September 1, 2010—Office Sector Challenges and Opportunities

By Tom Nieman, PICOR

TREND REPORT

September 1, 2010

When I was asked to prepare a few words regarding the current state of the Tucson office market, I figured that I’d try to report on some topics other than the usual vacancy and rental rates, who’s doing deals and what’s under construction. I wanted to give the readers a flavor of some of the factors currently shaping the market. After some thought, I decided a good way to do this would be to identify and discuss a few terms brokers active in the market are hearing and/or experiencing on a daily basis. So here we go.

Uncertainty. Given all of the economic, budget, regulation and tax issues facing the nation, states, counties and cities, as well as the new health care legislation, many business and medical professionals are very uncertain of what the future has in store. In recent years, we’ve seen unemployment skyrocket, with about 8 million jobs lost nationwide. These are all things that keep people up at night and translate into a real hesitancy to do anything, except to just try to maintain the status quo. I believe this is presently the one big factor affecting the Tucson office market.

We really don’t have a damaging vacancy factor like some cities and like our neighbor up the road. While we sit at about 12%, Phoenix is experiencing over 20% (CoStar Group). An interesting statistic…Phoenix has 33 million sq. ft. of vacant space. Tucson’s entire office inventory is only 23 million sq. ft.! Our problem is a lack of requirements in the market. We’re just not seeing the number of tenants and buyers in the market as we have in the past, which translates into a lost opportunity to negotiate and consummate a transaction. When a tenant does explore the market, their landlord, if he’s paying attention to what’s going on, will do what ever it takes to keep that tenant, because he knows if he loses them, it could be a long time before anyone else comes along.

An interesting side affect to this lack of activity is the challenge it presents to appraisers in trying to find comparable lease and sale transactions to base their reports on. And when there is a lease completed, it’s not unusual for there to be a confidentiality agreement where the tenant, landlord and broker are unable to share the details of the transaction. I tell them it’s why they get paid the big bucks!

Shadow Space. Walk around in almost any office, including your own, and you’ll probably see them…empty offices, cubicles or chairs. That’s shadow space…space that isn’t being occupied but isn’t being actively marketed either. This is the engineering company that has 6,000 sq. ft. of space and only 4 employees. They’re not sure if they want to try and sublease the space, as they’re trying to be optimistic, and think they’ll be rehiring those laid-off employees sometime soon. Shadow space occurs because companies can lay off workers faster than they lay off space. And again, there isn’t a lot of demand for that space, even at well-below market terms.

Currently, U.S. corporations average 190 square feet per employee. Some experts estimate that there is 130 million square feet of unused, or under-used, corporate office space in the United States today. Tucson has its share of shadow space, but it’s very difficult to say exactly how much. Shadow space represents an ongoing challenge to the commercial office recovery, nationally and locally. It could dampen down an already sluggish recovery and make it even longer before office vacancies and rents reach a more balanced level.

Opportunity. Now for something positive! All of the challenges I’ve been talking about above are aligning the stars in a manner that has created some amazing lease and sale terms for tenants and buyers. Granted, they need to overcome the “uncertainty” and have the confidence (translated, guts) to take action. Over the past couple of years, I have represented several tenants and buyers that have decided to explore the market and we’ve been able to identify opportunities that we won’t see again for a long time. Rent and price reductions, concessions and other terms, not necessarily offered up front, but acquired though patient and thorough negotiation. I’ve also been involved in several early lease renewals, where the tenant offers the landlord an extended lease term in trade for an immediately reduced rental rate and attractive ongoing rates. We call this a “blend and extend,” and it can be a “win-win” for both parties. They both get something they want…the landlord getting the security of knowing his tenant will be there into the future and the tenant getting an immediate and ongoing reduction in rent.

Financing terms are also appealing at this time. A borrower that has a strong financial statement and good credit history, and is able to persist through the process can expect to see some attractive interest rates and payment terms. When you consider some of the price reductions we’re seeing on existing built out properties, as well as newly constructed shell space, and then throw in the savings we’re experiencing for interior buildouts and remodels, it’s not hard to see that purchasing may be a good option in this market.

To sum it up, I have to say that for all of the 28 years of being active in the commercial real estate business, representing landlords, tenants, buyers, sellers and developers, I’ve never experienced times as challenging as these. It certainly provides for those frustrating conversations with clients as to why it’s so hard to fulfill their specific requirements as quickly as they desire. On the other hand it also offers some amazing opportunities for those with vision and confidence to take advantage of the times and make their moves, expand their businesses and even build their buildings. We should all be very thankful that we live in a city and a state that will see the growth and good times again. Hopefully, we won’t have to wait too long.

Tom Nieman, specializing in commercial real estateTom Nieman PICOR since 1977, possesses a diverse background in brokerage, development, and management. He joined PICOR in 1995, focusing on the office, medical and investment markets, becoming a Principal in 2001. He excels in providing the best solutions to the real estate requirements of developers, landlords, tenants and investors.