Real Deals

Real Deals: Lack of financing exacerbates tenants flight to nicer space

dbracken@newsobserver.comJune 12, 2013 

Over the past few years, the Triangle office market has been characterized by a predictable flight to quality.

After the recession temporarily wiped out demand for new office space, many tenants used the downturn as an opportunity to leave older buildings and get into new, better-located properties for about the same price.

While this shift happens at the end of most recessions, it has been particularly pronounced this time around.

The Triangle’s overall office vacancy rate was 16.5 percent in the first quarter, according to Karnes Research. The rate for so-called Class A space was 15.4 percent, down from 18.2 percent three years ago. The rate for Class B space, meanwhile, has risen from 19.3 percent to 20.7 percent over that same period.

Class B space, which accounts for 22 percent of all Triangle office space, now accounts for 28 percent of the region’s empty space.

Rich Harris, managing director at Synergy Commercial Advisors in Durham, says the flight to quality this time around has been exacerbating by the credit crisis that triggered the downturn.

Although most people talk about how tighter lending standards have prevented new office construction from taking place, it’s also being felt in other ways.

“It affects the Class B and C markets because nobody can really obtain financing to improve their building in any kind of meaningful way,” Harris said.

Without access to financing, many landlords of older buildings were in no position to offer free rent or money for renovations when their tenants began shopping around.

“When you don’t have access to that capital ... it makes it very difficult to do anything, including juiced deals for tenants,” Harris said.

In the past

Lack of financing was not a problem during the Triangle’s previous office bust, in the early 2000s. Back then, tech companies had committed to more space than they actually needed, leading to a building boom in and around Research Triangle Park. Landlords there were left scrambling when the tech bubble popped.

“Tech companies we’re really hit but the financial world was fine,” Harris said. “And we saw a lot of B and C owners in that downturn upgrade their properties.”

The current flight to quality, combined with the near total lack of new construction in recent years, has left the Triangle with very few blocks of Class A office space over 50,000 square feet.

Thus far the tightening market has not translated into significant rent growth. The average office rent in the Triangle was $20.61 per square foot in the first quarter, up 10 cents from a year ago, according to Karnes.

But landlords have been reducing free rent and lowering tenant improvement budgets as the market has improved.

The future

Harris said it’s hard to imagine a scenario where rents don’t rise in the Triangle, and a key driver is likely to be the performance of the new office buildings going up in Perimeter Park in Morrisville, Durham’s American Tobacco Campus and in downtown Raleigh.

“Once you have a couple of these build-to-suit buildings come out of the ground that’s typically where you see rent growth occur in this market,” he said.

Harris predicts that those projects will be fully leased by the time they open. That would be the clearest signal yet to all those sitting on the sidelines that the market has turned the corner.

For landlords, it may mean access to financing that will alow them to renovate their buildings and lure back tenants.

Bracken: 919-829-4548

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