The year 2013 marked a turning point for the Triangle office market. While overall vacancy remains stubbornly high, ending the third quarter at 17.2 percent, Class A vacancy is rapidly approaching equilibrium, spurring increased investment and development activity in the region.
A lack of new construction in recent years has led to a shortage of large blocks of prime office space. Class A vacancy ended the third quarter at 13.7 percent, down by 260 basis points year-over-year. As a result, owners of select properties are finding themselves with more leverage, and tenants are increasingly turning to their second and third choices when securing space. This lack of quality options kept a lid on absorption through most of 2013. Annual absorption stood at just 107,306 square feet through the third quarter, well below historical norms for a recovering market. This figure, however, is not a true reflection of leasing activity. Faced with limited choices, some growing and new-to-market tenants turned to developers, preleasing 700,000 square feet and driving a wave of new construction activity in the second half of the year.
Duke Realty broke ground on two new office buildings in the I-40/RTP submarket. Perimeter Two and Perimeter Three will total 451,409 square feet and are 72 percent preleased to multiple tenants, including Teleflex Medical, Fujifilm Medical Systems, MaxPoint Interactive and Compliance Implementation Services. Highwoods Properties broke ground on two buildings totaling 427,000 square feet at Weston Lakefront in Cary. MetLife will occupy both buildings for its new Global Technology and Operations Center, and a third building is planned for future development. Highwoods also broke ground on the 166,000-square-foot GlenLake V in Raleigh’s Glenwood Avenue submarket after law firms Ellis & Winters and Hedrick Gardner Kincheloe & Garafalo preleased a combined 41,500 square feet.
Just two properties of significant size were scheduled for delivery by the end of 2013. In downtown Durham, the 115,000-square-foot Diamond View III is 95 percent leased with FHI 360 as its anchor tenant. In downtown Raleigh, the 131,473-square-foot State Employees Credit Union tower will be at least 63 percent occupied by SECU, and the credit union has indicated it may take the remaining space as well.
While the development pipeline is beginning to fill again, little product will be delivered before late 2014 or early 2015, setting the stage for Class A space to tighten substantially in 2014, and for rental rates to rise notably. Asking rates stabilized in late 2012/early 2013 and began to increase by late 2013. Class A asking rates ended the third quarter at $21.96 per square foot, up by 3.8 percent year-over-year. Class B asking rates rose by 2.3 percent during the same period, ending the third quarter at $18.06 per square foot.
Sensing the rising tide, office owners came off the sidelines and began bringing more properties to market in 2013, spurring a substantial uptick in office investment activity. Demand for stabilized Class A assets was strong, but investors also found an appetite for value-add opportunities as leasing fundamentals improved.
KBS Realty Advisors purchased the 300,000-square-foot CAPTRUST Tower in North Hills, setting a new pricing record for the Triangle at $327 per square foot. The property was 95 percent leased at the time of sale. Federal Capital Partners paid $157 per square foot for the 238,792-square-foot Erwin Square Plaza in Durham, which was 96 percent leased. Prudential Real Estate Investors purchased Wade I and II, two buildings totaling 281,272 square feet in West Raleigh, for $163 per square foot in a debtor-controlled sale. The properties were 90 percent leased.
On the value-add side, The Simpson Organization paid $89 per square foot for The Arbors, a four-building, 254,266-square-foot portfolio located off of Highwoods Boulevard in Raleigh. Along Six Forks Road in Raleigh, Principal Real Estate Investors bought the vacant Northchase I and II buildings, totaling 171,237 square feet, for $68 per square foot; renovation of the properties is underway. A joint venture between Rubenstein Partners and Grubb Properties paid $57 per square foot for two former Sony Ericsson Buildings totaling 455,067 square feet in the I-40/RTP submarket; the owners plan to renovate the properties.
The Triangle office market is poised to shift in favor of landlords in 2014. While owners of Class B properties have a steeper hill to climb, a dwindling supply of Class A options should lead to increased activity for Class B product as well. As the market faces a gap between increasing tenant demand and the delivery of new product, owners of older properties have an opportunity to improve their competitive advantage by investing in system upgrades and common area renovations.
Construction and investment activity will likely increase further in 2014, and asking rental rates are likely to rise more sharply as tenants compete for a dwindling pool of quality options and newer buildings begin to be delivered at a higher price point.
— By Elizabeth Gates, Principal, Marketing and Research, Avison Young. This article originally appeared in the January 2014 issue of Southeast Real Estate Business magazine.