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With the third quarter results in, all signs point to continued incremental improvement of the Charlotte office market. Vacancy rates have fallen to a four-year low and investment sales activity continues to strengthen as new capital sources enter the market.
On the economic front, unemployment in Charlotte continues to lag behind some other North Carolina cities at 9.5 percent, but the city is experiencing positive economic movement in other measures, particularly single-family housing and retail sales.
For some long-term perspective, the labor force in Charlotte has grown 22 percent during the past 10 years, nearly three times the national rate. Additionally, in August, the population of Mecklenburg County reached 1 million people. With a population of approximately 2.3 million, Charlotte maintains its position as the largest MSA in the Carolinas.
Office Market Conditions
With a reported 460,000 square feet of positive net absorption in the third quarter, the overall office vacancy rate has fallen to approximately 15.7 percent, the lowest rate since 2008. Correspondingly, rental rates have continued to increase, with overall average rates reaching $22.55 per square foot ($23.59 for Class A space), the highest rates in the past four years.
While much of this tightening has occurred in Charlotte’s stronger submarkets (CBD, Southpark, Midtown, NC51/Southeast), some secondary submarkets report similar positive momentum, likely driven by rate increases and availability decreases in premium submarkets.
Rental rates for Class A properties are not yet high enough to support speculative construction. However, there are a number of large tenants currently in the market looking for a home. Many of these tenants are expected to ultimately drive new development with their anchor tenancy, and it would not be surprising to see a new office building break ground in 2014 in the CBD, Southpark and/or Southeast submarkets.
What Do Tenants Want?
The tenant demand metric has proven interesting. Nationwide, since the beginning of 2011, 75 percent of the net office absorption in the U.S. occurred in Class A properties, with the remaining 25 percent in Class B and C properties combined. Markets around the country continue to be a study of the haves and the have-nots. The flight-to-quality witnessed during the past three years is typical in poorer economic times, however, during recoveries it becomes more pronounced as the better buildings recover more quickly.
As Charlotte’s Class A buildings continue to recover, small- to medium-sized tenants often find themselves left out; either landlords are holding blocks of space for larger users, or the tenant’s moving timeline won’t allow for a lengthy upfit. In order to serve that market segment, some landlords are creating programs to specifically target those tenants.
In 2011, Trinity Partners created a pre-built program in downtown Charlotte’s Ally Center. The building started with 20,000 square feet of fully-upfitted space available for immediate occupancy. Now on Phase III of the pre-built program, Ally Center has been able to serve this market segment by giving them exactly what they need: smaller blocks of space in a Class A building that’s immediately available.
Investment Sales Activity
Charlotte continues to see increased capital markets activity, with demand for product often outpacing supply, particularly for assets in stronger submarkets. The resiliency of the market and sound economic fundamentals continue to serve as catalysts for investors, especially those that have seen opportunities in larger markets become too expensive for their capital. Charlotte’s position as a leading second-tier city has broadened the investor base, resulting in an impressive list of recent buyers in our market.
Cabot Properties, Exeter Property Group, Adler Kawa Real Estate Advisors, Griffin Capital, Starwood Capital, Dalfen, Parkway Properties, Cornerstone Real Estate Advisors and The Shidler Group have all been involved with transactions within the past 12 months. In addition to creating a diversified market (absent of one or two dominant owners), this level of institutional investor activity will likely pave the way for other entrants into the market.
Commercial banks have largely cleared their balance sheets of distressed product, and distressed purchase opportunities are generally in the rearview mirror, with the exception of assets secured by CMBS debt. These CMBS-encumbered assets are typically so burdened with complexity that it’s difficult for potential investors to uncover the investment opportunity. ?
Other than select distressed assets, the office sector in the Carolinas has largely been out of favor with institutional investors over the past two to three years. Today, despite only modest improvement in property-level fundamentals, office product in the Carolinas is back in favor. The market is bifurcated, however — capital is chasing top-tier, Class A product and well-leased/well-located Class B product, leaving lower quality, commodity suburban office product struggling to find investor interest.
What’s Next?
Because of Raleigh’s diverse economic base and quality of life, it is often used as a leading indicator of Charlotte’s future. The capital city is steadily recovering from the recession, with several new office buildings under construction, both spec and tenanted. As Charlotte’s fundamentals continue to improve and the city’s population grows, expect to see the office market follow suit, with increased investor interest and eventually office development in priority submarkets.
— Adam Colvin, managing partner, Trinity Partners