Musings on the Portland Office Market… Autumn 2019

It is difficult sometimes to figure out certain sectors of the commercial real estate market when looking at the high paid research of some of the larger brokerages because often times there can be some rather different numbers and information and often times the differences can be fairly stark.  I often ask… are they looking at the same market?’

Downtown Portland, Oregon
Photo by Hatham on Unsplash

This is especially the case I find when looking at the net absorption of office space in the Portland market which can be a bit of a squirrely number but trying to get at its true status is important because it shows how much space is being leased compared to new or recycled space that is coming on the market.  Then again especially with new projects being built, a healthy market should have considerable pre-leasing activity so this aberration should be rare. I will cut the young eggheads putting these numbers together a bit of slack because when and how they count when space is leased and when properties specifically are counted when that property comes on the market and speculative for lease and owner user all are looked at a bit differently. To give you a sense of the disparity, JLL had year to date net absorption of 428,000 sf… CBRE at 145,000 sf… Colliers 22,000 sf … Kidder Matthews 120,000 sf… Cushman and Wakefield 157,000 sf.  Go figure.

So if you use the old tried and true method of throw out the high and low and then average the remainder you get 140,000 sf of net office absorption.  Any way you cut this, it is not a very impressive number in one of the best economies in decades.

Generally, the first half of 2019 even with some of the above mentioned differences in the numbers does look fairly weak but as mentioned a half year of statistics a market does not make but the trend is a bit disconcerting but a few big deals can change the gloomy feelings.  But anecdotally there is a bit of concern out there by landlords with empty space sitting on or coming into the market that the velocity of interest they are seeing is not robust.  I have heard more than once that the RFP’s by companies out in the market for “legitimate” space requirements has been somewhat anemic compared to the trailing year or two.  I always reach out to people with thoughts and opinions about this who are in the thick of the market namely owners or developers “I would not touch the office market right now with 10’ pole…wait make that a 50’ pole” says principle Jordan Menashe whose family office portfolio encompasses several downtown buildings including one of the more successful recent developments the 60,000 sf cool glassy 12th and SW Morrison which mostly leased.

Jordan is great as he knows what he is talking about and he’s unafraid to give a very educated yet unfiltered opinion. “The demand is just not there right now then we have over a million and half of new space coming on the market in the next year or more so it just makes for a real tough office market. I just have to think some of these recent big institutional owners coming into town will be beating each other up to make deals over a very limited pool of tenants. Rents flat or down and concessions way up… no Bueno for the market.”

I asked a few more owners, brokers and observers to get a very unscientific survey of why our office market is in a bit of a lull and got a plethora of reasons:

  • Currently landlords are being very aggressive in trying to keep their tenants by offering up concessions or additional space (if they have it); rates especially in new buildings are easily north of $30 psf if not into the mid-$30’s with the every continuing growth of triple net (expenses) that now can be easily $8.00 psf and seen a couple approaching $10.00 psf so all in rents can easily approach $40 psf and beyond. This can easily be a jump of 30% over what many firms and organizations are currently paying where many of their leases were completed coming out of the recession when rates were considerably less expensive.
  • A small but not to be ignored migration has happened over the last year to suburban locations where rents are considerably more economical and there is tons of free parking and where net absorption for the first half of the year was 250,000 sf.
  • A growing concern that a broader economic correction maybe coming thus making firms more cautious about taking a more square footage at higher rates when in their minds the economic traffic signals may be flashing yellow.
  • Lack of proven and strong technology firms in Portland that have been on a tear recently (just look at Seattle) along with the lack of “real” relocations or expansions of tech firms we all hoped for out of the expensive and constrained markets of Silicon Valley to Portland.
  • Then there is the growing phenomenon of CoWorking spaces or dispersed or remote working where firms often look at maybe taking co-working space or having workers work remotely then committing to long term “fixed” spaces when the economy is iffy and their business and space needs so changeable.

Pick your reason(s) but as stated these lulls in office market leasing activity are not unheard of even in good times as Portland especially will have “bursts” of leasing followed by quarters of relatively little activity. Let’s hope this is a several quarter aberration but there are some factors that point to a “new normal” especially in light of the growing rumblings that the we are headed into what many hope is a mild recession

Vacancy rates for office space tend to be a bit more uniform and the agreement is that the rate hovers in the 11-12% range which has been fairly consistent over the last couple years but up somewhat from a few years ago where it dipped below 10% which I attest to increased leasing and little new product being delivered to the market in that timeframe. The rubber will hit the road in the coming 12 months when the 1.3 million sf of new or recycled older (see Wells Fargo Tower) space hits the market with hopefully a high percentage pre-leased.  If some of these new buildings get finished with less than 50% pre-leased and some of the larger buildings like 9North (178,000 sf) and Fields Office (300,000 sf) that traded hands mostly empty continue to struggle, then there may be some alarms sounding.

A bright spot is the sale of office buildings but even this has a dark cloud associated as two of the larger sales were of buildings that were either empty or marginally leased.

  • Fields Office:  Located on what many thought was a suspect and unproven fringe location of NW front into the industrial area, Field Office was developed by Project^ with all the dough coming from union pension fund group National Real Estate Advisors.  At just over 300,000 in two buildings it was designed with larger floor plates as a somewhat urban campus betting on big fish would come in and take the whole thing or at least much of the space.  It did not happen as from when completion in early 2018, they did one big deal (30,000 sf) with Adpearance and couple small deals and never got past 25% occupancy with no real activity for the last year. With tons of money washing around especially for opportunistic deals, and looking out on suspect leasing future, it hit the market and quickly found that exact big institutional buyer in the combo of Goldman Sacks and Lincoln property paying $411 psf which allows the developers and equity folks to get out with some scrapes but no permanent brain damage.
  • 9/North:  Though closing late last year this project in the Pearl by Williams/Dame and Denver based investor Miller Global was a flop with no pre-leasing or any deals since it was completed in the summer of 2018. Again not tons of patience which says again major investors long term confidence in the Portland office market is not good… they sold pretty quick after completion for $415 psf to one of CBRE’s funds. Plans are to invest a bit of dough for some sought after office amenities and get aggressive on leasing.
  • Montgomery Park: Here is the big boy. Long owned by the Naito family, they saw the timing was right with aggressive buyers out there and the office market wobbling and family members getting older, to move this iconic 30 year old renovation project.  It was an easy fit as Seattle based Unico had been playing monopoly in Portland for over 15 years and knows the market and had bought the family’s Galleria last year so I am sure someone at the family said “Hey you bought the Galleria… what about Montgomery Park?” Done! This huge bet by Bill Naito is a perfect fit for value-add Unico.  Though 94% leased of its 745,000 sf of space, the property has huge additional development capacity with an old multi-story warehouse used as a parking structure and an empty 3 acres for further development.  With the sale of the adjacent 22 acres Esco Property and eventual trolley service up Vaughn, this is a brilliant long term play as this neighborhood sheds its industrial past to more office; retail and flex development. “Buying one of Portland’s landmark properties with substantial future development capacity in the Northwest District is a huge opportunity. With look to deliver unrivaled new development and unrivaled amenities to help this area continue to evolve into a vibrant extension of Slabtown as ultimately a live-work-play neighborhood” says the Unico dude heading up the acquisition. Price I think really is not valid due to all the extra development capacity they get with this deal but it was $345 psf.
  • Leland James: This 118,000 sf revamp of an ugly 70’s office building for Conway logistics in the Slabtown area was partnership of Cairn Pacific and Capstone Partners. The building was just over 80% leased with major tenants Regus Co-Working brand SPACES having 45,000 sf and software company Jet Global taking 30,000 sf and retail tenants Good Coffee and fitness group Orange Theory.  It was total gut of this Brady Bunch era building opening up the interior to some more airy, light filled and more flexible spaces with like many buildings a great penthouse space with terrace and of course the much required bike facilities and also underground parking.  Buyer ASB Real Estate with over $8 billion of real estate assets has ventured into Portland previously with other purchases of the Viewpoint/Mackenzie building in the Central Eastside and a building in the Pearl with Specht Development. The price was $547 psf.

With multiple new projects under construction and set to deliver over a 1 million square feet in the next 12 months at top of the market rents portends for some worried owners and developers if this sort of net absorption continues along with the dearth of sizeable firms out looking for space becomes the norm. The close in eastside where I spend a lot of time is really where new office and creative space development has shifted recently so will review a few of those projects:

  • 7 SE Stark – This 78,000 sf of glassy space is finishing up by the end of year next to I-5 freeway off SE Water and Stark in the Central Eastside.  Located on an empty parcel Harsch Investment acquired along with two other city blocks, this project has yet to secure a tenant but “paper is being traded” with several tenants that may result in the whole building being taken soon. The great aspect (my opinion) of this project is the commitment to substantial parking of over 260 spaces in a time when parking ratios and availability continues to ratchet downward.  In a very much constrained area of parking in the Produce Row area and owning other parcels for future development, Harsch believes long term parking will enhance their future development plans.
  • District Office – Located on half block fronting SE MLK, Beam’s CLT office building of 72,000 sf is going to a great addition to the Central Eastside.  The Cross Laminated Timber construction is really gaining momentum. Delivering on highly durable, lighter carbon footprint, superior thermal efficiency, larger clean spans and open floor plates all with a beautiful wood aesthetic.  Better yet CLT is made in Oregon and true to our Oregon sustainable timber roots.  Hacker Architects designed the building and also leased 20,000 sf along with Regus Co-Working brand called Spaces taking another big chunk of space making District office a shining pre-leased star in the creative space development contest.
  • 5 SE MLK – This is a big deal and a project almost 4 years in the making and now rising to what will be 17 stories at the south end of the Burnside Bridge, this project by Gerding Edlen brings over 200 apartments and 120,000 sf of office space to the close-in eastside. It will be a bright modern sentinel at the main entrance to the Central Eastside providing a much needed counterpoint to the darker ominous feel of the 22 story Yard Building to the north.  Still a year away it will bring top of the market amenities and design to the eastside.
  • Tree Farm – The latest bust-the-norm development from idea-a-minute and altruistic developer Kevin Cavanaugh this 40,000 sf project will have 56 trees attached to outside of the structure providing a bit of nature into this office project. Catering towards smaller entrepreneurial uses, and an economical price point, Kevin will undoubtedly get continued press and probably forward-thinking tenants to his spaces that are set to be ready early next year.

A couple other projects are on the drawing board with a 90,000 sf project on a vacant parking lot at SE 2nd and Ash as part of the acquisition of the former Salvation Army properties by LLJ Ventures out of Sand Diego with local front man Adrian Brody of Willamette Stone Development.  Unico is also playing with a modern 120,000 sf +/- office project on the parking lot next to the Weatherly Building which they acquired late last year.  Also Vanessa Sturgeon is completing the buy of a 18,000 sf parcel on SE Grand a couple blocks south of Burnside for what is being rumored to be an office project and like LLJ Ventures is playing off the Opportunity Zone angle.

Downtown has a few new projects with the Walt Bowen Ritz Carlton breaking ground, which, besides the hotel and condos, will have some top of market priced office space in the 140,000 range but will take two years to complete. Security Properties is almost topped out on their Canvas Office Building of 138,000 sf across from the Timbers home at Providence Park and will deliver next summer. There are big holes in existing buildings like the former Jive Space at Federal Reserve and Wells Fargo has a ton of refurbished space coming on the market too.

If will be interesting to see what office lease deals are forged here this fall into Q1 next year, and if we continue to see some less than stellar space absorption and a dearth of “real” large qualified RFPs running around, all while continued new space hits the market, then there might be a bit of developer and building owner gastro-intestinal distress.  Let’s talk after Santa comes to see where the office market in Portland is really headed.