Strong Residential Demand Boosts Cleveland's Downtown Office Market

Apartment development is currently the driving force in downtown Cleveland’s commercial real estate market, including the conversion of office buildings to residential use and the rehabilitation of existing apartment buildings.

Downtown Cleveland’s population stands at more than 12,500, an 88 percent increase since 2000, according to a first-quarter market update from the Downtown Cleveland Alliance.
As a result, apartment demand is unrelenting with many properties boasting a long waiting list.
The renovated Ameritrust Building that includes “The 9” Apartments is one such development that has a significant waiting list.The strong tenant demand has driven Cleveland’s apartment vacancy to below 5 percent.

Corporate Relocations

In response to a growing number of young professionals seeking a downtown work/live/play environment, several corporations have relocated from the suburbs to downtown Cleveland. This trend is particularly evident among high-tech companies. The list of companies growing and expanding downtown includes Dakota Software, Dwellworks, National General Insurance, OnShift, BrandMuscle and BrownFlynn.

Renewed growth and demand for an efficient workplace has led to the construction of Cleveland’s first multi-tenant office building in decades, the Ernst & Young Tower. Inquiries and occupancy at the Ernst & Young Tower have been so robust that the developer, Fairmount Properties, has broken ground on Phase II, which will include retail, entertainment and residential properties.

Coupled with the city’s announcement of a downtown waterfront plan that will include apartments, a boardwalk, office properties and a downtown school, it is an exciting time to be a resident or worker downtown. Cleveland’s central business district (CBD) contains approximately 15 million square feet of office space. During the first quarter of 2014, the direct office vacancy rate within the CBD dropped almost a full percentage point from the prior quarter to 17.1 percent. In addition, rental rates increased approximately 50 cents to $19.24 per square foot.

The increase represents a strong jump quarter over quarter, especially considering that office rents in Cleveland remained static for so many previous periods. This jump is due to rental rates in the mid- $30s per square foot that the new Ernst & Young Tower is garnering.

HQ Projects Move to Suburbs

While Cleveland’s downtown office market continues to recover, the Cleveland suburbs haven’t sat idle. Thanks to the abundance of tax credits, available vacant land and access to potential “campus environments,” the corporate headquarters (HQ) surge is strong in the suburbs. In the past few quarters, HQ development has reached in excess of 1.4 million square feet.

Ongoing, announced or completed HQ projects include Eaton Corp. (600,000 square feet in Beachwood); Hyland Software Inc. (112,000 square feet in Westlake); and Omnova Solutions Inc. (70,000 square feet in Beachwood).

The emergence of new headquarters buildings will have a negative impact on absorption in the overall office market in the long run. Most corporate headquarters under construction or in the planning stage (Omnova Solutions and Eaton specifically) previously occupied multi-tenant and institutionally owned assets.

When these organizations move to an owner-occupied headquarters campus, the square footage, or footprint, will show up as negative absorption throughout the marketplace because most commercial real estate firms do not track owner-occupied buildings.

Downtown Versus City

When compared to downtown, the inventory of the suburban office market is similar based on total building square footage (13.5 million square feet for the suburban market versus 15 million square feet downtown). The overall Cleveland suburban market experienced modest positive absorption of 4,884 square feet during the first quarter of 2014.

However, direct vacancy in the suburban office market rose 50 basis points from the fourth quarter of 2013 to 15.7 percent during the first quarter. The average rental rate dropped from $19.08 per square foot to $18.93 per square foot during the same period. The decline in occupancy and rental rates in the suburban market is due to increased space efficiency (better layouts, less office space per person) and downsizings that have continued since the Great Recession.

Cleveland’s downtown CBD market will continue to improve following years of static rent growth and relatively high vacancy rates. The redevelopment of office inventory to residential apartment complexes, the conversion of functionally obsolete buildings to hotels, and a growing residential population will continue to drive growth. We expect the suburban market to continue to experience some vacancy and rental rate decline, but in the long term the market will benefit from the construction of new headquarters and amenities to serve the growing business population.

The suburban market will always serve a portion of the business community due to its proximity to affluent neighborhoods, hotels, shopping and restaurants. However, next year will provide some challenges as owner-occupied headquarters are built, older properties are vacated for newly constructed properties and tenants take advantage of lower rental rates to experience a flight to quality.

By Andrew Coleman, senior vice president, Great Lakes Region, JLL. This article originally appeared in the July 2014 issue of Heartland Real Estate Business magazine.

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