Business headlines over the past few months have been full of sunny reports from Seattle: Boeing, for example, is in full swing thanks to the production ramp up of the 787 and the backlog of orders for both the 787 and 737, representing a workload of more than 5 years. The tech sector is hopping here as well, with Google adding up to 840 jobs, Amazon doubling the positions available from a year ago to 1,900, and solid growth at Facebook. This all takes place, of course, in a market that happens to include big-name employers like Microsoft and the increasingly active Gates Foundation, and strong sectors such as Biotech and Pacific Rim trading.
Given this strong and diverse economic base, then, it is perhaps no surprise that Seattle is robust compared with many other U.S. markets. This is not to say the recession had no effect — a year ago, rents in empty boxes were leasing at discounts of up to 40 percent of what had been paid by previous tenants. However, the market here has gradually stabilized, and those discounts have shrunk to 15 to 20 percent of previous rental rates. Today, in fact, retailers like HomeGoods, Sports Authority, Dick’s Sporting Goods, T.J.Maxx, Ross Dress for Less, Hobby Lobby, Dollar Tree and Tuesday Morning are absorbing boxes at a good clip. With no new developments coming online and fewer tenants going dark, space is harder to come by, and landlords are feeling a bit more optimistic.
Overall, vacancy rates in the Seattle MSA are between 6 and 7 percent, but they are declining thanks to the reasons cited above. Naturally, tertiary markets are taking longer to lease up, so vacancy rates will vary depending on the submarket in question. While tenants’ negotiating leverage may be slowly shifting back to center, Seattle is still a tenant’s market thanks to the reduced level of retailer activity in general. When chains are in the middle of rollouts involving hundreds of stores, markets like Seattle are very appealing. But when major retailers are opening just a few stores in a given year (as many are today), landlords are not just competing with local properties — they’re competing against shopping centers from across the country.
So while the Seattle MSA is performing well overall, certain submarkets continue to lose deals to better-performing or more attractive markets elsewhere. Despite this, certain Seattle submarkets are doing quite well. The East Side markets of Bellevue, Redmond, Woodinville and Issaquah, for example, will continue to be the focus of new tenant expansion and subsequent development activity thanks to their excellent demographics. Lynnwood, an affluent suburb 20 minutes north of Seattle at the intersection of I-5 and I-405, also continues to be a focal point for absorption of existing vacancies. Over time, this market will likely see healthy rent increases as supply decreases.
We are finally seeing some new projects come online. These include a new Kohl’s at Rainier View Marketplace in Puyallup’s South Hill Neighborhood, being built by a private developer, and three new Safeway stores (in Bothell, Gig Harbor and West Seattle) that, in total, have the largest concentration of shop space currently under construction in our market. Meanwhile, Walgreens’ redevelopment of a retail shopping center in East Bellevue will also include at least two junior anchor spaces. Freedom Crossing, a development of the Army & Air Force Exchange Service (AAFES) at Joint Base Lewis-McChord, will add a new dimension to retailing in this area by introducing national and regional tenants in a controlled-access shopping center. The project is slated to open in 2013. And finally, the long-proposed Issaquah Highlands retail project — a “high street” that would serve the Issaquah Highlands New Urbanist community — may start anew now that it has a new developer in place. This essential component of what was to be a live-work-play community had stalled amid the collapse of the housing bubble.
On the transaction front, activity is strong within Seattle’s Class “A” properties — well-located boxes with good demising potential, for example, now attract plenty of interest among buyers and tenants alike. And as locations in primary, closer-in markets grow scarce, tertiary areas are picking up the slack. As evidence of this activity, we are seeing roughly a 25 to 30 percent gap between the asking price and the tenant’s offer. By the end of the deal, that gap has usually narrowed to somewhere between 10 and 15 percent.
This will change as construction of new projects intensifies, financing terms continue to relax and demand increases. However, financing remains tight for new construction and there is no upward pressure on rents to accommodate high dirt prices paid in 2007 and 2008. Additional challenges are the tenants’ new needs and designs — many are shrinking their prototypes and creating new formats in response to the seismic shifts in the retail economy — making demising existing anchor spaces quite expensive and challenging. Increased scrutiny from lenders on existing product has become a new challenge as well. Lower achieved rents mean that lenders are more likely to require additional equity or collateral before approving a lease.
We are seeing increased interest in single-tenant development and investment sales. Some retailers are starting to act more as developers — transitioning away from the traditional, preferred-developer model to self- or fee-development. Through its development arm, for example, Safeway is developing three different retail centers (Gig Harbor, Bothell and West Seattle), and Walgreens is redeveloping a shopping center in east Bellevue. These additional pressures coupled with current economic conditions and tightened financing requirements have forced change upon the business model of many small to mid-sized developers, while greater flexibility within ownership arrangements appear to be even more crucial. Joint ventures, equity partners and fee developing are all on the rise.
Moving forward, it also seems clear that the so-called Great Recession and its aftermath will have a lasting effect on development in Seattle. The operative word is “downsizing.” Faced with the value retail imperative and fierce Internet competition, retailers are keen on reducing their store footprints and doing all they can to offer competitive prices. Seattle has more tech savvy shoppers per capita than most of the country, so competition from e-tailers is particularly strong here. Another recent trend we expect to see accelerate is more tenants becoming landlords (subleasing space or surplus land).
Barriers to entry are high in Seattle — our special geography, environmental concerns and growth-boundary limitations make entering this market tricky, to say the least. Given today’s risk-averse, capital-starved development climate, we expect to see REITs and banks become increasingly dominant. These same forces mean that developers will continue to prefer renovation of existing space to dealing with the expense and headaches associated with new construction.
— Michael Olsen and Tony Omlin are X Team International partners and brokersat Seattle-based Rainier Commercial Real Estate Services.