Tax Act

Tax Act

COMMERCIAL REAL ESTATE by Jean Gruss | Editor/Lee-Collier

The rush to beat a tax increase in Lee County distorted the commercial real estate market and will result in a glut of empty space. Meanwhile, the highest taxes in the state on new construction in Collier County keep a lid on new development.

A dramatic increase in taxes on new construction last year spurred developers in Lee County to beat the tax-hike deadline. Because of that, they're building too much commercial space just as tenant demand has softened.

Meanwhile, in Collier County, with the highest taxes on new construction in the state, is creating the opposite effect. It costs so much in taxes to build a commercial building in Collier that the lack of new construction has created an economic moat for existing property owners that's driven rents and sales prices artificially high.

Call it government-induced market distortion. "They've created this monster," says Debra Johnson Shuey, regional director for Coldwell Banker Commercial NRT. "Everybody's kind of at a standstill right now."

The monster in question is what's euphemistically called "impact fees," a tax many Florida counties impose on new construction. Collier County has the highest such taxes in the state. The tax amounts to $49,000 per 1,000 square feet of medical-office space, for example. That's only enough space to fit four office workers.

By contrast, Charlotte County officials realized the depth of the downturn and they've suspended collecting taxes on new construction for a year. It's a move that could help the county's commercial market recover faster than its neighbors to the south.

The region's rents are likely to fall as vacancies rise, but experts are not sure by how much. "It's partly a function of how much the oversupply continues," says David Gee, associate appraiser with Armalavage Associates in Naples. Gee compiled data for the CCIM Real Estate Outlook Conference in Fort Myers on Jan. 22.

"If the slowdown is not that severe and it doesn't last very long, most landlords will try to tough it out," Gee says. "If the general perception is that the slowdown will be more severe and last longer, there will be a certain number who will lower asking rents and get a tenant in there paying anything rather than letting the space sit empty."

Lee County tax boom

In February 2007, the Lee County Commission raised taxes on new construction, in some cases tripling the taxes builders had to pay. For example, they raised the tax for new medical-office space from about $8,000 to as much as $24,714 per 1,000 square feet of space. The office-space tax rose from $2,705 per 1,000 square feet to as high as $7,724.

Developers rushed to beat the February deadline to avoid the tax increase, speeding up plans for new construction because the tax spike would make their buildings too costly to build. "That's the reason why everybody built when they did," says Shuey. "It was not out of need."

In late 2006, vacancies were still generally low and the economy appeared resilient. Developers and builders with plans on their drawing boards jumped to beat the tax deadline. "Everyone was looking at the same conclusion across all property types," says Gee.

The result: 4.6 million square feet of shops, offices and warehouses are now under construction in Lee County, much of them speculative. That's enough space to fill about 80 football fields.

Now, demand is weakening and some tenants are even walking away from leases. "There's been a lot of that happening among small contractors who were heavily dependent on the house-construction business," says Gee.

Some tenants are subleasing space because they don't need as much as before. It's hard to track, but CoStar Group data compiled by Armalavage shows that Southwest Florida's office vacancy rises from 8.8% to 9.3% when subleases are factored in. "There's more of it than I've ever seen," says Shuey.

How to fill space

With all this new speculative space under construction, brokers are wondering how it's all going to get filled with new and expanding tenants.

A look at industrial space shows the concern. The supply of existing vacant industrial buildings in Southwest Florida will total 1.9 million square feet this year, representing a four-year supply. In addition, another 1.2 million square feet is space are under construction, which represents slightly more than a two-year supply at the forecasted absorption rate of 550,000 square feet.

"Lee County is getting the bulk of this new space," says Stan Stouder, founding partner of CB Richard Ellis in Fort Myers and Naples.

Stouder says brokers may underestimate demand for new space and the picture may not appear so bleak. By removing the best year (2005) and the worst year (2007), the last seven years have averaged 1.4 million square feet of absorption, representing a more manageable two-year supply of existing space.

The office market may not become as overbuilt as some fear. "Because of construction, I think we've got about a year and a half of absorption," Shuey says. She points to continued population increase as a favorable trend.

The challenge is that only 47% of the new office construction is owner-occupied or pre-leased. The rest is built on speculation with the hopes that tenants will sign leases.

The retail sector appears particularly healthy with just a 3.4% vacancy rate. But a closer look at the data reveals that there is a 14.1% vacancy rate in shopping centers built over the last five years.

More worrisome is that demand for store space is declining just as new construction is booming, says Karen Johnson-Crowther, principal and director of retail services with Colliers Arnold in Fort Myers.

In her discussions with retailers, they reported to her that holiday "sales were down substantially." Women's apparel sales were especially disappointing, a major worry since women are generally the ones who control household budgets.

Still, Johnson-Crowther says some builders will hold off on construction of new shopping centers. Reports that 2.2 million square feet of shopping-center space is now under construction in Lee County may be overstated, she says.

Collier builds a moat

While Lee County struggles to absorb the new supply of space, Collier's high taxes have kept much new construction at bay. For example, only one-fifth of the projected supply of new office space in the region will be built in Collier.

That's led to some distortions in the Collier market, home to the city of Naples. For example, the average office rental rate is 15% higher in Collier than Lee. Medical-office space costs $24.18 per square foot to rent in Collier, a 34% premium over Lee, on average.

"I was surprised rates were not higher for medical when the impact fees are so high," says Shuey. Some brokers speculate that developers and builders are absorbing the cost of higher taxes and not passing them along to tenants who can't afford to pay.

Prices paid for office buildings in Collier have reached into the $800-per-square-foot range as high taxes have essentially created an economic moat for existing property owners. The median price for a Collier office building recently has been $256 per square foot. In Lee County, it was $159 per square foot, according to Armalavage.

Builders and developers are now eyeing Charlotte as an area of opportunity. Builders, architects and developers who once were busy with Naples and Fort Myers have opened offices in Charlotte County. "They have the least amount of space," says Johnson-Crowther.

MARKET SNAPSHOT

Retail/Shopping center

Rentable space Average shopping

Area (millions of sq. feet) Vacancy rate center rent*

Lee County 43 3.5% $17.12

Collier County 20.9 3.3% $21.31

Charlotte County 8.8 3.4% $16.63

Office space

Rentable space Average shopping

Area (millions of sq. feet) Vacancy rate center rent*

Lee County 13.6 8.6% $17.53

Collier County 7.2 10.1% $20.17

Charlotte County 3.5 10.8% $12.85

Flex/Industrial space

Rentable space Average shopping

Area (millions of sq. feet) Vacancy rate center rent*

Lee County 29.2 7.1% $8.12

Collier County 14 2.1% $12.30

Charlotte County 3.8 3.9% $7.80

*$ per sq. foot per year, net. Sources: CoStar Group; Armalavage & Associates

space advice

Commercial brokers say more space and lower demand will likely give tenants the upper hand this year. It's a switch from recent years. Here's some of their advice.

For landlords:

Sprits up your buildings. Give them a fresh coast of paint, tidy up the landscape, fix the fences.

Avoid raising rents and chasing tenants away.

Keep tabs on your existing tenants. Ask them about their business so you can be ready if they need to terminate the lease.

Know what your competition is offering.

For tenants:

If your lease is expiring soon, look at other options. Lots of building owners are competing for your business, so shop around.

Be a strong negotiator. Landlords are attracting tenants with concessions such as free rent, tenant-improvement allowances and other incentives.

Consider locking in a lower rental rate from your landlord in exchange for signing a longer-term lease. When the market recovers, deals will disappear.

REVIEW SUMMARY

Issue. Impact fee increases in Lee and Collier counties warp the commercial real estate market.

Result. A glut of commercial building in Lee; a shortage in Collier.