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June 19, 2015

Uh-oh moment: Three office buildings are rising. Tenants are going away. Should Bellevue be worried?

Puget Sound Business Journal

Marc Stiles

Buses during the rush hour are full, and the volume of cars on the streets seems as heavy as ever.

Downtown Bellevue hardly seems like a place that's losing one major employer, 3,000-employee Expedia, and where another, Microsoft, is downsizing.

Microsoft is downtown's largest occupier of office space, and Expedia comes in at No. 2, and together the tech behemoths are vacating almost 667,000 square feet of space. That's around 11 percent of the space in downtown's Class A buildings.

Piling on is the recent exit of another downtown tenant, architecture firm MG2, which moved its headquarters to Seattle.

It gets worse for Bellevue office landlords. They'll soon have a lot more competition with the addition of three new towers.

Construction is under way on big projects that will bring around 1.5 million square feet of additional space to the office market. And so far only a minuscule amount of the new space has been pre-leased.

While it seems like this is downtown Bellevue's uh-oh moment, the developers of those three new buildings are not panicking. On the contrary, they're moving ahead with confidence.

Bouncing back

Bellevue has always bounced back from tough times, said Eastside office broker Gary Guenther of Kidder Mathews.

In 2002, in the wake of the dot-com bust, downtown's vacancy rate was close to 30 percent. Yet the market recovered much faster than people were predicting, and subsequent growth was strong enough to fill up new office buildings.

The two tenants at the heart of the current saga - Expedia and Microsoft - drove that growth.

Guenther foresees a similar situation this time around, with two types of office tenants filling up space. There are existing companies in the region that will need space to grow. And there's a hopeful expectation that more Silicon Valley companies will relocate or expand in the Northwest.

Bellevue also has time on its side. Expedia's leases in Bellevue expire in late 2018. That's more than two years after the office buildings now under construction are scheduled to be completed. Optimists think the new buildings will be leased up before the owners of Expedia's office space have to find new tenants.

The new buildings will arrive in phases, starting with the end of 2015, which will see the opening of the 929 Office Tower, where construction workers earlier this year placed the last beam atop the 19-story building.

The other two towers, the 16-story Centre 425 and the 31-story 400 Lincoln Square, are scheduled to come on line in the latter half of 2016.

Announced tenants are few. Market sources say that former Microsoft CEO Steve Ballmer has leased one of the top floors in 400 Lincoln, and Bank of America is taking space for a branch on the first floor of Centre 425.

So with large blocks of office space that are not yet spoken for hitting the market in the next couple of years, Guenther said, some landlords "are probably sweating a bit."

Tenants in the wings

The Eastside commercial real estate industry is banking, however, on the long-term prospects of downtown Bellevue.

It's a rock-solid market today. Only about 8 percent of the office space is vacant downtown, and anything less than 10 percent is considered a strong market.

Of course, that's before online travel service Expedia vacates all of its headquarters building and part of another tower for a total of around 500,000 square feet. Microsoft is moving out of seven floors, or nearly 167,000 square feet, in one tower on the Bravern campus.

The developers of the new buildings say they're not losing any sleep over these moves. Both Kemper Freeman, the head of Kemper Development, which is developing 400 Lincoln, and Craig Dobbs, a principal with Trammell Crow Co., the developer of the 929 project, say there are enough tenants in the market to more than fill up their buildings.

Earlier this spring, Freeman indicated that his leasing team had talked to Expedia about leasing space in 400 Lincoln. It's not a problem, he said, that Expedia is leaving town because he's showed the project to other tenants, he said.

There's enough demand, Freeman said, to "more than fill two buildings" the size of 400 Lincoln.

Around the time the final beam was hoisted into place at the 929 Office Tower, Dobbs made a similar comment.

"We are exchanging proposals with several tenants," he said, "whose combined demand far exceeds our building's capacity."

Pam Hirsch, managing partner of Schnitzer West, the developer of Centre 425, added she is "very confident in the market." She likes the fact that Expedia's leases run until the end of 2018, and thinks that by then the three new towers will be filling up.

The numbers seem to back up the developers. Alexander Muir, senior research analyst for the JLL brokerage, said his company is tracking 62 tenants who are looking for space on the Eastside. These companies are on the hunt for a total of 2.6 million square feet of demand.

Not all of these tenants will move downtown, and other developers are under construction on big mixed-use projects around the Eastside.

Capstone Partners is developing the 28-acre Esterra Park project in Redmond, and Wright Runstad is building the 36-acre Spring District just east of Interstate 405 in Bellevue. Office construction has not yet started in either project, and now it seems less likely to start than it did earlier this year, before Expedia announced it's moving to Seattle.

'Not particularly troubled'

While he's still optimistic about the strength of the Bellevue office market, Wright Runstad & Co. President Greg Johnson said that as a result of Expedia and Microsoft's moves, "We are going to look more closely at the situation today than we would have three or four months ago,"

Yes, Expedia's departure and Microsoft's downsizing are going to have an impact, Johnson said, but "I'm not particularly troubled on a longer-term basis for the Eastside."

Longtime office broker Paul Sweeney of the Broderick Group has been hired to find tenants for 400 Lincoln, the largest of the three buildings now under construction. He said that for Bellevue, the good news is the economy is strong and many tenants are growing.

The bad news is that Microsoft, the main driver of the office market on the Eastside, is decreasing the size of its Bellevue footprint and expanding at its Redmond headquarters campus, where the software company is building new space.

"When that happens in your market you can still have a good market, but you're are not going to have a great market," Sweeney said, "and that is sort of where we are right now."

For the full story, go to Puget Sound Business Journal.

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