Cleveland’s relatively affordable cost of living compared with other major Midwestern cities is attracting businesses to the metro area, fueling demand for office space.
A steady stream of new employment opportunities supported the 1.6 percent expansion of Cleveland’s workforce over the 12-month period that ended Sept. 30. Hiring during that period was driven by the education and health services sectors, which collectively added 9,300 positions.
It is expected that by year-end 2016, Cleveland employers will have increased payrolls 1.3 percent with the addition of 14,000 workers. Office-using employment is expected to rise 0.4 percent this year, remaining steady with only a slight variation over the past three years.
Cleveland’s stable economic fundamentals, coupled with businesses attracted to the city, have supported the revival of a dormant development pipeline.
During 2015, just 46,000 square feet was added to Cleveland’s office property inventory. The majority of the new office completions are located downtown. In the four-quarter period that ended in September, approximately 660,000 square feet came into service.
While office completions were sluggish in 2015, construction has picked up significantly and builders are on track to deliver more than 1 million square feet of new office product by year’s end.
The majority of completions this year will either be build-to-suit or have a signed anchor tenant with limited speculative development working through the pipeline.
The majority of deliveries will be located within the West submarket. The largest project so far this year, which was delivered in the third quarter, was the 660,000-square-foot headquarters for American Greeting Creative Studios, located in the city of Westlake, approximately 11 miles from the Cleveland Hopkins International Airport. The office space is part of the Crocker Park expansion, which will grow to include a hotel, apartments, retail and restaurants.
Nearly 271,000 square feet of office space is under construction, with completions scheduled through 2018. Slightly more than half of these deliveries will be located within the East submarket.
One major project in the planning pipeline for downtown Cleveland is a large mixed-use development named the nuCLEus. Located on Huron Road, the site will contain 200,000 square feet of office space, 150,000 square feet of retail space and 500 apartments. The nuCLEus is expected to serve as a catalyst for new development in the downtown area and is slated for completion in 2017.
Vacancies to Rise
In the previous 12 months ending Sept. 30, vacancy fell 50 basis points to 16.5 percent in the third quarter on net absorption of 900,000 square feet. No new office space opened in the first half of 2016, which enabled the existing space to be absorbed.
Although office demand has been strong, the year will end with slightly over 1 million square feet completed in the second half. As tenants shift between buildings, the overall vacancy rate by the end of this year is expected to reach 17.5 percent, up 60 basis points from a year ago.
Rents Tick Up
Despite the expected slight uptick in vacancy, demand for quality office spaceparticularly in the downtown Cleveland and East submarketswill push up rental rates. This year, the average asking rent will rise 2 percent to $17.35 per square foot, and several submarkets will have average rents extending beyond $20 per square foot.
In downtown Cleveland and the East submarket, average rents ranged between $18 and $20 per square foot over the past 12 months.
As companies expand their footprint in Cleveland, office fundamentals will likely continue to improve, which will encourage investor activity in the area. Healthy increases in rental rates have lured buyers to Cleveland and energized investors to put capital into the city’s office assets as market fundamentals improve.
Buyers Bid Up Prices
Transaction velocity has remained steady over the last four quarters with buyers primarily targeting facilities in downtown Cleveland and the West submarkets. Here, the average first-year return typically falls between the mid-7 to mid-9 percent range based on the property’s age, location and size.
Due to the overall heightened demand by investors for offices in Cleveland, the average first-year return dropped 30 basis points in the 12-month period ending September 2016, to the mid-8 percent range.
Additionally, many owner-users are snatching up space as prices remain relatively affordable compared with the national average, and as asking rents remain on the rise.
Moving forward, upward pressure on rents and relatively higher returns compared with gateway metros will continue to motivate investors to inject capital into the Cleveland office sector, primarily in downtown Cleveland.
-By Ryan E. Moore, Associate, Marcus & Millichap. This article first appeared in the December 2016 issue of Heartland Real Estate Business magazine.