The Next 12 to 18 Months Will Be Revealing for the Columbus Office Market

There are other compelling questions, which should keep things interesting for the next 12 to 18 months. Will the handful of prospects for large blocks of office space opt for longer lease terms versus recent trends favoring short-term deals? Will Canadian investors continue to perceive Central Ohio as a great place to shop for bargains as the Canadian dollar maintains its strength against the U.S. dollar?

Development Picks Up

Of course, new construction is currently the big story. Last year, the development community broke ground on more than 1 million square feet of new office space, including two downtown projects near Nationwide Arena. The projects include a 286,000-square-foot building, of which Columbia Gas has pre-leased 208,000 square feet, and a 214,000-square-foot Nationwide Insurance build-to-suit.

In the Northeast office submarket, nearly 200,000 square feet of new development is under construction, including a headquarters facility for Bob Evans and Discover Financial’s call center. This build-to-suit activity and a lack of new speculative construction contributed to the Columbus office market ending the year with 15.3 percent vacancy, a decline of 68 basis points from the end of 2011, and a total of nearly 300,000 square feet of net absorption.

Consequently, average asking rents at the end of the year were $18.84 per square foot, while tenant improvement allowances have shrunk over the past two years from approximately $30 per square foot to $20 per square foot.

With the improvement in market conditions, large blocks of available space have become scarce. While practically all of the new development is build-to-suit, we may be poised for new speculative development in the third or fourth quarter, particularly as aggressive, successful developers such as Daimler Group seek to be first to market with new product.

One big challenge may hamper new speculative development, however. As a result of the slow economic recovery, tenants with large space requirements sought more flexibility, opting for two- or three-year leases with options for longer terms. Given the high degree of economic uncertainty at the time, end users didn’t know if they would need to further downsize three years later or if they would be positioned for growth.

In a market that favors tenants, owners had to acquiesce, but it left them in a tough position, hopeful that the tenant would take the long-term option and enhance the property’s value. If this trend were to continue, securing tenants for spec office projects could become increasingly difficult.

Capital Markets Outlook

We may see a counterintuitive approach to office investment in the Columbus office market during the next 18 months. Special servicers and receivers have become increasingly involved with Columbus office properties because many building owners have been unable to refinance their properties in the face of declining asset values.

We expect special servicers to take back properties as absorption and rental rates continue to improve, diminishing risk and enhancing opportunity for these properties and their new owners. This strategic approach helps position special servicers and receivers to harvest more value — certainly more than was possible two years ago — than they would achieve by shedding these distressed assets as quickly as possible.

We also expect Columbus and Central Ohio to remain on the radar of Canadian and other foreign investors who are seeking bargains. Last year, Montreal-based IMC increased its holdings in the area with the $20.5 million acquisition of a 250,169-square-foot building in the North submarket of Columbus.

Meanwhile, Montreal-based Amcor Holdings closed its first U.S. acquisition, a 10-building, 780,000-square-foot portfolio in the I-270 corridor for $25.1 million, or $32 per square foot. A strong Canadian dollar favors these investors who generally are buying Class B and C assets poised for repositioning. After a fairly active 2012, we anticipate more investment sales activity in 2013 as owners achieve higher rental rates, occupancy and net operating income and stabilize assets.

The Columbus office market shares many slow-growth characteristics with its peers in the Midwest and across the U.S., but several factors do differentiate the Central Ohio region. Institutions such as The Ohio State University and Battelle, as well as local companies such as Nationwide Insurance and Cardinal Health, bolster the economy and fuel growth. The organic growth of small business also has propelled the market for the past two decades.

If we can avoid an economic slowdown locally and nationally — something that’s clearly attainable — we expect office owners to slowly fill existing vacancies. That should lead to increased rental rates and cause the overall vacancy rate to drop to 13 percent by the end of the year as the local market’s prospects and vitality continue to improve.

— Thomas McGarity, managing principal, Cassidy Turley