Memphis ended 2017 with an overall vacancy rate of 14.8 percent, which is up slightly from where the year started at 14.5 percent — the highest level in three years. As the saying goes, “don’t judge a book by its cover,” and this especially applies to the Memphis office market. In 2017, 600,000 square feet of office space was absorbed.
Developers also started 2017 with more than 1.2 million square feet of new office space in the pipeline, with 800,000 square feet delivered last year and the other 400,000 square feet expected to be delivered by the end of the first quarter this year. So within just six months, nearly 6 percent of Memphis’ total office market size was added to the overall available space. That is more new product being delivered than the city has seen in over a decade.
Ron Kastner, CBRE
Of this 1.2 million square feet, nearly 80 percent will come from adaptive reuse projects, where previously non-functioning properties located in non-core submarkets have undergone significant repurposing. The Sears Crosstown building was erected in 1927 as a 1.5 million-square-foot, mail-order processing warehouse and Sears retail store. The project was the largest building in Memphis at the time of its opening. After Sears left the building in 1993, it stood vacant for 24 years. The newly transformed, mixed-use building opened its doors once again last summer, featuring 550,000 square feet of new office space, 200,000 square feet of retail space and 265 apartment units.
Johnny Lamberson, CBRE
ServiceMaster, a residential and commercial consumer services firm, announced in June 2016 it would relocate its global headquarters from its longtime East Memphis site to one of downtown’s largest vacant buildings, the former Peabody Place entertainment and retail center. This 300,000-square-foot redevelopment was completed earlier this year, and ServiceMaster will take occupancy during the first quarter. The remainder of the new product delivered is coming from traditional new construction in East Memphis, the city’s core office submarket, where the new space delivered is coming in smaller chunks in the 100,000- to 150,000-square-foot range.
Compressing Rent Growth
As with many other cities in the Southeast, the amount of new office space delivered in Memphis in the past two years is causing rental rate growth to recede, certainly until more of this new product can be absorbed. In fact, rent growth lately is more often seen from heavy tenant improvement packages enhancing the lease rates. But this is to be expected, when most new leasing is occurring either in the last 10 percent of vacancy or in first generation spaces among new buildings. Meanwhile, tenant improvement costs continue to grow due to scarcity of materials and labor, caused by both natural disasters in the U.S. and Caribbean, as well as the overall construction boom the U.S. has experienced recently.
Renewal concessions are increasing as the negotiation pendulum is swinging back toward the middle, especially among Class A space renewals. The highest Class A rates in Memphis are topping out at $32 per square foot, but market-wide Class A rates are still just slightly above $21 on average. The highest Class B rates are around $23 per square foot, but we are averaging $17.31 market-wide due to the continuing oversupply of Class B space.
We’re currently tracking about 900,000 square feet of active tenants in the market, which is down from its previous high of 1.3 million square feet that was recorded this time last year.
Reducing Footprints
As we see across the country, labor also remains the primary challenge facing corporations in Memphis, with cyclical low unemployment, technology-driven competition and a widening skills gap. Occupiers are taking a balanced approach to real estate strategy, continuing to pursue space efficiency while reinvesting savings into workplace enhancements that will attract and retain employees.
As a result of this trend, we’ve seen a lot of companies confronting their current space inefficiencies by moving to newer, smaller spaces. Nevertheless, for 2018, we are expecting the leasing velocity of the past several years to continue throughout this year.
Investment Activity Picks Up
The Memphis office market has seen more investment transactions in the past three years than the prior five years combined. One of the most notable transactions was the sale of the Highwoods portfolio that included the four-building Southwind Office Center, two Shadow Creek office buildings and 3400 Players Club Parkway. Group RMC acquired the portfolio for $39 million.
Also noteworthy was the sale of a portfolio of two high-rises to Faropoint Investments. The firm has been very bullish on Memphis in the past year and acquired the Lipscomb & Pitts Building and Poplar Towers for $19.3 million. We expect this momentum to continue as more private capital flows into Memphis.
— By Ron Kastner, Senior Vice President, and Johnny Lamberson, Senior Vice President, CBRE. This article was originally published in the March 2018 issue of Southeast Real Estate Business.