By Jack Stubbs
At the turn of the year, many companies are trying to keep a pulse on trends in the industry that might give an indication of what lies ahead.
We recently spoke with JJ Shephard, managing director with JLL’s Seattle office, about current trends in the commercial real estate market and what these might indicate about the strength of the market in the upcoming year and beyond.
JJ Shephard’s specialities include agency leasing and capital markets and he also represents a variety of companies including Fortune 500 companies and local startups. JJ has been involved in more than 800 leasing transactions totaling over 5 million square feet and in excess of $800 million of sales transactions.
JLL (Jones Lang LaSalle) is a professional services firm that specializes in real estate and investment management. The firm’s teams provide integrated services to clients seeking increased value by owning, occupying, developing or investing in real estate. As of June 30, 2017, the firm had $59 billion of real estate under asset management.
Looking in the rearview mirror, how did 2017 shape up based on your expectations at the beginning of the year?
Office market trends generally followed similar themes to 2016: strong demand, a very active construction pipeline and tech firms dominating activity. Demand for space (net absorption) ended 2017 at 4.1 million square feet, compared to 2.4 million in 2016. In short, the Seattle-Bellevue markets are still very active with over 150 tenants in the market looking for a total of 8.9 million square feet. 60.3 percent of these office requirements are from firms in the tech/software space, which can be seen as a further indicator of Seattle’s status as a critical tech hub nationally.
Were there any trends in particular in the commercial real estate market that surprised you in 2017, and do you think these trends will continue into 2018?
The diversity in tech tenants entering the market has expanded. Historically, Seattle has had a few prominent companies at the forefront of the business landscape, but office users have diversified in the tech space.
F5 leased 100 percent of the F5 Tower in the Central Business District in what is now a globally representative skyscraper of the Seattle market. Both Facebook and Google, as well as other tech companies, developed stronger presences here. Given the number of tenants in the market in both Seattle and Bellevue, we expect these trends will continue through 2018.
Were there any significant deals that shaped the market in 2017? What did these deals reveal about the strength of the markets in Seattle and the greater region?
The F5 Tower deal reveals the demand for Class A space amongst high profit margin industries, including tech. This building was entirely leased by a firm that is leveraging quality office amenities to compete for tech talent. We have seen several of this kind of major transaction across the market, with both developers and firms looking at full building opportunities.
Additionally, foreign investment fell significantly from the peak in 2016 as domestic groups carried the transaction volume in 2017. However, this was not due to a lack of interest. According to the Association of Foreign Real Estate Investors, Seattle was the seventh most desirable city to invest in globally, behind only New York City and Los Angeles. The sale of Tilt49 to the Japanese investment firm Takenaka Corp at $926 per square foot represents a significant deal in 2017 and is indicative of strong foreign investment demand.
How did the strength of the Seattle market compare to that of the Eastside in 2017? What are some of the factors contributing to the trajectories of the two markets (in terms of overflow, cost, etc.)?
We are seeing equilibrium between the core Seattle office markets, encompassing CBD and South Lake Union, and the Bellevue CBD. These markets are showing rental convergence at around $44 to $45 per square foot, which is indicative of concentrated urban development in both Seattle and Bellevue. Tech tenants value creative office space and proximity to talent, driving development concentrated in urban environments that are adjacent to hip neighborhoods like Capitol Hill, Ballard and Fremont.
For the Bellevue CBD, the development of light rail across Lake Washington will allow new office towers to attract tech workers from Capitol Hill and potentially allow tech firms based on the Eastside to compete for talent based in Seattle, which has otherwise been hindered due to traffic congestion and lengthy commute times.
In your view, what were some of the factors that drove demand for office properties in Seattle and the greater Puget Sound region in 2017? Is supply and inventory constrained right now, and what impact will this have on demand overall?
The key factor underlying the development cycle is that the Seattle-Bellevue market has an incredibly educated workforce with a comparatively affordable cost of living over other tech cities, notably the Bay Area. While housing affordability is certainly the number one public policy issue in the region, new jobs being created by tech firms are attracting workers who find living in Seattle affordable. We are tracking San Francisco firms aggressively expanding their Seattle footprint due to this reason.
In terms of supply, our current development pipeline shows that there are 5 million square feet under construction, with 1.7 million square feet due for delivery in 2018 and an additional 2.3 million square feet in 2019. A strong indicator of future demand for office space is studying the pre-leasing trends of new development. We currently estimate that 48.9 percent of the 4.9 million square feet of office space in development has already been leased. As such, we are watching closely how this will affect rents in the new Class A development
Speaking of demand, I suspect you track tenant demand in markets across the region. How large is it? How many tenants are looking for space over 50,000 square feet and over 100,000 square feet? How does this compare to say last year or the year before?
We are tracking a total of 150 tenants totaling 8.9 million square feet of requirements, including nine users over 100,000 square feet and a further eight users between 50,000 square feet and 100,000 square feet. At this time last year, we were tracking eight tenants over 100,000 square feet and nine tenants between 50,000 and 99,000. This is indicative of the broad trend we experienced over the past couple of years and expect to continue into 2018.
Looking at the year or two ahead, do you think most of the growth of the Seattle and Eastside markets will occur organically (i.e. from the expansion of already-established companies here) or from newer companies entering the market?
It is a mix of both. More Bay Area tech firms will move into the market with established firms, such as Google and Facebook, likely expanding footprints in both Seattle and the Eastside. Additionally, we are seeing migrations and expansions from up-and-coming startups from both California and other states, which contributes to the sustainable development pattern we are seeing in Seattle currently.
Where do you think leasing rates will go in 2018 in relation to last year? Do you think they will flatten out or continue at a steady rate? Do you predict landlord incentives increasing in the coming year? What factors might drive these changes?
The Seattle-Bellevue market favors landlords and concessions will likely stay low for 2018. Rates continue to rise as leases from traditional office users expire and are taken on by firms in industries with higher profit margins. The Seattle-Bellevue rent market overall is a bit artificially depressed because of the number of full building leases by single tenants rather than multi-tenant structures seen in other markets. That will change as more and more leases transition from traditional users to tech users.
What are some of the numbers and trends that you track, personally, that give you a sense of the current state of the market? What might these figures indicate about the year ahead?
Cranes are a great leading indicator of economic development in any mature economy. Seattle is leading the nation with 58 cranes, 60 percent more than any other top city. Another good way to measure the health of an economy is the number of migrants. In the past year alone, some 35,000 people migrated to King County, again showing the strong economic fundamentals underpinning the current cycle of office development.
Lastly, given how much of this growth is fueled by tech, it’s always a good idea to keep tabs on tech worker employment. Seattle currently has 121,000 tech workers, which is larger than even San Francisco’s 89,000 strong tech workforce. Seattle’s tech workforce has grown at an annualized 4.8 percent over the past five years, [which] provides further context to the current development boom.
Does 2018 represent any unique challenges to years past?
Many of the challenges facing the Seattle-Bellevue office market are external forces. Public policy that concerns how Seattle pays for affordable housing could temper development, coupled with LID [local improvement district] taxes associated with the redevelopment of the Seattle waterfront. JLL monitors these challenges carefully to guide our clients to the best outcome based on how current and proposed legislation could impact real estate decisions. Moreover, there is a talent shortage, so despite the intense demand from tenants for Class A space, there may not be enough workers to fill those new office towers.