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2018 will be one of the Triangle's busiest years for builders. Here's what's coming.

Gentrification in Durham: What is it and where is it

A decade of downtown Durham revitalization has raised concern about rippling effects of gentrification. Durham is changing, with construction cranes marking the city's skyline as new businesses and residents move in.
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A decade of downtown Durham revitalization has raised concern about rippling effects of gentrification. Durham is changing, with construction cranes marking the city's skyline as new businesses and residents move in.

Get used to the construction — it’s not going away anytime soon. And the new skyscraper you were just getting used to is going to be followed up by several more.

There are 2.6 million square feet of office space currently under development in the Triangle, setting 2018 up to be one of its busiest years for construction, according to real estate services firm JLL. That comes on the back of the 1.7 million square feet of office space delivered last year.

The Triangle is a “huge, growing market,” said Ashley Rogers, JLL’s senior research analyst in Raleigh. “What is driving that is tenants attracted to talent in the area where 47 percent of the millennials have a bachelor degree or higher. As tech and life science (companies) are looking at the markets with affordability — not everyone can afford the Silicon Valleys of the world — Raleigh-Durham is a good entry point.”

The Triangle is still relatively affordable when compared to some of its other fast-growing peers. Class-A office rents hover around $31 per square foot in the Triangle, which is cheaper than Charlotte, Atlanta, Nashville and Austin, according to JLL.

Since 2014, an average of 1 million square feet of office has been built each year, a rate that puts the Triangle on pace to exceed 50 million square feet of space by 2020, putting it on par with the amount available in Charlotte, said Paul Hendershot, director of research for the Carolinas.

On top of that surge in office construction, more than 13,000 apartment units are expected to be built by 2020 to absorb all of the new transplants attracted to the area for jobs. Local officials often cite the fact that 63 people are moving to Wake County per day and 20 to Durham. That growth has brought a lot of change to the area and will continue doing so for the foreseeable future.

Developers and landlords also expect the growth to continue. Highwoods Properties, a Raleigh real estate investment trust that invests and manages office space across the country, recently called Raleigh one of the strongest markets in the nation.

“Across our Southeastern markets, we've seen continued job growth, and real estate fundamentals remain healthy,” Highwoods Properties CEO Ed Fritsch said during an earnings call with investors earlier this year. “In particular, Nashville, Raleigh, Atlanta and our Florida markets continue to post some of the highest job growth and population growth rates across the nation, and there are no yellow flags suggesting these trends are going to reverse anytime soon."

After more than a year of construction, one of the pioneering developments on downtown’s west side has begun to take shape. A single element worth emphasizing about the design of The Dillon would be its view: expansive to the south from an outside

Back to the Burbs

Most of the recent growth has been concentrated in downtown Durham and Raleigh, two areas that have seen demand rocket and supply try its best to follow.

Downtown Durham’s vacancy rate was 2.6 percent of the first quarter of 2018, with more than 600,000 square feet of office under construction, and downtown Raleigh had a vacancy rate of 5.1 percent in the first quarter of 2018 with more than 260,000 square feet under construction, according to JLL. That compares to an overall vacancy rate of 10.6 percent for the region.

"You are seeing inventory explode in response to the downtown environment that (new businesses) have created," Hendershot said.

Several large-scale trophy projects are coming to downtown Raleigh, he added, including The Dillon, One Glenwood, the 22-story FNB Tower and the 20-story 400H on Hillsborough Street. That's also the case in Durham, where multiple office and residential towers are coming out of the ground, including the 27-story One City Center.

But all of the attention focused on downtown has caused land prices to soar. Boston-based The Fallon Company recently paid around $9 million per acre in downtown Raleigh, and Hendershot said it wouldn't be surprising to see office rents in downtown rise to $36 per square foot this year.

OFFICE RENTS.JPG
How office rents in downtown Raleigh compare to its peer cities. Courtesy of Downtown Raleigh Alliance

There's going to be a "bit of sticker shock as this market continues to innovate and see growth," he said.

As that sticker shock takes hold, expect developers to begin moving more of their money to the suburbs where land is cheaper. Emily Bostic, a multifamily analyst for Colliers International, said investor money is already heading out of the downtowns and into places around Cary, Morrisville and west Raleigh.

“There’s going to be a lot more development and investment in suburban (areas), because of increased construction costs and land prices that are exorbitant,” she said. “The market will remain strong — with really low vacancy rates and high absorption rates — but construction is going to slow" after this year.

Rogers, of JLL, said that is also the case for new office supply.

"Demand in the suburbs is still there, and rentals rates are responding," she said. "You can still price yourself at $27 and $28 per square foot, so you can compete with amenities in downtown."

She added she expects to see see more "pseudo-urban campuses in suburban environments" be built going forward, similar to what John Kane has accomplished in the North Hills area, which is expected to add another high-rise in the coming years.

But it's also the case that the Triangle will always be a suburban-heavy market.

"What makes Raleigh unique, compared to Charlotte for example, is that we have 48 million square feet of office inventory, and the downtowns are only" around 15 percent of that total, Hendershot said. "Charlotte is more of a 50-50 split."

"Everyone wrote suburbia off as dead this entire cycle," he added, "but, if you look at a place like Raleigh you see a great blend of an urban core with vibrancy, but also the ability to offer suburbia with higher life quality, better schools and more affordability."

Is a slowdown on the horizon?

In terms of the activity for residential units in the downtown areas, this flurry of construction might be the peak for some time, especially in the downtown areas.

“I think we are reaching our peak in terms of construction numbers (for multifamily) in the next year,” Bostic said, noting that already permit totals have dropped by 1,222 in the past three quarters. “You are just running out of space in the downtowns, especially in downtown Durham."

The increase in supply is expected to be so strong this year and early 2019 that she expects rents to plateau. Construction won't pick up again until rental rates begin growing significantly again, she said.

"We are seeing a slowdown in construction, which we expected, but that doesn't mean the market is going to take a dive," she said because the demographics are so good.

For both office and multifamily, the rising costs of land, labor and lending costs could naturally dampen the amount of new development the area will see in the coming years. Already some forecasters are predicting a drop in the number of projects built on speculation.

“Steady increases in construction costs and a measured lending environment for speculative projects gives us comfort that we're not likely to see a rise in the volume of speculative development in 2018,” Fritsch of Highwoods Properties said in the earnings call.

But overall, these are good times in the Triangle, where wages and demographics are strong. Any decrease in growth will likely be gradual, Hendershot said.

“If you look at the fundamentals of the U.S. economy, everything is pointing in the right direction,” Hendershot said. “I don't foresee something like 2008, or 2000 with tech collapse. If we do see some headwinds from interest rates and construction running full employment, we are in for a shallow, soft descent not a collapse.”

Zachery Eanes: 919-419-6684, @zeanes
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