Prepare for War?

Prepare for War?

COMMERCIAL REAL ESTATE by Dave Szymanski | Tampa Bay Editor

More than 1 million square feet of new office space will come on line in Tampa's Westshore market in the next

18 months, which may trigger a rate war.

Russ Sampson has seen the Tampa Bay area grow up the past 21 years through the eyes of a commercial real estate broker.

He has rolled up his sleeves, sold and leased property, and hired some of the brokers in the market today.

This is what he sees now: War clouds on the horizon.

Why? Office rental rates have hit a new high in Tampa Bay area, spiking at $32 to $34 a square foot. Those are Miami-like rates.

In the next two years, at least 1 million square feet of new office space will pour onto the market like a title wave of stone and glass in Westshore alone. The main projects are being done by Crescent Resources, MetLife and Rubenstein Co. In the case of MetLife, it's a mixed-use project that includes a hotel.

The office space number actually could go higher because of other projects being discussed in Westshore and downtown Tampa.

The result: A pressure to bring rates down as supply seeks balance with demand, plus a battle among building owners, brokers, construction firms, lawyers, public relations people, contractors, nearly everyone involved in commercial real estate.

If the economy rebounds more quickly, the war could be shorter. If not, it could be a prolonged battle.

"The question is, 'Will demand keep up?'" Sampson asks.

The answer: It is uncertain.

It takes two to three years to build a Class A office building. By the time it opens, the market has likely changed.

However, with this much confirmed space, under construction, something is likely to give. Leases will be rolling over, prompting tenants to look around. If the economy is sluggish, buildings will compete more for a limited number of tenants.

The slowdown in the residential real estate market has already affected commercial office space. That's because title companies, mortgage companies, brokers and homebuilders, which have a lot of office space, are vacating some of it and trying to sublease it, putting more space on the market.

"This could be a storm coming," Sampson says.

Pass-through costs

Part of the reason the market got to this point is because of increased pass-through costs.

About three years ago, roughly $7 of a $20-a-square-foot lease came from pass-through expenses, such as janitors, electricity, building maintenance, taxes and insurance.

When real estate taxes and insurance went through the roof in Florida, the pass-through expense rose 50 cents a square foot in 2005. The costs continued to rise, moving from $7 to $10.50 a square foot.

Meanwhile, buildings changed hands and sold for record prices. That encouraged new owners to boost rental rates. Soon buildings were leasing for $26 to $27 a square foot.

New buildings face yet another cost increase: Higher impact fees, which force developers to pay for infrastructure improvements.

With all of these upward pressures, rates hit $32 to $34 a square foot. Meanwhile economic growth slowed as the residential real estate market cooled off. The Tampa Bay area is expected to record 0% office space absorption this year.

Ray Sandelli, senior managing director with CB Richard Ellis in Tampa, is a little less concerned about rates, which he called "very reasonable."

"I think that the market fundamentally is in very good shape, as far as supply and demand," Sandelli says. "In order to have new construction, which we have sustained, you're going have to have rents at $30 a square foot or greater. It's a matter of what it takes to build those buildings. Those numbers, from a user perspective, are very reasonable and reasonable compared to other markets in the state."

Ron Ruffner, vice president of Crescent Resources, the North Carolina company that is developing one of the three major Westshore office buildings, says it's hard to determine what rates will do because it depends on how the economy recovers in the next two years.

Crescent has three other successful buildings along Boy Scout Boulevard, near International Plaza. Tenants include Outback and Bay Cities Bank.

"We're coming out at around $32 (per square foot)," Ruffner says. "We have a LEED-certified building. We've seen evidence that the market will support those rates."

New-building efficiency

When Crescent opened Corporate Center I in Westshore in 1999, it had been 10 years since a large speculative office building went up in Westshore.

Since then, parking ratios and floor plates had increased, offering a whole new tier of office building quality.

That tier of buildings commanded a higher rent. They offered better mechanical features, such as air quality, and larger floors to allow for better office layouts and better work flow. They had more amenities. That space is leased up. Some of the tenants came from 1988 Westshore buildings.

"There's a lot of functional obsolescence in that older product," Ruffner says.

Class A space that is 10 years old represents a submarket and may lease for $27 to $29 a square foot.

"With better work flow and better amenities you have happier employees," Ruffner says. "Studies show that people are more productive."

In Westshore's favor is the number of leases expiring, which will send tenants looking at new space, and Westshore's proximity to Tampa International Airport. Job growth peaked recently in 2005 and is now at less than 1% annually in the slowing local economy. That could also diminish demand and put pressure on to lower rates.

Tampa attorney Ron Weaver, who has worked with many developers, agrees with Sampson that the $34 rate will be tested.

"There likely will be a new dynamic," Weaver says. "The new supply will create downward pressure."

Weaver says there are plans and people interested in the Tampa market to add still another 1 million square feet of office behind the current wave.

"This is all on the hope that the glory days will hold somehow," Weaver says. "But people like new space. New car-itis is big."

As the market uses up land, redevelopment is happening more often in Westshore, most recently for the 160,000-square-foot Goodyear-Wachovia project, which Weaver helped rezone.

"We're seeing a lot of creative re-use," he says.

REVIEW SUMMARY

Company: Colliers Arnold

Industry: Commercial Real Estate

Key: A bulging office supply and slowing economy could force down lease rates.