February 9, 2010—Absent speculators, office market stays stable

By Roger Yohem

INSIDE TUCSON BUSINESS

February 9, 2010

All categories of commercial real estate saw vacancy rates rise to double-digit levels in 2009. The office market however, was the only sector to achieve a measure of relative stability. It ended the year with a 16.5 percent vacancy rate, up from 15 percent at the end of 2008.
Rick Kleiner, of PICOR Commercial Real Estate Services, attributed the small increase to “the lack of speculative office development that has insulated Tucson from a huge overhang of vacant space.”

Indeed, there were only eight new construction projects last year totaling less than 250,000 square feet. New office space that opened was only 10 percent vacant, indicating they were build-to-suit projects and not speculative construction.

Of note, the Oracle-Ina Professional Plaza on the northwest side will add 93,000 square feet to the market this November. The Monte V Corporate Center, 3501 E. Speedway, is sized at 40,000 square feet. It is scheduled for completion in August.
“First quarter activity will serve as a leading indicator whether companies will be coming back into the office market to lease and purchase. Or, will they continue to delay renewal and relocation decisions in light of economic uncertainty?” said Kleiner.

In general, office market experts agree the sector is at or near its bottom, showing more firmness than other commercial real estate. Yet with declining, soft rental rates, 2010 and 2011 also will be a prime time for deal makers in the office category.

“As far as office leasing, Tucson is slowly moving in the positive direction. This year will see some movement of tenants if the deal makes sense or the tenant needs to grow and there is no expansion space where they are presently located,” said Michael Gross, office leasing specialist with Tucson Realty & Trust.

He emphasized that relocations, solely to take advantage of lower rates in other buildings, make no economic sense unless tenants can save $3 to $4 per square foot per year.

If tenants don’t need to expand their operations, many businesses will negotiate with their present landlords for a better deal.

“Tenants look for productivity gains by lowering their space-per-capita ratios and will want big accommodations in rents and concessions,” Gross said.

Kleiner agreed, that lease rates will continue to soften because under-utilized office space is being discounted for subleases. Incentives will include rent abatement, tenant improvement allowances and “even a full complement of furnishings,” he said.

“Purchase activity by owner-occupants and investors will be virtually nil because of the difficulty to secure financing,” Kleiner added.

Vacancy rates in all submarkets increased for during 2009, according to Don Ahee, office operations manager of CB Richard Ellis.

The northeast submarket posted the highest rate of 23.8 percent vacant, followed by the northwest sector at 18.9 percent and downtown Tucson at 16.8 percent.

Ahee pointed out three significant transactions in 2009.

For just under $15 million, BP Gateway Investors purchased a 76,268 square-foot building at 7333-7373 E. Rosewood St. Two major leases were for 75,000 square feet of space by M3 Engineering, at 2051 W. Sunset Road; and Tucson College’s 40,945 square-foot lease at 5151. E. Broadway.

Cap rates will increase during 2010 due to the economy’s slow recovery, competition from other real estate investments, and tenants “not as strong financially as in past years,” said Gross. “I think cap rates increase to 9.5 to 10 percent to get a building sold. The battle will be to just find financing. There will be a lot more scrutiny and requirements by the lender.”

Contact reporter Roger Yohem at [email protected] or at (520) 295-4254.