Industry insiders are witnessing a groundswell of new demand that is creating a sustainable recovery in the commercial real estate market. Several high-profile developments are underway, and our experts predict positive ripple effects throughout every segment of the industry.
What’s the state of commercial real estate in Utah?
K. PETERSON: It’s actually a very exciting time. It’s the general consensus that we have hit bottom. In 2009/2010, we started to come up. And this year, we’re expecting some moderate growth. As far as the office market, we’re starting to see some tenants say something besides, “I’d like to do a six-month extension.” People hunkered down for so long just to see if they were going to get through the market, to see how things were going. But now people are trying to be a little opportunistic, to get out and take advantage of market conditions and make that change to upgrade their space and improve their image.
SHIELDS: In addition to just the positive attitude and the turning in the market, there is a ground swell of significant change—Salt Lake City is becoming a major place to do business and not just a place to have an office. Having been in the business since 1980, I don’t think I’ve ever seen the kind of underpinning of a foundational infrastructure, business structure and just the general combination of economic factors that bode for what appears to be a more sustained, long-term growth that is taking place now.
BURTON: On the multi-family side, we’ve seen almost a never-before kind of situation. More units were delivered and absorbed last year than ever in the history of the state. It was about a 5.2 percent absorption. And more units were completed.
Our concern last year was that we’d see occupancies go down, and they actually improved from 8.6 percent down to 6.2. We projected this year they’d stabilize around six, and I think we were wrong and they’ll be around five.
What we’ve seen is something that we’ve not seen before: the decline in homeowner households and the mentality of owning versus renting. In 2008, that ratio of homeowner versus renters was 75 percent to 25 percent. And it dropped 7 percent from 2008 to 2010, which caused the rental market to absorb all these units that came on the market.
FUGAL: The most exciting news is a return to positive absorption. Following the greatest drop in negative absorption that we observed in 2009, to see us come out of 2010 with dynamic, positive absorption and activity in all sectors has been a real sign of recovery. If we can capitalize on that momentum and continue to make deals in order to draw companies to Utah, the future looks very encouraging.
How is the office market doing right now?
WOODBURY: There’s improvement, but people are still out looking for deals. I haven’t seen a lot of rental rate increases. In fact, it may be almost the opposite. The real question for landlords is, how long can they hold out? Because we know there’s positive absorption. So we know that the deals are going away, but when are they going away?
Most tenants are saying, “Now’s our opportunity to get a good deal because we know the economy is improving.” And the landlords are thinking, “How long can we hold out before we give the next good deal because we know the economy’s improving?” So there’s a little bit of a clash there, and it could be interesting to see how it works out.
S. PETERSON: If you go into a little more detail, there’s different segments within the space. For B or C class office space, that’s very true. There’s a lot of downward pressure on lease rates and higher concessions. But in the class A trophy properties, our experience has been there’s limited supply, there’s high demand, and we’ve been able to hold rates.
However, the B class properties are going to start increasing in demand due to a lack of availability for A class properties. If you look along the Wasatch Front—whether it be Millrock or Cottonwood Corporate, Old Mill, Thanksgiving Park, Sorensen’s property across the street, or even Dave Layton’s project out there at RiverPark—each one of those properties are newer properties, and most of them are pretty full, if not completely full.
WOODBURY: But I am losing deals to some of those properties because of rent rates.
FUGAL: That’s the experience we’re seeing. The positive absorption is kind of the price. We’ve seen increased concessions. You’re right, there has been a little bit of rate erosion over the course of the last year. And there’s been a disparity between landlords’ expectations and tenants’ expectations as a result of what we’ve come through.
But Steve’s right, in that we’re seeing a trend where tenants continue to gravitate toward quality, while older projects in secondary locations are suffering. I do not think that trend will change. We will see more B, or secondary locations, still challenged for some time to come as a result of the correction.
BINGHAM: I agree with you, Rick. We have seen greater activity, and our pipeline is a little full. We’re about 60 percent leased in the building right now, here. And I hope to be 80 percent before the year is over. We’ve got a reasonable expectation that will happen.
We are giving less concessions than we did. Just plain and simple: we don’t feel we have to do that anymore to get people’s attention. We have to do it to make a deal, but we’re just not leading with, “What can we give you,” the way the conversation was six or 12 months ago.
S. PETERSON: A lot of it has to do with demand. For example, down at the Cottonwood sub market, there’s a 5 percent vacancy. So there’s a lot of demand and low supply. Timing, particularly downtown, on bringing projects out has a little bit to do with that.
But as the market strengthens, at least in our market, we’re less eager to provide anything other than standard concessions. We’ve held on that philosophy and it’s worked for us.
L. PETERSON: One thing that’s helping the class B properties—there’s probably still some consolidation going on, where tenants are moving up class to class—but the strength of the local economy is working in some cases for the existing tenancies, because a lot of established firms don’t want to relocate, even though there might be some economic advantage to them. They’re settled in their locations. But things are improving in their businesses to the extent where they want to renew, they want to stay or expand. Not everybody is fleeing, which is a happy thing for owners.
PRISKOS: Downtown Salt Lake has been hurt—well, not even hurt; it has been considerably better than the suburbs. There was an out migration right before the Olympics, given the new construction, the freeways and many other factors. It’s been almost 10 years, and a lot of those companies are looking again and they’re seeing downtown as a better option, maybe, with all the infrastructure and everything that’s been built downtown. So downtown hasn’t suffered as much as the outlying areas.
Some of the tenants that have driven these hard, hard deals, when they come up for renewal, they’ll be a little surprised when landlords have a good, long memory and it’ll be tougher to do deals downtown. And rightfully so. There’s a lot of value added to being downtown. We will see rates being higher than the suburbs, where the trend has been.
How is the office market doing outside of downtown Salt Lake?
CHATFIELD: We’re seeing right now, from a banking standpoint, a lot more activity in owner-occupied stuff. We’re seeing people that actually want to go out and buy something. And that’s really different because over the past year or 18 months, that just hasn’t been an option. A lot of that is because of the rent. Rent has been relatively inexpensive from what we’re used to.
S. PETERSON: There’s another dynamic going on there also: there’s new legislation that’s being implemented in 2013 in terms of the tax laws and how leases are treated on the balance sheet. We’re going to see more businesses buying their own buildings and less leasing, and possibly leases with shorter terms, so they don’t have to book it on their balance sheet.
FUGAL: The exciting new construction is actually happening largely outside of Salt Lake Valley. At Thanksgiving Park, you have another five-story building under construction. And actual pre-leasing efforts that are coming to fruition for a third building that will probably break ground by the end of the year, another 140,000 square feet in that location. Again, there’s some momentum toward the Point of the Mountain.
Up north in Davis County, you have the Station Park project with 800,000 square feet, all going simultaneous right now with class A office, retail, hospitality. It’s a landmark project that is fully funded. Further north, at Hill Air Force Base, there’s Falcon Hill, which Woodbury Corporation is under construction on a five-story building that is 100 percent leased to Northrop Grumman. And we’re working on another building that will be a multi-tenant at that location.
All of these things are quite exciting when taking into account how difficult it is to secure financing.
WOODBURY: We are finding substantial interest in that property at Falcon Hill. It’s a unique market. The construction going on there is just fantastic. Because we’ve got two other buildings, that we don’t own, that the Air Force is doing right now: the Security Forces building and the relocation of the Gate House. So it is a dynamic, exciting project.
How is the retail sector faring?
SHIELDS: Retail vacancy overall is continuing to fall. Transactions are still a little bit tougher to do just because tenants are trying to get the concessions they’re getting in other states. And many landlords have held their ground very effectively.
Tenant representation is up all throughout the market. Development has not really caught up. There are some new projects starting to be talked about, but we’re really running out of space and hope that we get some new development.
WOODBURY: The retail market is in a conundrum. If you look at it from a macro point of view, money to spend has to come from jobs or increases in equity in assets. Until housing prices start increasing, retail’s going to be somewhat limited. Because where do they get their money?
On the other hand, people were forced into a savings mode, and there may be some pent up demand as a result. For the first quarter, on sales that we get reports on, we’re seeing substantial increases in sales right now. And it was a reasonably good Christmas.
Tenants were forced, because of the banking situation, to take their expansion capital and put it into working capital. They had to pay down lines and do that type of thing. They were forced to cut back on employees. And so they’re making money, but they have no excess capacity to expand as far as personnel is concerned.
But now the banking has opened up, they’re better capitalized and looking for opportunities. I’ve had at least four national tenants in the last three months call me up and say, “Rick, what have you got? We’ve got to get some locations.” And that is really, really nice.
I’m very hopeful. I think that we’re going to see better retail absorption. That’s why we’re just holding on by our fingernails.
One of the big changes is City Creek. As that comes online next year, how is that going to affect downtown?
PRISKOS: We have received more and more calls for retail on Main Street than we ever have received. “Can we get in now? Can we sign a 10-year lease at today’s rates?” That’s very hard to do, and there is a lack of supply. If you look at the other three sides of City Creek, there are no choices. So there’s going to be a huge demand around City Creek just because of the lease rates in there. And City Creek will be absolutely successful.
The one downside we hear from the folks at Gateway is that there is some moving of tenants—as there was when Gateway opened, tenants going from the old ZCMI Mall and Crossroads to Gateway. We’re seeing the reverse happen now. But I think that’s just a few tenants. It will be interesting to see how Gateway re-tenants itself.
SHIELDS: Given the long-term nature of City Creek, one thing that is critical for downtown retail is that they hold the line and not start cutting rates in an attempt to be full, and just let absorption take its course. It will fill up fast enough. It will be hurtful to downtown retail for them to do any slashing of rent. Certainly, a few tenants are going to move from one place to another, but the absorption will be there.
The industrial market is really interesting right now. What is your perspective on that market?
S. PETERSON: We secured a 60-acre site and we’re prepared to master plan a million square feet of industrial space. It’ll be demand driven. But from what we see out there, there’s low vacancy and a lot of interest in Utah. There’s some other developers who are bringing out some pretty good boxes. So we’re looking more for the large users on this particular site.
FUGAL: You have the tightest vacancy factor overall. The industrial market, through the last several years, has remained the strongest. It’s because Utah continues to be seen as the crossroads of the West. The greatest challenge for the industrial market is lack of product, or large blocks of space, moving forward. We’re hoping to see developers take some risks in order to develop product to meet demand and to continue drawing companies.
How is the investment side? Are capital and financing available?
PAUL: The investment market is exciting; it’s moving forward with great momentum. To put it in perspective, three or four years ago, we were seeing total sales volumes—retail, office, industrial and apartments—in the $1.5 billion range, which are just staggering numbers for Salt Lake. We, honestly, were very excited when we first eclipsed the billion dollar mark.
Over the last two years, the market has produced about $500 million in sales. So we’re off by about two-thirds. However, 2011 is off to a great start. There are a lot of sizeable transactions in the market. We think we’ll see around $800 million, perhaps the billion dollar mark again. Really, the only thing holding back that sales level is the lack of available properties. There’s still a tremendous amount of capital out in the market place and a strong desire to invest that in Salt Lake City.
One other interesting trend that we track is how properties are financed. Prior to the recession, I would estimate 5 percent were completed on an all-cash basis. Over the past two and a half years, 50 percent of the investment transactions were all cash. That’s everything from a million dollar transaction to a $25 million transaction. That’s driven by the fact that there is still ample capital. They’re earning nominal return sitting in the bank, so the thinking was we’ll just pay cash for the property, and when the lending markets settle down a little bit, then we’ll go refinance the properties. Thirty-three percent of the transactions were new financing and 17 percent were assumptions of existing debt.
BARTON: On the industrial side, Congress incentivized energy development in a pretty dramatic way. The cash grant provisions for wind farms, for example, were supposed to expire on December 31. They extended it for another year. We’ve seen an influx of a lot of money in joint venture projects that we’re doing on industrial deals, including energy sites, that are in the planning stages for Utah and in the surrounding states. There’s a lot more going on today than there was a year ago.
CHATFIELD: It used to be, “How high are you going to put your LTV to get my loan?” Now most of these people are saying, “I need to bring my loan down to where my cash flow will service my debt.” They’re kind of taking a different stance on it, which means they are interjecting a significantly greater amount of capital in some of these things. Which has been really kind of a surprising thing in the years I’ve been in the business.
The other thing that has been really noticeable to our bank—and we’re not a huge bank—is the number of outside firms that contact us saying, “Are you aware of properties like this?” Or “Do you have something in your portfolio that we can possibly go to your borrower and buy?” When you get to questioning these people, they’re saying that Utah is positioned better than any other state to come out of this downturn. Some of these are extremely large hedge funds that are trying to get some of this money that everybody’s saving out.
The investment story is there are some real opportunities here for some people if they’re willing to go forward. And it appears that the time’s now.
SHIN: A lot of our owners have done a refinance or a loan modification, which has been very favorable for them. We’ve seen some significant loan modifications that made it much more reasonable to own apartments now. In addition to that, a lot of that growth in Utah is on the multi-family side. The question is, how can all those units be supported? As Craig mentioned, a lot of people are choosing to not purchase homes anymore.
WHYTE: Certainly suburban commercial, to a large extent, has been driven by rooftops. And we went through a period of time, let’s say from five years ago to about three years ago, where developers were prepared to take a wing on it and say, “We’re going to assume that growth is going to be here and we’re going to build grocery stores in advance of them.” And small tenants would come in and open up shop before the rooftops were really there. That’s a luxury that we’re not going to see again in the near future.
What we’re instead seeing is that a lot of those merchants are going into established centers that are already in good locations, and they’re becoming a second tenant in that space, where there’s been a turn over in users. So from a suburban sense, retail is almost an amenity for a place like Daybreak—it’s important to have it nearby. We’re fortunate in that there are some nearby centers that have been petty positive.
The other thing that tends to attract commercial investment is infrastructure. As we see roads that get completed and public infrastructure, like transit, completed, we’ll see investment follow that public investment. We’re just starting to see some of that happen in the suburban sense.
S. PETERSON: We’ve studied the multi-family area a little bit. We’ve been brought into the Ogden River project, and I think we’re going to commit to that. But it has to have a multi-family flavor to it. There’s 78 million new renters across the country going into multi-family rental due to things such as bad debt, a bad credit rating, or not having a large enough down payment. So there’s a lot of opportunity for those that are in the multi-family market.
PAUL: One other project goes to the point of a strong apartment market in Salt Lake, and that is the former Chase Suites transaction on 7th East and 4th South. That was the first extended-stay hotel built in the valley. At the bottom of the market, hotels were in a tough situation. And a client out of Newport Beach acquired the property and vacated the hotel approach and has turned it into an apartment complex. So you’ve got a unique location that serves the downtown and the University area right on a Trax stop.
How do you think City Creek is going to impact downtown and the suburban markets?
PRISKOS: The 700-plus units in City Creek are exciting, but it’s pretty unique housing. It’s higher-priced housing. They’re doing great on the reservations and are actually starting to close.
We’re looking forward to the development of the Tribune building and other downtown assets into apartments. We could possibly see in the next five years a couple thousand units downtown that could easily be absorbed in the central business district. And it’s needed. There’s a new dynamic with people opting to rent rather than buy and wanting to be close to infrastructure and getting rid of cars and changing their lifestyle.
BINGHAM: One of the comments made by David Lane of Goldman Sachs is that a lot of their employees are going to live downtown. They’re young, well educated, highly incomed for Utah, and they want to live close by. That supply is going to be absorbed by this demand of new people moving here. City Creek is a big component of the attractiveness of what this is all going to be.
SHIN: The comparables that we see in downtown residential are by far the highest we’ve seen. A lot of developers are trying to be creative to get into the downtown market.
My concern, though, is with the newer developments in north Utah County—Adobe and Microsoft, among others. If housing developers are getting the land cheaper, I wonder if they can have cheaper rents and pull some of that demand to Utah County, where a lot of these businesses are going as well.
BURTON: The suburban properties that were developed in 2008 and 2009 had to drop rents up to 4 percent. That took a toll on overall rents. But downtown stayed pretty stable. The overall occupancy for downtown at the end of last year was about 4.5 percent, where the overall rate was around 6.2 percent. And we see that continuing to decline and rents strengthening—as opposed to the suburban areas, where you’ve still got some push by these new units that came on. They could deliver units at reduced rents because they got incredible financing rates.
WHYTE: It’s really important that the market place satisfy all users. And the amount of growth that we’re going to see in the Salt Lake Valley overall needs both downtown units and suburban growth in order to meet that demand. So it’s exciting that we’ve got a different kind of product now that’s going to attract those young people who want to work at Goldman Sachs, who are used to a more urban lifestyle. I don’t think Salt Lake has been able to do that very well historically.
What about the foreclosure environment, both from the residential and the commercial perspectives? How do you see that playing out through the rest of this year and carrying over into next year?
S. PETERSON: Nationally, a healthy market has about a 6 percent inventory of residential properties. An unhealthy market has nine months. In Utah, we have a 32-month ghost inventory that will be coming online. That’s inventory that’s not hit the market yet. So one in five homes in Utah is in default of their loan. We see a lot of pain yet to happen in the residential.
But as a result of that, there will be more renters coming into the market because they won’t be able to qualify, afford or have the down payment for a residential loan.
We have found that new construction comes with a premium of 30 percent. So for the existing ghost inventory, any of that product will sell for 30 percent less than the new product coming on the market place. So there’s a lot of dynamics—there’s a lot of inventory that’s going to need to go through the system to balance it. But we still believe that multi-family’s going to be a strong spot within the state.
BARTON: Our bankruptcy and workout lawyers are really busy. We do commercial work, and we represent about 125 lenders. The initial push was, “We’re going to enforce our loans,” and they took projects back. That got old in a hurry because of the regulators. The banks were just getting beat to death, as everybody knows.
Everybody’s doing workouts. Nobody wants those projects on their books. Banks have been, in the last nine to 12 months, very flexible in working terms out, whether it’s reducing interest rates, lengthening the loan terms or reducing the payment.
CHATFIELD: I think that most of the banks in the area—and I don’t want to speak for national banks because I’m not familiar with the way they work—but most local community banks here really took a stance at the beginning of this that it was in our best interests to keep developers in a project if we could. Now there were some of those projects that, because of reduction in their rent amounts, just weren’t viable products at that point in time, and you had a guarantor or a borrower who didn’t have the ability to go forward with that, so we did take those back.
The reason we took a stance to work through this is two-fold. First, as soon as you gentlemen around this table find out I own that property, if the market went down 20 percent, you want to pay me 35 percent less. And that’s good, old-fashioned capitalism. But if we can keep them in it and sell it, they’ll do a little better and we won’t have as large of a loss.
PAUL: The bankers did a much better job this cycle than they did back in the RTC days of managing their way through the difficult circumstances. That’s why there wasn’t the volume of foreclosures that we saw in the RTC days.
SHIELDS: Speaking specifically to the hospitality aspect of our business—we lost a couple full-service products to foreclosure that a group just paid way too much money for, and some stuff at the bottom end, but virtually nothing in what’s called the limited service, focused service brands, the Marriott Courtyards of the world, the Hilton Garden Inns, which are really the darlings of the hotel industry today.
Hospitality is a great predictor of where things are headed simply because it’s based upon people betting on what’s going to happen in office, industrial and tourism, which is discretionary income. Not only did we not see a big foreclosure number, but our amount of hospitality property under contract has quadrupled in the last 90 days. And with 60 percent of the buyers being out of state and 50 percent of them being all cash, we are talking $100 million worth of stuff. So it’s not a small amount of money that people are investing based upon their predictions of where this state is going.
We’ve talked a little bit about Utah and Davis counties. What’s happening in St. George?
SHIELDS: From a retail standpoint, we’ve been in St. George recently looking for clients. Retail appears to be fairly strong and pretty darn tight. The one client that I had, Harbor Freight Tools, considered a build-to-suit in St. George. Now that may not happen because they’ve changed personnel, but it’s unheard of that we couldn’t find a site. So from a retail standpoint only, it seems pretty strong.
EDWARDS: We’ve seen some new projects down there that have added new jobs, which we’re really encouraged about. It’s been a tough go for them. Industrial has basically come to a stop in a lot of ways. There were a few spec buildings that were absorbed, one of which is a new food processing company that will add 150 new jobs in Washington County, which hasn’t happened for the last couple of years.
SHIN: On the apartment side, over the past two years we saw vacancies go down about 30 percent. What we’ve seen there recently is the high 80s, low 90s, which is much more respectable.