Recap of 2018 Portland Office Market… Study in Contrasts. Definitely some Caution… Unico on Buying Spree.

I think looking at some recent office building sales in Portland does a decent job of illustrating the schizophrenic nature of the current Portland office market. In general the last couple of years has seen a robust uptick in sales of office properties throughout the metro area with over $ 1 billion of sales for the 4th consecutive year. But this strong activity diverges somewhat from the withering (hopefully temporary) strength of the leasing market and a couple of the more “interesting” sales illustrates this.

Unico the uber-aggressive private equity investors from Seattle which has been present in Portland for over a decade and has quietly been owners of iconic buildings like the 42 story US Bank tower and the Commonwealth building has been on a tear recently with multiple office building purchases in the core this past year or so. They come in buy and then improve and reposition properties, lease em up at hopefully higher rents then exit sometimes in the 3-7 year time frame (it varies) to usually institutional investors with mostly healthy profits.

Not a new story but these guys are pros at spotting trends and opportunities. Unico though has been particularly aggressive this past year as they have been flush with cash from a sale of an 11 building portfolio in Seattle and Denver at the top of the market and has redirected attention into several Portland purchases, one of which will be one the largest in the history of Portland. Unico bought the Moda Tower (400,000 sf for $429 psf) dovetailing on their other downtown purchases of the Galleria ($352 psf) and the 23 story Congress purchase in 2017.

Their two other purchases are a bit more entrepreneurial with the $20 million purchase of the iconic 1930’s 75,000 sf point tower of the Weatherly building in the Central Eastside last fall and their pending purchase of the poster child of Portland renovation: the Montgomery Park (MP) complex with 850,000 sf which is rumored to be at sub 5% capitalization rate on current NOI at 95% occupancy.

The deal twist with both of these acquisitions is that there is a creative land play for additional space to be developed on both sites. At Weatherly where they will hipster up this old dog with small floorplates but they have also have floated an additional 12 story tower on an adjacent parking lot with 200,000 sf of office space.

Montgomery Park is a rare animal with tons of parking in an adjacent garage but lots of surface parking too which gives them again a nice site to add more office space. The thinking is that they get a good long term asset to hopefully add value with good income but also development land at a fraction of the cost if land in these areas had hit the market independent of the office buildings.

Unico believes like other big institutional investors that Portland has “room to run” plus they are like a few other investors that have come to Portland recently in that they are tired of banging heads with other big boys to buy top of the market properties in white hot locations in Seattle, San Jose, LA and the Bay Area where the room for upside is perceived to be much less or non-existent. As Unico VP Brian Pearce capsulizes, “We like the pulse of Portland and the organic needs of Portland’s tenant base and Portland’s core areas have quickly emerged as one of the nation’s fastest growing tech and innovation hubs. The upside value in Portland is more optimistic than other more mature larger markets. We think firms will continue to migrate to the region in search of strong space value alternatives as compared to San Francisco, Los Angeles and Seattle”. This is a common investment theory going on in all product types in Portland and has many big money guys looking at us as a great AAA ball club worth throwing some shekels into for the mid to long term.

Just for comparison a recent review reveals that core average office rates in Seattle are $45 psf; SF are $70 psf and Portland is just north of $30 psf. As a counterpoint, the 9 North Office building (Now called Tanner Point) in the Pearl which is a Dame Williams with investor Miller Global project totaling 172,000 sf was sold last fall: EMPTY! Field Office on NW Front which has 330,000 sf also was quietly offered for sale at less than 30% occupied but after getting a rather tepid response was pulled off the market recently. While the price for 9 North was eye-popping at $463.00 psf the fact that the owner Miller Global and Field Office wanted out does not bode well for a seasoned investors (developers too) outlook for the leasing depth of the Portland office market in the next year or two but hungry investors with cash pouring out of their shorts have papered over a somewhat iffy current office market in Portland.

If you are a tenant out looking for a chunk of groovy new creative (overused term) or even traditional office space next year in Portland’s core and fringes, you will most likely have the “pick of the litter” or at the very least, depending on your size range and your financials, your list could easily rise into the double digits. This is due to some new projects coming on line and some “recycled space” in some of the older core buildings (Wells Fargo) that are a result of “givebacks” or rejiggering of some large tenant’s office spaces and in some cases a move to cheaper space in the burbs. It is kind of an interesting disconnect in the market where the overall velocity of companies looking for space especially in the larger 20,000 sf plus range seems to be slowing or are finding landlords willing to be aggressive to get them to stay thus pushing vacancy up but not enough to lessened the heightened interest mainly from out of state by larger institutional money sources in buying Portland office buildings which I am told is a more mid-term to longer term outlook that shrugs off this recent blip in flagging lease demand that will come back even in light of many of the economists predicting a mild recessionary downturn starting in 2020.

It is kind of interesting to read the quarterly stats by the major big boy real estate firms that chuck a fair amount of dough into research and data collection. When you read the statistics by each firm they can often vary widely, go figure. But two of the more in the know firms settled right around 13% office vacancy rate for Portland which is a decent rise from 10% at the start of 2018. I like comparing so Seattle/Bellevue vacancy in the CBD came in at 9.8% and San Francisco was at 7.1% but both were declining rates from previous quarters along with tons of new space coming on the market. So those markets look much healthier at this point. Overall nationally the office vacancy rate (again many different conflicting numbers) was “around” 13% which puts us in the meaty portion of the Bell curve.

The back drop is that the Portland and Oregon economies are humming along nicely with further declines in unemployment to an all-time low of 3.6% and Portland’s economy turning a 3.2% annual growth rate. While this is all good news, the anecdotal information I get frequently is that all this great growth is stretching the labor market to a tight and tenuous position which may play into the firm’s decisions to expand. As one tech employer in Portland’s core related “We just cannot find good people and it really is hampering our ability to grow and makes it difficult to make investments in the business as we may not be able to have the personnel to handle additional work and business. We currently have 20 openings and it is taking time to fill these slots and we compete against lots of other firms both here in Portland and in other cities”. While Portland’s tech worker availability is growing and providing expanding and relocating tech firms with more skilled workers, there is an on-going challenge for many firms considering Portland for an “outpost” or significant tech oriented operation some pause. What helps in this decision making process is that I found the average salary (Source for Seattle Tech workers is $132,000; San Francisco is $145,000 and Portland $93,000. A buddy of mine that works for Sales Force in downtown SF tells me that salaries for software engineers with only a couple years of experience easily often exceed $200K. He says it is a bidding war often times. I am sure in Seattle it is pretty similar where the statistics on salaries mostly are on the low end of what is actually occurring in the tech labor market. Obviously these salaries reflect cost of living in each of these cities and even higher competition for skilled employees in the bigger tech markets of Seattle and SF where a 100,000 sf lease barely makes the papers.

The low down on the market is that there seems to be a definite “respite” taking place in regards to leasing activity and general interest in firms out there throwing around LOI’s for chunks of office space. JLL (which I trust the most for their research) reported that because of the delivery of new buildings and recycled space in older towers that net absorption for the year was actually negative for the first year since 2009. While there was some real bright spots of leasing activity such as Genentech taking 62,000 in the one of the dated towers in Lloyd; Vetsource taking 35,000 sf out at Cascade Station and smaller deals like Roundhouse Creative taking 16,000 at Central East side’s Custom Blocks, the velocity of deals and just firms out looking just seems to be subsiding as we closed out the year, as one broker told me “It seems like there is a dearth of “serious” firms looking for the larger spaces above 30,000 sf right now but many may be waiting in the weeds to both look at rents and the economy and then we may always see some bigger companies arrive out of blue on the scene with some big needs”. There may be a wait and see attitude right now with a turbulent stock market, a slowing China motor, trade beefs, a record setting expansion cycle that many think we are in the 7-9th inning, plus we are seeing existing landlords being really aggressive to keep tenants if possible. There is also a lull in some of expanding technology companies many of which secured rounds of financing in previous years to look at bigger or new spaces or some of the older tech firms getting bought and being folded into their larger buyer firms spaces. These start-ups in all stages are very reticent even in growth mode to add to fixed costs like expensive office space especially when growing firms suck up cash and head count can vary month to month so keeping fixed costs like leases flexible is important when the future is a bit cloudy. Also with co-working spaces; distributed workforces that can get the job done anywhere and converted warehouses with cheap open floorplans handling growth, the start- up tech scene most likely will not be candidates taking many large spaces in the coming years especially in the more expensive projects until the business model is well established like Vacasa which committed to over 60,000 sf in the Pearl earlier in 2018.

It is really a situation of feast or famine with some of the new office buildings coming on the market. First Feast…Walt Bowen’s Broadway Tower which has `180,000 sf of office space with half leased to Amazon and so being 90% leased when it officially opened at the end of last year is fairly fat and happy. Security Properties smaller Heartline Building in the Pearl had 61,000 completely swallowed by vacation rental hotshot start-up Vacasa earlier in the year is also pretty happy. Then we have famine with the forementioned vacancies at Tanner Point and the Field office projects. With some big gaps in some of the older towers you easily get to half million square feet of “dark” space and the core vacancy rate could hit the mid-teens or higher in the next couple of quarters. You have to think that asking lease rates which are reaching into the mid-30’s NNN have to stall from their run-up the last few years beyond the customary enhanced free rent and TI dollars landlords use before backing off rents. So if I have any sort of flexibility as a tenant, waiting to see if this glut in space can translate into a better deal for my company if I have flexibility at my current location is not a far off notion and is being discussed by brokers and firms over IPAs all over town in our way too many breweries.

Central Eastside Rises… in Office Market

Since I spend a lot of time in the close in eastside I have to mention how new office development in this market has gone from a little toddler to a rambunctious teenager as several new projects are under construction or being tweaked on AutoCAD at several architectural firms for future shovel bending and is proving to be a real challenger to CBD and Pearl projects. Though there have been a decade of previous pseudo-office development rumblings with mostly renovated warehouses under the Guidance of pioneer Beam Development such as Olympia Mills and Eastbank Commerce Center to serve generally smaller “industrial office” users at some rather competitive rates, it was the Clay Creative Office Building developed by Killian Pacific at SE 3rd and Clay that really gave the Central Eastside its membership card into the Class A country club. When fintech firm Simple grabbed the whole 72,000 sf building in 2014 and a phase II of another 50,000 sf next door (they have since gave back half their space) did the Central Eastside throw down the gauntlet to downtown and the Pearl that it was a hipper, trendy and energetic alternative to “my dad’s” westside. This status and office locational viability of the Central Eastside was cemented when Autodesk committed to an even bigger enchilada of 100,000 sf at the renovated Towne Storage builder in late 2016. Now we have four very different developments under construction in the Central Eastside with a couple more on the drawing boards:

Custom Blocks: Capstone Partners smart warehouse redevelopment of the former Custom Stamping warehouses into 72,000 sf is a year in and admittedly lease up as gone slower than expected but they expect to be close to full by spring. Two creative agencies Roundhouse and Archrival along with Mahlum architects are on board and “paper is being traded” on the last of the space with rents just short of $30 psf with TI’s in the $40 psf range.

5 SE MLK : Gerding Edlen’s flashy 17 story project is rising above street level at the former Fishel Furniture’s Burnside Bridgehead location containing 120,000 sf of office space ( along with 220 apartments too!) is the more glitzy entrant. It has a ways to go till opening in early 2020 but the glassy and modern design will really set a new higher standard for space in the Central Eastside.

District Office: Beam Developments largest office bet to date is with 72,000 sf of office and ground floor retail on a half block fronting on SE MLK and Yamhill on what was a non-descript half block that was home to Portland Music. Employing construction type dujour of the cross laminated timber, this project is plowing some deep piles into the ground for a late 2019 opening. Hacker Architects who designed the building will take a full floor and talking with Beam they feel pretty comfortable that most of the space will be spoken for before opening in about a year.

7 SE Stark: Harsch Investments innovative office project where Stark swings into SE Water has one important ageless design aspect that most of the other projects do not..PARKING!. The Works Partnership designed building has eye-popping “stacked glass cubes” look which will really spiff up mostly a warehouse industrial area and I bet at night will be something to see. Maybe employing the true maxim that “He who has parking wins in the long run”, the 70,000 sf of office space sits on top of 4 levels of parking totaling 260 spaces which is close to three and half times the standard ratio office developers are trying to hit of 1 parking space per 1000 sf of space. Having other tenants nearby, ownership of an older adjacent warehouse next door for further office development and in one of the most parking constrained areas of the eastside, Harsch smartly thinks parking will be a differentiator for their office project and properties over the long term. I definitely agree

Tree Farm: Kevin Cavanaugh and his Guerilla Development has quickly built a “brand” in real estate development in Portland by stressing altruism, out of the box design, power to the people financing all with a sprinkle of mischievousness. His latest project is more of the not so same or mundane with a 40,000 sf of office space next to a bridge overpass and get this…over 50 trees growing out the sides! Tree Farm has he has christened the project is under construction and with more of his crowd funding model fueling it, he hopes to hit rental rates 20% lower ( sign on the building bills rates at $25 psf) than his more traditional competitors.

On the drawing Boards: Tom Cody’s Project ^ and vaunted private equity guys SKB have dueling 140,000 sf projects that now have plans being perfected at architectural firms but commitments to moving dirt are not quite there yet given the growing vacancy rates, macro-economic storm clouds mentioned above.