, the Los Angeles-based real estate investment firm that paid $436 million in October to acquire the Bank of America Plaza, a 55-story landmark skyscraper, certainly has no plans for a quick flip. “I don't care where you buy your property in America today, you better be prepared for intermediate or long-term holding periods,” says David Cobb, president of BentleyForbes. “We never really buy for the mid-term. Something like the [Bank of America] Plaza, we may own for 10 or 15 years.”

While BentleyForbes plans on staying for the long haul, other players have made a decisive exit. This year alone, Atlanta lost two of its largest landlords — Equity Office Properties Trust and Trizec Properties Trust — through the planned sale of a combined 10 million sq. ft. of space.

The turn of events is nothing short of stunning. At the start of 2006, Equity Office was the largest Atlanta office landlord with 7.5 million sq. ft. owned locally. Then almost overnight both Trizec and Equity Office were acquired by private equity giant Blackstone Group. As of December, the sale of EOP's Atlanta assets had yet to be completed. Meanwhile, New York-based Tishman Speyer made its Atlanta debut with the 3.5 million sq. ft. Trizec office property portfolio, which included both Buckhead's Alliance Center and a pad site for a second center.

Even though private capital typically has a shorter hold period, many of the properties in Atlanta are being bought on the basis of cash flow. So many of Atlanta's trophy assets have already traded hands that Parsonnet says industry watchers expect there to be fewer banner transactions in the metro area during 2007.

While some offices that traded hands five or more years ago could hit the market again, there may be another source of big purchases — straight from the development bonanza. “There may be some owners who have held for a few years and may decide to take a crack at the market,” says CBRE's Pierce. “But if you ask where are the next quality assets [for sale], they may be in the development pipeline.”

Jarred Schenke is an Atlanta-based writer.

ATLANTA - BY THE NUMBERS

METRO POPULATION: 4.9 million

Source: Atlanta Regional Commission

UNEMPLOYMENT RATE: 4.4%

Source: Reis Inc.

LARGEST PRIVATE EMPLOYERS*:

  • Delta Air Lines Inc.
    19,235 employees

  • Publix Super Markets Inc.
    16,855 employees

  • Kroger Co.
    15,500 employees

  • BellSouth Corp.
    15,500 employees

* Atlanta employment base only

Source: Metro Atlanta Chamber of Commerce

METRO AREA VITAL SIGNS

Office:

19.6% vacancy, 3Q 2006
20.5% vacancy, 3Q 2005
$19.61 rent per sq. ft., 3Q 2006
$20.19 rent per sq. ft., 3Q 2005

Source: Dorey Market Analysis Group

Multifamily:

7.8% vacancy, 4Q 2006*
8.0% vacancy, 4Q 2005
$742 avg. effective rent, 4Q 2006*
$728 avg. effective rent, 4Q 2005

* Projected

Source: Marcus & Millichap

Retail:

8.2% vacancy, 3Q 2006
10.5% vacancy, 3Q 2005
$15.13 rent per sq. ft., 3Q 2006
$15.15 rent per sq. ft., 3Q 2005

Source: Dorey Market Analysis Group

Industrial:

16.6% vacancy, 3Q 2006
15.7% vacancy, 3Q 2005
$4.41 rent per sq. ft., 3Q 2006
$4.51 rent per sq. ft., 3Q 2005

Source: Dorey Market Analysis Group

Hotel:

67.6% occupancy, 4Q 2006*
65.2% occupancy, 4Q 2005
$87.16 average daily rate, 4Q 2006*
$80.74 average daily rate, 4Q 2005

* Projected

Source: Smith Travel Research, PKF Consulting

MAJOR PROJECTS:

Terminus is a mixed-use project consisting of two office towers, Terminus 100 at 580,000 sq. ft. and Terminus 200 at 520,000 sq. ft.; a 32-story condominium tower called 10 Terminus Place; and various retail and restaurant spots. The project is centered in Atlanta's financial district of Buckhead at the corner of Peachtree and Piedmont roads.

Developer: Cousins Properties Inc.

Completion: 2008

Cost: $170 million

3344 Peachtree, a 50-story vertical mixed-use tower, consists of 494,000 sq. ft. of Class-A office space, 93 condos and various ground-level retail and restaurant space. Regent Partners is currently in negotiations with tenants.

Developer: Regent Partners Inc.

Completion: 2008

Cost: $250 million

Hines rides Atlanta office wave just right

Toward the later half of 2005, the decision was made to sell Hines' iconic 41-story, 670,000 sq. ft. skyscraper in the heart of Midtown. Hines Interests, one of the city's most prolific office developers, funded the project via the Hines National Office Partners LP fund. The largest investor in that fund is the California Public Employees' Retirement System (CalPERS).

1180 Peachtree opened in March of 2006, and is often credited with helping propel an Atlanta Midtown renaissance of sorts, especially among law firms, which have been clustering in glittering new spaces in the office submarket.

The developer broke ground on the tower in the fall of 2003. A lease with law firm King & Spalding, plus others, brought the tower to 80% occupancy.

In 2005, Hines embarked on a disposition spree, selling some $1 billion worth of real estate from its National Office Partners LP fund. Hines officials concluded that 1180 Peachtree had reached a tipping point, recalls Kurt Hartman, vice president of Hines in Atlanta. Eastdil Secured LLC was hired to market the building. “From our perspective, that's close to stabilization. So when we got it to stabilization, it pretty much made sense to sell,” Hartman says.

The end result was that in September 2006 an affiliate of General Electric Pension Trust paid $268 million, or $400 per sq. ft., an Atlanta office record, according to local reports. Hartman says the decision to market 1180 Peachtree ultimately had more to do with the direction of the fund, which was in a selling mood. Better still, the timing coincided with a flood of capital washing over the city's commercial real estate market.

Hartman was surprised that the building sold so soon after completion. “In hindsight, it certainly seemed like a good time to sell,” he says. “But it had nothing to do with Atlanta specifically.”
Jarred Schenke