Time to Get Moving: Commercial Space Guide
With the American economy teetering on the brink of another recession, the quest to find new commercial space might not be a top-of-mind task for Greater Madison employers. Yet with continuing economic sluggishness, those who think outside the box might find this autumn an ideal time to consider moving, even if there is nothing wrong with their existing location or lease. To get a read on the current state of the commercial office market, IB interviewed several experts, including tenant representatives, to answer several key questions: Is it still a market where good lease deals can be negotiated, particularly rents and office improvements? How flexible are landlords still willing to be? Which Madison submarkets are closer to equilibrium, where tenants have less negotiating power? We present a snapshot of the commercial office market (current as of 9/16/2011) and offer 251 commercial property listings with over 8,000 sq. ft. of space, courtesy of PropertyDrive, LLC. [View the complete list of 658 available properties online at ibmadison.com. Current Madison and Dane County listings are always available at propertydrive.com.
Market in the making
At the start of 2011, the commercial space outlook was improving in the forecasts of Grubb Ellis|Oakbrook Corp., which tracks the Madison office market. Chris Caulum, director of research and financial analysis, believes conditions continue to gradually improve.
"The classic way to explain things is that the office market lags the economy as a whole, so we usually see, as the economy improves, actual improvement in occupancy six to nine months later," Caulum said, noting the converse also is true if the economy declines. "From the start of the year forecast through now, what's been happening in real life has been consistent with that forecast. Things are improving."
The improvement, however, has been gradual. Still, vacancy has come down to 16.2% and lease concessions are starting to tail off. Conditions differ by submarket; at the moment, the strongest submarket is the west side, both near and far west. The lowest vacancy rate among the submarkets was on the near west side, with 8.4%. The highest vacancy rate among the submarkets was the 22% reported on the east side, which includes the office buildings just east of the Capitol Square.
Equilibrium – that midpoint balance between a landlord's market and one in which tenants have the upper hand in negotiations – is a vacancy rate of anywhere between 10% and 12%.
There has been some tightening due to recent moves. Catalent Pharma Solutions moved into a 100,000-sq.-ft. space on Heartland Trail, Sentry Insurance now occupies 45,000 sq. ft. on the top two floors of 1800 Deming Way, and Shopbop, the online retailer, has moved into the former Gisholt Machine Co. building, consolidating three Madison offices and a warehouse into 200,000 sq. ft. of former factory space at 1301 E. Washington Ave.
"We've seen a couple of notable transactions recently in the market that have suggested a tightening," said Tim Rikkers, a principal with CresaPartners. "However, I think as a whole, the market still remains a tenant's market with a lot of options for most users."
The exception, he added, is a limited amount of large box space – 30,000 sq. ft. or greater – but there are a lot of options for small to mid-sized users.
In Caulum's view, there are good deals to be had, but it's case specific. "The way I would describe it is that a year ago, it was a tenant's market for every tenant in every submarket," Caulum said, "and right now it's a tenant's market only in certain submarkets and for certain space types [Class A, B, or C].
"The east side is still definitely a tenant's market. For the most part, Class B and C properties are in tenant's markets."
According to Caulum, Class A properties are closer to equilibrium, especially the far west side and downtown. A quick synopsis of the five submarkets, in terms of Class A space, is as follows:
Downtown market: "The downtown has held steady, with vacancy at 14.2%, "tiny" absorption of +8,000 sq. ft. in a market of 3 million sq. ft., and an average asked-for lease rate (as opposed to negotiated lease rate) of $22 per sq. ft. "In 2007, it was 17 cents higher than it is today," Caulum noted.
Near west market: Vacancy in the near west market, which includes everything from the edge of the isthmus to Hilldale Shopping Center, is down to 8%. Thanks in part to the completion of the 800 University Bay Dr. building, absorption was 77,000 sq. ft. in a market that has a total of only 670,000 sq. ft. At an average $17.27 per sq. ft., lease rates are higher than before the onset of the recession, mainly because the new University Bay Drive facility raised the average.
Far west submarket: The far west market starts at University Research Park and extends past the Beltline, and vacancy in that expanse is 16%. Absorption was a minuscule 50,000 sq. ft. in a submarket of 5.8 million sq. ft., and the average lease rate was $20.06, up about 50 cents from two years ago.
East submarket: East side vacancy of 22% is somewhat skewed by the fact that some of that square footage is on the very near east side, within 10 blocks of the Square, and that as you get to the American Center and High Crossing, it's not quite as high.
In addition, there was a negative 50,000 sq. ft. of absorption in a market of 2.7 million sq. ft. Somewhat surprisingly, lease rates are up due to the addition of new buildings. The average lease rate is $18.04, up 30 cents from 2009 and 70 cents from 2008.
South submarket: In terms of vacancy, the south market (16.1%) was aligned with the overall percentage, while there was relatively healthy absorption of 56,000 sq. ft. in a market of 1.7 million sq. ft. The average lease rate of $18.22 is mostly unchanged from two years ago.
Lease on life
"Lease rates come down a lot slower than negotiated rents," Caulum explained. "The effective rent is always highly influenced by the amount of free rent and concessions, so of the three metrics (vacancy, absorption, and lease rates), the rents are the least important because they are not the actual negotiated rents."
Key terms related to rent are "triple net" and "gross." Triple net is when tenants pay their pro rata portion of the building's operating expenses. With the gross structure, tenants know essentially what they are paying per month, regardless of whether the building's taxes rise, or the insurance or utility costs dramatically increase.
Regardless of rent structure, the negotiating flexibility of landlords remains in flux, and it's influenced not only by the economy, but the status of the tenant and, in some respects, the property owner. "With landlords, some are able to do tenant improvements, while others don't have the cash flow and are more willing to consider a month's free rent and negotiating the lease rate," said Annette Gelbach, a partner in Key Commercial Real Estate.
Tenants should not count on a still sluggish economy to force concessions, or because more space has become free. Landlords have fixed costs, too, and as long as there is still a contractual relationship, tenants will have some persuading to do if and when they seek relief. During the recession and its slow-growth aftermath, some tenants have been able to upgrade from Class C office space to Class B space, and from Class B to Class A space, but that doesn't mean landlords are completely at the tenant's mercy.
"It's a case-by-case situation that has to be a win-win for both landlord and tenant," Gelbach noted.
While Madison's unemployment situation is much better than the national picture, the zero job growth reported nationally in August has intensified fears about another economic downturn. Should there be another economic contraction, the
impacts will be felt in the commercial space market.
"It has to be a pretty long-term trend before it affects things," Caulum noted. "When you go on a downward path, things don't change much for a while, six to nine months. If this is just a rough patch that is three or four months long, I don't think there will be a big change. If it's a true recession, a double dip, it would have an effect."
Deb Ersland, also a partner with Key Commercial Real Estate, thinks people will maintain their focus on existing conditions rather than fret about what could happen. "Anytime something unsettling happens in the market, everyone takes a deep breath and pauses a bit," she said. "Leasing space or making changes, I think people will still just deal with the economy as it is today."
In terms of market equilibrium, the most important metric in today's economy – job creation – is the one that plays the largest role in driving the market back to center.
"Consumer confidence does not really affect the office market too much," Caulum explained. "That would be more of a retail and industrial metric. I would say it's the overall increase in employment, which for Madison the biggest impact will be in office space, whereas in Milwaukee it would be industrial space. They are just much more of a blue collar industrial manufacturing type community than we are."
Another trend that is impacting commercial space is the growing volume of distressed property hitting the market. Distressed property is either bank owned, owner distressed, or pre-distressed, where owners think they have to sell property within a year and they figure they might as well put it on the market to see what they get.
"Banks had not put a lot of stuff on the market prior to this year," Caulum said. "They have a lot of choices when they get property back. They can sell to a neighbor. They can auction the note instead of sell the real estate. They can foreclose or they can decline to own it and lease it so it increases occupancy, and then sell it later. There are a lot of things they can do, but we're actually seeing more and more stuff come on the market that is banked owned.
"If you are a tenant that is maybe 5,000 sq. ft. or greater and you've kicked around the idea of owning your own office building, you might be able to find a building that is twice as big as you need and then lease to tenants, and you can have a full building or close to a full building."
It's probably a good thing that Mark Renner was a Lutheran minister when he butted heads with the administrators and elected officials overseeing municipal and county permitting processes. To get final approval for his modest golf course development, he needed the patience of Job.
Developers of commercial space or any other kind of commercial enterprise, especially in Dane County, can probably feel his pain. But more than a decade after finally gaining approval for his truly green development, Renner certainly has the right to say something to his former tormentors: "I told you so."
Not that a little "how do you like me now?" is actually part of his makeup – he still takes to the pulpit on occasion – but the thought of people purposely delaying a project, while mischaracterizing the intent, will stay with him until the day he dies.
Renner, president and co-owner of the Argue-Ment Golf Course, proposed to take farmland property and transform it into an affordable, nine-hole golf course for families and kids. The property, nestled between Belleville and New Glarus, about one mile south of State Highway 69 on Argue Road, required approval from the municipalities of Primrose and Montrose in Dane County, New Glarus and Exeter in Green County, plus the counties of Dane and Green.
It took all of three weeks to gain approval from the parties in Green County, but even though the proposed use was well within the legal framework of what was permitted, it took three years, and some almighty cajoling, for this man of the cloth to get Dane County officials to see the light.
The multiple meetings and lengthy permitting process in Dane County almost sunk the whole project. Renner and his partners were operating with a limited pool of capital, which was almost completely drained by the process.
Explained Renner: "This was an isolated parcel, and the objection that they came up with at all levels was, 'You guys are just doing this so you can put up a housing development,' for which we had never applied and had no intention of doing."
Eleven years later, there is no more argument about Argu-Ment, nor is there any housing. Such is the case, Renner laments, when people place their own prejudicial whim over the rule of law.
"The issue of regulatory difficulty comes down to the difference between governance on the basis of the rule of law and people who actually stick to the text of the regulation, versus governance on the basis of personal opinion," he asserted.
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