Industry Outlook: Commercial Real Estate Industry Outlook: Commercial Real Estate
Industry Outlook: Commercial Real Estate

For the commercial real estate industry, 2016 was a banner year. The question on the minds of our panel of real estate executives is whether that growth can continue at the same pace into 2017—and beyond. With construction costs and interest rates on the rise, tenants and owners are becoming more conservative with their real estate footprint.

PARTICIPANTS:

Dana Baird, Cushman & Wakefield Commerce

Jim Balderson, JLL

Bruce Bingham, Hamilton Partners

Bryce Blanchard, Newmark Grubb ACRES

Jake Boyer, The Boyer Company

Andrew Bybee, Stack Real Estate

Mary Ann Callister-Day, Keller Williams Commercial Real Estate

John Dahlstrom, Wasatch Properties

Karin Fife, CREW

Brandon Fugal, CBC Advisors

Bret Mackay, DLM Development

Greg Shields, Pentad Retail/Hospitality

Daniel Thomas, St. John Properties

Kip Wadsworth, Wadsworth Development Group

Scott Wilmarth, CBRE

Eric Woodley, Woodley Real Estate

A special thank you to Brandon Duke, vice president, KeyBank Real Estate Capital, for moderating the discussion.

 

Generally speaking, was 2016 a positive year for local commercial real estate market?

FIFE: We design and furnish commercial spaces and commercial businesses, and for us, 2016 was a fantastic year. We broke every record that we’ve had before. And 2017 is slated to be just as good. We’ve been lucky enough to start and work on the CHG corporate campus and several other large projects over the past two years. It’s been a great thing for us to learn about the changing market, changing workspaces, and attracting and retaining the millennials and the workforce that’s needed today.

FUGAL: I think 2016 was a historic year for all sectors of the market, perhaps the best year we’ve seen on record. Record new construction in Salt Lake and Utah County. And the absorption has never been more dynamic. But as we look to the future, I think all of us in this room are looking forward with a degree of caution based on changing velocity.

WADSWORTH: I’m out of the construction business and have been for a few years, but based on what I do know, construction was brisk last year. The biggest issue contractors have is finding people to manage the work. TIs and new building costs seem to increase. Price is going up. It’s going to be a challenge for the owners going forward. And the pro forma, with the cost rising, it’s a challenge to contractors to bring the people and the resources they need to meet the demand. So construction is on its way up and kind of hitting the top.

SHIELDS: I think 2016 was not necessarily the best year to be repping a lot of retail tenants. In certain categories we’re fine, but it’s very difficult to find a spot for your restaurant or for your retail shop because it’s been tight. Toward the end of the year, as some new developments started to come online, it’s loosened somewhat, but it continues to be a little bit of an issue. I’ve got a national restaurant group I’m bringing in from Dallas and they’re a little particular and they want their first site to be a great site, and I think we finally have their first site landed after about a year and three months of looking.

Let’s dovetail that in with the articles we’re reading every day about retailers shuttering stores across the country.  

SHIELDS: Most of the retail shuttering is concepts just going out of sync, such as department stores that have been around for a long time. We saw that in the early ’80s, when the concept of the local department store disappeared. Castleton’s, Auerbachs, the Paris Company, Maycoff’s—they were institutions when I was growing up in this town and they all got swept away because they became functionally obsolete.

Retail sales are actually very high; it’s just that we’re going through a concept change where people no longer shop at the places they used to shop at 20 years ago. And department store sales have gone down I think from $90 billion a year to $60 billion—and yet T.J. Maxx and Marshalls and those guys are doing great. So it’s just different concepts.

MACKAY: We have an example of that. At Home in Sandy has a concept that’s very different. It’s still a big box but they use it completely differently. If you compare an At Home to a Home Goods—Home Goods tends to have a much smaller footprint. You go in and there is, like, one table, and if someone buys that table, then they have the warehouse ship out another table. At Home actually uses it’s space partially in a warehouse configuration. So if you go into At Home, instead of having one table, they’ll have five or six of them right at the space. So we are seeing that shift of how the space is used. Even though we have a tenant that’s, in theory, a big-box tenant, they are using it in part as a warehouse facility, as kind of that last connection, instead of having a large warehouse.

SHIELDS: E-commerce is only about 10 percent of all retail sales right now, although it’s expected to grow to 20 percent by 2030. That affects certain businesses—really, really hits them. Like the office supply business, paper and products, it’s really hurt because of technology. But most of it is because the businesses are just functionally obsolete.

BALDERSON: Looking ahead 10 years, how things are going to change in retail is pretty substantial. Amazon is going to be rolling out grocery stores and virtual reality shopping, where you put on a headset and you are able to try on all the different outfits with just your eyes. That’s going to change how people shop and how customers interact with Nordstrom and these other soft goods retailers; it’s probably going to trigger a pretty big change.

How was 2016 for the industrial sector?

MACKAY: There are a couple of large projects that are under construction right now: the Post Cereal building that’s being built on 56th West, and UPS is constructing a very large building that is going to be doing essentially last-mile distribution. So you really do start to see that fulfillment, that e-commerce driven demand.

In 2015 and the first part of 2016 there were several large buildings developed by five industrial developers in the community that were multitenant buildings. They were 300,000 or 400,000 square feet, but they were made for two, three, four different tenants. But we didn’t see that space lease up as fast, so we ended up with a little bit of an overhang condition in 2016. And we didn’t see the price support in 2016 that we thought we would see. We actually had some reversals on some of our pricing in rents on the industrial side if you weren’t doing that big-box, single-tenant, build-to-suit.

We got some support on the really small-end, multitenant buildings where the tenants are about 10,000 square feet, but even that kind of got overbuilt. So even though we had really good numbers in 2016, the rents didn’t reflect what we had hoped they would be. In 2017, as that space gets leased up, we may start to see some rent support in that big industrial stuff.

WILMARTH: CBRE does a national investor survey every year, and for the first time in five years investors rotated out of multifamily and their number one product was industrial, which is interesting because multifamily has been bulletproof, and everywhere you go there’s multifamily going up on every corner. But there is some sentiment nationally that it’s maybe run its course a little bit and that yield may be leaning toward the industrial. I don’t know if that’s just big box or—

MACKAY: I think it’s across the board. And cap rates, especially on the west coast, but in all the major markets, are phenomenally low, almost regardless of the product type we’re talking about. Our cap rates are in such low, single digits, you kind of scratch our head and say, “How does this really happen?”

What will be interesting is whether or not we’ll continue to see really aggressive low cap rates as we get some adjustment in the interest rates going forward. My guess is there is enough room for some increases in the interest rates without losing the benefit of that cap rate depression we’ve seen.

BLANCHARD: The thirst for investment product is as high as it was in 2014, when we set an all-time record, and ’15 and ’16. Nothing has changed yet short of a blip in the fundamentals. I wouldn’t expect there will be because Utah has a great story relative to the other competitive marketplaces in our region.

I sold a handful of industrial deals last year, all below seven caps. And for every one seller there are 10 buyers, at least. It’s a matter of having a willing seller right now. You have still got to price things. You can’t be crazy on your cap rate. Some brokers are thinking there is this irrational business of putting properties on the market that are garbage properties at six and a half caps. There still has to be quality in the real estate. It still has to be risk-adjusted. But for industrial, the vacancy rate is still below 5 percent, generally.

We just sold a property out by the airport. A company out of San Diego, Westcore, was the buyer. He was willing to skip a lot of risk because we had two tenants in the building, both with fairly short-term leases, but he’s banking on the market, he’s banking on that area at the airport to continue to grow. Just closed on a deal with an out-of-state buyer in West Valley, a big industrial multitenant deal. They can’t find enough of it fast enough. Truly, for every deal I can sell, there is a long list of buyers.

WADSWORTH: What do you think the impact of the airport expansion and the prison relocation will be on that quadrant out there from an industrial standpoint?

BLANCHARD: It’s going to be impactful and it will drive a lot of value in that submarket, for sure. It does dump a lot of new inventory on the market because that’s going to open some surrounding parcels for development. We’ve always had the story that Utah has got a real supply constraint on industrial because of some natural boundaries, and that changes that story a little bit.

SHIELDS: From a distribution standpoint, you’ll never change the fact that this is the geographic center of the west. That helps.

What kind of activity are we seeing in the office market?

WILMARTH: If 2009 did one thing, it reset the way big users look at real estate, because, historically, there was always five to 14 spec buildings under construction. Large users really didn’t have to be all that strategic in their planning because there was always plenty of inventory. If you took any 10 years of time, seven of those were in the tenants’ favor, because we had more supply. 2009 reset that. Now if you are a large user, you really have to be strategic. You have to be thinking about where you are going to be three years from now.

DAHLSTROM: There hasn’t been a lot of spec building. The financial institutions aren’t there for spec building, the tenants aren’t there for spec building. A lot of the tenants are now very careful about their footprint. So you’re seeing more of these companies that come into Utah, and their option really is build-to-suit or look in another market. There are enough opportunities in the build-to-suit arena that people haven’t gotten out and started really speculating.

FUGAL: A lot of office tenants continue to delay evaluating their requirements until you’re within a six-month to nine-month window, and they are relegated to either a product that is already under construction or a second-generation space. So the few developers who build on a speculative basis are the only ones, in the market of the last several years, that have been the beneficiaries of those headquarter requirements.

THOMAS: Historically we aren’t strictly a speculative builder—our portfolio isn’t designed to accommodate a lot of those build-to-suit users because there is not many of them out there nationally. We like the 5,000-square-foot user. And we’ve found you always have to build spec to attract them. So our project in Pleasant Grove will continue to build on a speculative basis, just because that’s the way we feel the market leans.

BYBEE: In the last half of ’16 we experienced a lot of sublease space coming back where tenants were saying, “Hey, you know, we’re not going to grow into this quite as fast as we thought we were,” and that has frozen a little bit of the spec space, because the landlord’s sitting on space longer than they wanted to. And, consequently, you don’t have anything under construction in north Utah County right now because there’s hundreds of thousands of feet that are out there still.

WOODLEY: We love all the sublease space on the tenant rep side. You’re able to lock down space at a pretty easy clip without a ton of foresight. If you’re a tenant that needs up to 50,000 feet, it’s pretty easy; you have options. You go outside of that and you need a 50,000-square-feet-plus solution, it gets a lot more difficult, and that’s where we’re going to start feeling a little bit of panic if we don’t have these developers wanting to take risk on a 150,000-square-foot spec building.

FUGAL: Right now you probably have 400,000 square feet of sublease space available, mostly in the Point of the Mountain/Lehi area. But I would say most of that space is in playbook right now, and the largest block is probably Solar City.

WOODLEY: A lot of that sublease space is providing downward pressure in the shorter term. But if you have any tenant going with any size above two floors, you are still seeing a lot of these 27, 28 rates, and it’s pretty competitive. It will be interesting to see if people can take that leap or if they stay lean and mean and nimble and keep chomping down these one-, two-, three-year deals and aren’t too bothered by being in two different locations waiting to strike.

BYBEE: What’s everybody’s strategy on the sublease space? We paused at Thanksgiving Park. Last year we had Building 5 at Thanksgiving Station under construction, ready to go, and our kickoff tenant started to feel the weight of the additional space they took to grow into. They pulled back, and eventually shut down in Utah, said, “Hey, we got 60,000 square feet and we don’t have a body to go in it.”

So we played musical chairs with some tenants down there. Thank goodness we had some velocity. And we pressed pause on that building because we didn’t want to introduce more supply and compete with the sublease market. That’s been our strategy the last 12 months. Maybe that changes in ’17. I hope it does. Obviously, we want to build if we have enough demand. But we’re going to be super conscious about adding supply while we have sublease space as high as it was the last half of ’16.

SHIELDS: This cautious optimism is really good for the market long-term. So often when you have a 2016 year, certain segments, if not all of them, tend to just drive right off a cliff, where it’s like, “Oh, it’s so good, we’re going to do 2 million feet of spec office.” And 2008 did a remarkable job of that. Now we see people holding off. That’s a really good thing, because what has overbuilt the market in the past is sometimes a mob mentality that does not seem to exist in the marketplace today. That bodes well for more steady growth and not getting things too whacked out.

Is downtown Salt Lake following those same office trends?

WILMARTH: Downtown is a pretty good story that not everybody is talking about. For the first time in probably five or six years, we had as much absorption downtown as we did in the suburbs. When you’re talking about a million square feet of absorption and just under half of it is downtown, that’s pretty significant.

What makes it significant is if you look at the absorption overall, I would say that 65 to 75 percent of it was technology-based. Downtown that’s not the case. Financial services and others have all expanded. That speaks to the economy as a whole and not just perhaps this venture capital that reached our market, started in ’14 and really came to fruition in ’15 and was manifest in ’16.

BINGHAM: There is a demand for office space downtown that’s ready to go. I don’t think that exists in the suburbs. There is just too much stuff out there.

BOYER: The big concern I’ve had, as I’ve watched downtown, is it seems just a shuffling of the deck. If you really analyzed 111 Main, other than the Goldman transaction, several of the transactions that were done there were out of other buildings in the downtown. They weren’t net new to the downtown. Sometimes there’s incremental growth within the law firms or the financial services companies, but in terms of highlighting specific new tech companies—compare it to the suburbs. Let’s take jet.com. They’re coming to the market. They are taking 120,000 square feet. You’re not seeing a lot of that happening in the downtown. I hope that changes.

WILMARTH: There are a number of technology tenants who have put their offices down here. What we haven’t seen is that big corporate headquarters come down here.

BOYER: I think it’s just overcoming all the typical challenges of downtown for a lot of the tech companies. It’s the usual issues of having to pay for parking, a higher cost structure. Your rents are just going to be a little bit higher. But the amenities are downtown. It’s a great place to be. If we could tilt over the edge with one or two tech companies that are 100,000-plus-square-foot users, it would really get the ball rolling, and then we would be viewed more. But right now there is still enough land out south in Lehi, where the cost structure is still much lower.

BLANCHARD: There is a catalyst to the downtown story, and that is the 3,000 new apartment units that we have and are under construction. Those people need jobs, and they are not going to commute to Lehi. They are planning to work, live and play downtown and go skiing on the weekends. So that’s your catalyst for driving a employer saying, “I want to be downtown because my workforce is a millennial generation who doesn’t want to buy a house in Herriman on a third of an acre with four kids.” They want to live here. They are out-of-staters looking for lifestyle and cost of living arbitrage between San Francisco. That is where your employers can say, “OK, I can lease space downtown and not need to fight the commute discussion about living in the suburbs.”

Now, if the apartments that all get developed here struggle, then that thesis might fall on its face. But the amenities continue to be developed downtown to support the theory that office would continue to be absorbed downtown.

DAHLSTROM: When you look at Goldman Sachs, that’s exactly the story. Those are the kind of people who want to have an urban living experience, and they are attracted to this.

BLANCHARD: Of every spot in Goldman Sachs, Utah is the second-highest requested office. So that millennial trend is bigger than anything going on.

DAHLSTROM: The thing that got Workday downtown is the fact that we’ve got this great transportation infrastructure. All points lead to Salt Lake City on the TRAX line. So 50 percent of Workday’s workforce comes in on TRAX or the Frontrunner.

The other point is we’ve had great success in building apartments in our urban area—3,500 new apartments in the last 10 years. There isn’t enough affordable housing in downtown. The fact that more people want to live in an apartment environment has driven up the price of all of the apartments. So one of the real big problems we have is there is not enough affordable housing.

The economists said the recession was over in June 2009, which means that we’re 91 months into our economic recovery. The longest recovery on record is 120 months. It’s not to say we can’t go farther than that, but do you find yourself waiting for that next cycle to arrive?

THOMAS: That’s the reason we’re in Utah. The economy here is a lot more recession-proof, it’s a lot more stable than other parts of the country. A lot of us are thinking much, much beyond 2017—the next three, five, seven, 10 years for the state of Utah. I don’t think anybody thinks this state is going backwards over that period of time.

I kind of hope there is a little bit of a recession. It tends to make things go back to fundamentals in the way that seasoned professionals operate. So I don’t want a recession, but…

BINGHAM: We moved here 15 years ago from Chicago, and there are few, if any, places better to have been in the last 15 years than Utah. The biggest challenge Utah has right now is complacency. We think we’re great, and we are, but so what? We’ve got to come up with the next idea, the next concept or the next improvement. Boise has got two Fortune 500 headquarters, and how many does Salt Lake City have? Zip.

We’ve got work to do. EDCUtah and GOED and all these other folks, frankly, they need to quit looking just at manufacturing spaces up in Box Elder County and start bringing financial headquarters to downtown Salt Lake City and let that radiate to the suburbs.

BOYER: The bigger concern with the state—it’s a great problem to have—is that our unemployment is down at 3 percent. As we go to recruit new businesses to Utah, they are taking a look at our unemployment and they are saying, “Who am I going to hire? I need to bring 400 jobs here, but who am I going to hire?”

BINGHAM: One of the things the state legislature did was $300 million toward education. Those are the kinds of steps that just have to happen. We’ve got a billion dollars toward infrastructure over the next four years. Those kinds of positive steps are going to keep us where we need to be. But we’ve got to keep at it. We just cannot let up.

CALLISTER-DAY: All of you work with big companies, and I’ve worked a lot more with the smaller retail companies, startups. I am feeling that people are really excited about starting their own businesses and getting going with that. I’ve felt that stronger than in the last 10 years. Everybody was kind of scared. I’m finding that there is a new surge for that, which is very exciting.

I see a lot of people that want to get out and take a little bit more of a chance on a smaller level than the large buildings and the large shopping centers. I’m really excited to see that happening. We’ll see how it comes together for 2017. I have several people who are just looking to start up new, maybe more unique and specialty-type companies. It’s been really fun to sit down with clients and listen to their ideas.

SHIELDS: We need to really push our quality of life. As we do things, part of the program is to recruit workers. We need to start talking to people. How do we do it? Through ad campaigns that say, “Have you ever thought about coming to Utah to work, this is the quality of life,”—to start recruiting people, even more than we do now, to come to the state so that people have more workers to hire.

MACKAY: One of our challenges, though, is that sometimes our legislature seems to stub its toe as it’s trying to do those very things. Whether or not you’re a supporter of Bears Ears being a monument, it got made a monument. Rather than the state being the champion of a whole industry that’s already here in our state—we talk about bringing headquarters, and we have a huge component of our industry that’s serving outdoor retailers—and for some reason we weren’t able to figure out, as a state, how to move forward with that issue, where you take an economically depressed area of the state and match that up with taking advantage of another monument. Until we figure out how to do those kinds of things, until we come out, as a state, and become the champion of some of these key issues—I don’t know if the bad press has impacted your hospitality guys, but I would imagine that we’re going to start seeing a real impact. We know there is a $40 million loss that we’re going to see in here.