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January 25, 2018

On the Block: Office glut? What office glut?

Seattle Daily Journal of Commerce

Brian Miller

The holidays are past, and now it's time to cast a cold eye back on 2017. Was it a good year or a bad year for the office market? Year-end and fourth-quarter market reports from Broderick Group, Colliers and Kidder Mathews provide generally rosy assessments - plus a few hints about 2018 and beyond.

KM strikes a happy note in its fourth-quarter report: "The Seattle office market had a solid, stable 2017."

Broderick concurs: "The Seattle leasing market has persisted throughout the 2017 year as a very landlord-favorable market. Although there were three new developments that entered the market, they have all been pre-leased or are in the process of becoming fully leased."

Significant drivers are tech tenants led by Amazon, of course, and shared office vendors. Among the latter, WeWork isn't the only example. Broderick cites Spaces/Regus, which has staked out a significant presence in Pioneer Square, where other old brick piles have been similarly colonized and repurposed for the New Economy.

The Seattle vacancy rate has continued downward since the Great Recession began to ebb. Broderick puts our overall year-end vacancy rate at almost 6.4 percent.

Looking at Class A space only, Broderick forecasts that the next two years will be essentially flat for Seattle vacancy rates: up to 6.5 percent in 2018; then down to 6.0 percent in 2019. There won't be a significant softening until 2020, at a projected 7.5 percent, when more new buildings open.

Given current demand, Broderick forecasts Class A rent growth in Seattle of 4 percent this year, compared with 4.3 percent in 2017.

Among the submarkets, South Lake Union remains the tightest, with a vacancy rate of only 1.13 percent. Virtually nothing gets built there without a tenant in place. Though the nearly completed 9th & Thomas could be a case in point or an exception to the rule. Developed by the Sellen-owning Redman family, it broke ground in 2016 without an announced tenant - which this month turned out to be Amazon.

For the year, says Broderick, a little over 3.1 million square feet was absorbed in Seattle. Class A space represented about 1.9 million square feet of that robust total.

The nexus of healthy tenant demand and constrained supply isn't likely to change this year. Says Broderick, "No new developments are expected to deliver in 2018 with a large supply of unleased new office space."

Potential tenants will have to wait until late 2019 for the next two big unclaimed towers in development: Skanska USA's 2+U, with 665,000 square feet; and Kilroy Realty's 333 Dexter, with 645,000 square feet.

Colliers makes the same point in its fourth-quarter report, saying, "Seattle is set to deliver just 663,722 square feet in 2018, but is expected to jump to more than 3.75 million square feet in 2019, with 57 percent being pre-leased."

Colliers has a more regional focus than Broderick, and says that over 6.7 million square feet are now under construction in Puget Sound. Of that, almost six million are in Seattle, and 742,000 are on the Eastside and in South King County.

On the other side of the lake, says Broderick, "Office vacancies for the entire Eastside market are a landlord-favorable 9.46 percent, the lowest vacancy since 2006." With fewer new towers ahead, Broderick expects the vacancy rate to drop to 8.2 percent this year, and to 7.2 percent in 2019.

Again: Landlords are favored, and Eastside rents will climb somewhere between 4 and 6.5 percent this year, a better yield than in Seattle.

Almost one million square feet were absorbed on the Eastside last year. But Broderick foresees a gradual slowdown in leasing there, since there are fewer big blocks of contiguous space on offer.

"There is virtually no new construction on the Eastside," says Broderick. "Only Kirkland Urban will be delivering in 2018, and is currently over 50 percent pre-leased with leasing activity likely taking that project to full occupancy at completion." That mixed-use project by Talon Private Capital is being developed in phases. Tableau and Wave are the announced tenants in the first two office buildings.

Is there a horizon in sight for the current cycle? Not in Broderick's binoculars. It says, "It is still difficult to predict what factor(s) might bring an end to this run. Escalating housing costs and transportation issues push some companies to consider other cities or states."

Some might argue that's exactly what's happening with Amazon's search for HQ2. On the other hand, the anticipated 2023 introduction of light rail on the Eastside -where land is cheaper and more abundant- will lessen some of those pressures. The Spring District is one early example.

In Seattle, Colliers warns of "rising construction costs and dwindling space to build," adding that "a peak in construction activity is apparent moving forward."

To that, KM replies, developers will simply pass along those costs, and tenants will pay more: "Even with construction costs continuing to increase, the current rent levels remain cost-feasible." (See: rent growth, above.)

KM also says, "Looking forward, there still appears to be little potential of significant oversupply in the near term, considering the limited amount of speculative space being built."

On that latter list are 2+U, 333 Dexter and the recently opened Madison Centre. Schnitzer West began that project in 2014 without any tenants signed. As of now, the Broderick-leased building is still 70 percent vacant, with about 526,000 square feet available. Just don't call it a glut.

For the full story, go to Seattle Daily Journal of Commerce.

©Copyright 2018 Seattle Daily Journal of Commerce

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