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October 12, 2015

Thurston's office vacancy problem

Business Examiner

Zachariah Bryan

In Thurston County, there is an office vacancy problem.

Or, as real estate brokers like to call it, there's an opportunity.

Evan Parker, first vice president and partner at Kidder Mathews, believes there is a major office vacancy imbalance in Thurston County. At Thurston County Economic Development Council's recent Real Estate Showcase and Forum, he noted that the amount of vacant space in the market "acts as a barrier to entry to build new product."

On the flipside, he said, owners now have an opportunity to create a truly unique - and, more importantly, saleable - product through reinvestment in existing buildings.

"You've got a lot of footage (of office space) in the market, but it's all the same. There's nothing that really stands out that you walk into and say ‘Wow, this is unique.' Reinvest in your own product. Make it unique. That's the opportunity."

And if there was a time to reinvest, Parker argues, this may be the time to do it. The economy is growing at a steady clip and companies may be looking for more cost-effective space outside of the major cities, but still close enough to adequate resources.

According to other real estate experts at the real estate forum, there are a bevy of reasons for companies to move to Thurston County. Among them are good work force development thanks to a solid K-12 system and variety of quality higher education options; organizations that advocate for businesses; the Port of Olympia; proximity to Joint Base Lewis-McChord; the center of state government; entrepreneurial diversity; and economic stability. The list goes on and on.

"When I think of investing, I'm always looking for something that will give me a competitive edge. When you look at (Thurston) county, it's about the sum of the whole. When you look at the county 20 years ago versus now, we've weathered a storm," said Zach Kosturos, president and designated broker of commercial real estate company Prime Locations.

Sill, at least when it comes to office space, it's hard to overlook the challenges.

Part of the problem is that nobody knows exactly how much of Thurston's office space is vacant. The data collection that is available is either outdated or hasn't garnered enough participation from local brokers to depict a fully accurate picture.

According to Parker, Kidder Mathews estimates that 15 or 16 percent of Thurston County's office space is currently vacant, or about 800,000 square feet.

A 2013 report commissioned by City of Olympia noted that office vacancy rates increased four years in a row, from 4.8 percent in 2009 to 9.7 percent in 2013. As a result, rental rates decreased, from $19.61 per square foot in 2009 to $15.69 in 2013.

"My guess - and I don't have a crystal ball - I don't see the vacancy rate changing dramatically one way or the other in the next 12 or 18 months," Parker said.

Then there's the county's largest tenant, the state government, which is consolidating office space into new buildings, leaving behind a wake of formerly leases spaces.

"The state has had a couple of projects where they consolidate their square footage," Parker said. "They've chosen to build new buildings, which in turn pulls those state agencies from multiple existing buildings into that one building. They're not creating new jobs or new absorption."

Parker said much of the current vacant office space, if not the majority of it, is from the state vacating leases and consolidating into new space, rather than leasing pre-existing buildings. Not only does the vacancy rate drive pricing down, it's hard to find a large enough tenant who wants to take over the leftover space.

Certainly, Thurston is no King County. Tenants tend to be smaller, in the 2,000 to 3,000 square-foot range, Parker says. There are no Amazons building in Lacey or Microsofts creating expansive campuses in Tumwater.

"The state of Washington is clearly the largest tenant in the market. ... They might pull out of four or five or eight different buildings (when they move), it depends on the situation. And now, what's left in the market is difficult to lease space. You have local business owners and local building owners and local citizens left with, ‘OK, what do I do with this building? How do I refill it?'"

Likely, those questions are going to be asked a lot more when the state finishes construction on the 1063 block, which will play home to a new five-story, 215,000 square-foot building that will consolidate part of the Office of Financial Management along with several legislative agencies. It is scheduled to open in the summer of 2017.

Parker says the 1063 building is only going to exacerbate problems.

"I don't believe it's going to help the market. They're not occupying any existing vacant space. Building a new building is not going to help the vacancy rate," he said.

Parker is not all doom and gloom, though. As a broker, he deals in optimism, and he believes there is still opportunity in the market.

So far, he said, the building owners who have seen the most success are the ones who are willing to reinvest in their buildings.

"(There are) companies that choose quality over a cheaper rental rate," Parker said. "Their goal is to find space that's going to work long term, that looks nice and is functional. They're willing to pay the rate to turn that space into what they need.

"That's what you see more of in the larger markets and we're starting to see that type of transaction in this market."

The biggest test of Parker's theory will be proven or disproven in the Woodland District of Lacey, where MJR Development is investing millions of dollars to transform a campus of buildings into Class A office space. At least $1 million is going into landscaping alone, including 14,000 trees, bushes and shrubs. The company is calling it "The Hub at Woodland."

About five years ago, the state vacated Woodland Square spaces held by Employment Security Department and Department of Social and Human Services agencies from the Woodland Square campus. To this day, the area never quite recovered with over half of its office space still vacant - a modern ghost town, by some standards.

So far, the renovations and the rebranding seem to be working, Parker said. Kidder Mathews, which is working with MJR Development to lease the property, is actively working on letters of intent with prospective tenants, including two medical related companies and one financial-related business.

"It's being well received by the tenant community," he said. "It's a function of MJR's willingness to reinvest and rebrand in their product. If they weren't willing to do that, would we be talking to these companies? I would say no."

Parker said reinvestment has seen it work elsewhere. Whether it's sprucing up the facade, fixing the HVAC system, replacing the carpet and the paint, fixing any mechanical issues, deals are getting done.

"We're seeing deals done as low as $16 per square foot and as high as $25 dollars per square foot fully serviced. We're seeing market rate deals done," he said. "The optimistic side of me likes what we're seeing in the market, when you have an able and willing tenant, and an able and willing landlord, they're coming together and doing deals that make sense for both sides."

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