Tenant Activity Begins to Percolate

Several leases above 30,000 square feet were finalized in the first half of 2012. The accounting firm Baker Tilly Virchow Krause LLP took 68,000 square feet. Healthcare information systems provider Connecture Inc. inked a deal for 32,200 square feet. Marshall & Swift/Boeckh, a provider of building cost data and estimating technology to the property insurance industry, leased 38,200 square feet.

Leasing activity helped push absorption into positive territory during the first two quarters, although rent growth remains minimal. It will take a few quarters of strong absorption before any significant upward trend in rents is realized.

The limited construction pipeline has helped stabilize vacancy. The few competitive projects to break ground must have major leases in place before building activity gets under way. A rise in owner-occupied and government construction, however, could affect short-term vacancy in targeted areas, if leased space is vacated.

About 30,000 square feet of office space came on line in the second quarter upon the completion of the refurbished Clock Shadow Building on Bruce Street in Milwaukee. The mixed-use building is 100 percent occupied. Although there is more than 1 million square feet of office space in the planning pipeline, most of these projects were on the drawing board before the recession and are not likely to break ground in their current form.

Only a 60,000-square foot development in the Brookfield/New Berlin submarket is slated to get under way this year. A 12,000-square foot building for Spectrum Investment Advisors was due for completion in the third quarter. The company will occupy a majority of the building, leaving 1,000 square feet of space for lease.

As the local economy edged forward, vacancy dipped 10 basis points to 19.1 percent in the first half of 2012 after a drop of 40 basis points in vacancy during the previous two quarters. Class A vacancy contracted 20 basis points in the first two quarters of the year to 17.4 percent as attractive rents encouraged businesses to upgrade into higher-quality space.

Vacancy fell 40 basis points in the prior six months. Class B/C vacancy remained unchanged at 20.7 percent over the past six months. However, the migration of office users to higher-quality space will put upward pressure on vacancy for the remainder of this year. Stubbornly high vacancies have limited the ability of owners to lift rents during lease negotiations.

Operators advanced asking rents 0.4 percent to $18.82 per square foot year-over-year in the second quarter, while effective rents increased 0.6 percent to $14.01 per square foot. Higher demand for Class A space enabled owners to push up asking rents 0.6 percent during the last 12 months to $22.25 per square foot.

Asking rents are 2.3 percent below the peak reached in the first quarter of 2008. Class B/C asking rents have inched up 0.2 percent to $15.83 per square foot in the past year as operators keep vacancies in check.

Who's buying?

Investors in the metro tend to be long-term, local operators. Many of these owners were able to weather the economic downtown by reducing costs, rather than offering overly generous concessions. As a result, the number of distressed REO properties has been much lower than other metros. Bargain hunters will still outnumber traditional buyers, targeting some of the available high-vacancy properties. These assets typically trade at cap rates above the 10 percent threshold. Nonetheless, stabilized assets are available. Out-of-state buyers tripled their presence in the past 12 months to expand their portfolios.

Cap rates for prime assets start at 7 percent in the Downtown-East of the River business district and range into the high-9 percent span for lower-quality assets and locations. Medical office properties, meanwhile, command first-year returns in the mid-8 percent range on average.

— Matt Fitzgerald is vice president and regional manager of the Milwaukee office of Marcus & Millichap Real Estate Investment Services.