Commercial Real Estate Begins the Slow Crawl Back

Seattle’s long-ailing commercial real estate industry is coming back to life.

With vacancy rates down and building prices rising again, developers are pursuing plans to construct new buildings for the first time in years.

If you look at 2008, it was a real train wreck, but here we are in 2012 with strong buyers and sold property, says Dan Ivanoff, founder and managing partner of Seattle-based investor/developer Schnitzer West. The company expects to restart construction of its M5 project, which was shelved in 2008 at the beginning of the recession. The design calls for a 36-story office tower at Fifth Avenue and Madison Street in downtown Seattle with 750,000 square feet of office space and 14,000 square feet of retail space.

It is one of many office projects which, added to the recent rise in apartment construction, are bringing back tall cranes to Seattles skyline, promising jobs for construction workers and architects, and offering grounds for new optimism in the real estate market and the broader regional economy. Some others:

Touchstone Corporation paid $18.4 million to The Seattle Times last year for a 2.5-acre site inside the Troy Laundry Block and is poised to begin construction at Fairview Avenue North on two 12-story office buildings offering 770,000 square feet of space.

R.C. Hedreen Company, whose 39-story Olive 8 condo and hotel project struggled as it came to market just as the recession hit, is finally seeing healthier sales. The company is now proposing a 900-room hotel and a 700,000-square-foot office tower on the block where Seattles aging Greyhound bus terminal sits.

Paul Allens Vulcan Real Estate is proposing a six-story building three blocks to the west.

Spear Street Capital is planning a 114,000-square-foot project at Westlake Avenue North and John Street.

As this story went to press, the second phase of the Stadium Place project in Pioneer Square received a boost with news that Daniels Real Estate, the primary developer, will partner with Henry Liebmans American Life to develop a 23-story hotel with 16,000 square feet of shops and restaurants, a 376-stall garage and a health club.

The most significant development is Amazon.coms decision to build 3 million square feet of office campus in downtown Seattle, anchoring the company in the city far into the future and increasing confidence in the regions long-term prospects.

That confidence has been buttressed by the growing strength of the commercial real estate market. In 2011, Seattles commercial property market saw the sale of 6.5 million square feet of space for $1.7 billion, its best showing in four years. Seattle has consistently ranked among the top five commercial real estate markets in the country.

This trend continues. In May, Vance Corporation sold its Plaza 600 Building to Seattles Joshua Green Corporation for $54.9 million. In June, Brookfield Office Properties of New York announced the purchase of Metropolitan Park East and Metropolitan Park West, known as the Twin Toasters in Seattles Denny Triangle, for $210 million from Walton Street Capital. Later this year, Schnitzer West will close on two downtown office towers it is selling to J.P. Morgan Asset Management for $480 million.

Underpinning the stronger real estate market has been steady job growth in the Seattle area. Since the region’s unemployment rate peaked at 10.4 percent in early 2010, local employers have added back 56,000 jobs of the more than 83,000 lost during the Great Recession.

Seattle has become a talent magnet for job seekers fresh from grad school who want to build a career, says A-P Hurd, vice president at Touchstone. And California companies are out to tap that talent. If Californias Silicon Valley employers have been outsourcing to Bangalore, Seattle now looks like a good second choice, she says, pointing to lower housing and labor costs, and the absence of a state income tax. Just as it was with Microsoft in the 90s, we now have a self-reinforcing loop with web tech, software and console game companies.

Amazons aggressive growth has been instrumental in boosting both direct and indirect demand for office space. Many companies want to be near the Amazon campus in the South Lake Union area, says Rod Keefe, a partner with Kidder Mathews commercial real estate services in Bellevue. But Seattle has also benefited from the strength of other companies such as Microsoft, F5 Networks and Nordstrom, all of which are taking up new office space. This spring, for example, Nordstrom said it would lease 300,000 square feet in the 32-story building at 1600 Seventh Avenue downtown formerly known as Qwest Plaza.

To be sure, were not likely to see a return to the boom days of 2006 anytime soon. While all the activity is a good sign, experts say the market remains vulnerable. The pace of improvement in Seattles [overall] office market vacancy has been frustratingly slow [in the first quarter 2012] compared to last years gains, says Patricia Raicht, research vice president for Jones Lang LaSalle, a real estate services firm. Many companies are reluctant to make major commitments to new office space. The demand profile is cautious and deliberate, says Ivanoff.

Seattle saw net office space absorption in 2011 of 1.9 million square feet, but vacancy fell only slightly to14.8 percent, from a high of 15.4 percent in 2009. Raicht says Class A space has outperformed commodity space, while space in the central business district has outperformed the Eastside.

While condo sales have shown some strength, prices remain at a level that makes it hard to justify new construction. Consequently, when it comes to the residential market, developers are still focusing instead on apartments. That calculus could change. Developers anticipate City of Seattle zoning regulation changes this year that will allow more downtown high-rise apartments and condos, bringing additional residents to the urban core. Such a change would allow developers to get a higher return on their investments.

Depending on the citys rezoning changes, Touchstone Corporation expects to start work on its Troy Block project in South Lake Union. That complex will bring as much as 770,000 square feet of new construction to 2.5 acres there. But its unclear whether demand is strong enough to absorb all that new space.

Another challenge facing developers is the willingness of banks to lend. Many were burned by real estate lending during the recent downturn and are cautious about committing large sums to projects.

Financing is still very difficult, says Scott Shapiro of Eagle Rock Ventures LLC, which specializes in buying and renovating older buildings. He expects a gradual turnaround for the region as lenders grind through their bad loan portfolio and adjust to a tighter regulatory environment. This will be a long-term recovery. Thats not going to change. On a scale of one to 10, I guess Im a six … cautiously optimistic, says Shapiro.

Trends in Washington, D.C., are also a concern to Shapiro and many others as they decide whether or not to pursue real estate development.

We look at 10-year horizons, and it is impossible to know what interest rates are going to be, says Kevin Wallace of Wallace Properties in Bellevue. It concerns us that the U.S. government keeps adding trillions of dollars each year to its debt. Even so, Wallace expects to begin work soon on a $55 million second phase of its Northgate project that calls for 252 rental apartments and 20,000 square feet of retail in north Seattle.

There are plenty of indicators that point toward a healthier market over the long term. One is a demographic trend that has young, highly educated professionals attracted to urban neighborhoods instead of suburbs. Theyd rather walk or bike to work than commute by car. That preference prompted the relocation of Brooks Sports headquarters from Bothell to the Fremont/Wallingford area, says Lisa Picard, executive vice president with project developer Skanska USA Commercial Development.

Brooks, a high-performance running shoe designer, is moving its 300 employees into a new five-story 120,000-square-foot ultra-green building at 3400 Stone Way. We see this as an urban trailhead project, Picard says. This building is where the workforce wants to be. And its creating a sense of place for Brooks.