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Kinzer Partners’ Look at Mid-Cap Office Product in the Puget Sound Sees Both Pullback and Opportunity in 2020

Kinzer Partners, Seattle, URM Mandates, Washington Park, 4th and Pike

By Meghan Hall

Navigating the Puget Sound commercial real estate market can be tough, even for firms with vast amounts of capital and plenty of credit to back them. However, just as important are mid-cap companies, those who occupy the not full buildings, but individual floors or spaces deemed too small by the region’s major tech firms. According to Adrienne Hunter, principal at Kinzer Partners, the 2020 landscape could hold both pause, and opportunity for investors, owners and tenants in the mid-cap space.

Kinzer Partners, Seattle, URM Mandates, Washington Park, 4th and Pike
Adrienne Hunter, Kinzer Partners

Adrienne, you have more than a decade’s worth of experience in the Puget Sound commercial real estate market. How has the market’s growth over the last economic cycle impacted the mid-cap companies you work with on a regular basis?

We work primarily with mid-cap office product ($10 to $50 million) so in that regard we are seeing a tremendous market shift on multiple levels:

A) Owners: Many individuals or smaller groups who have been interwoven in Seattle’s ownership history and who also tend to have a very low basis are considering selling. They are doing so not only to capitalize on unprecedented market growth, but also out of fear of future costs such as unreinforced masonry (URM) laws, increased taxes and the cost of improvements.  

B) Developers: As user demand increases in subsidiary markets, our developer clients are considering geographic areas and transaction sizes they haven’t considered in the past. They are also becoming more bullish in their rent pro-formas to justify today’s purchase prices. 

C) Tenants:Our tenant rep team works with all sizes of companies, from Fortune 100 companies to start ups. On the tenant side, significant growth in the market has pushed the small- to mid-size tenants (and some non-tech-related tenants) into secondary markets. This is a result of a combination of significant growth in some sectors pushing up rental rates, and not enough new product being delivered to help offset increasing rental rates. These companies have to contemplate how far out of the core they want to go and if it will negatively impact their business to do so. The impact of COVID-19 could swing the market back the other direction though, and it remains to be seen what the full effect will be.

While many commercial real estate headlines focus on mega transactions driven by firms like Amazon, Microsoft, Google and others, why are mid-market companies important to health of the local CRE industry?

There are many economic reasons mid-market companies are important to the Seattle CRE market. From an investor’s perspective, I would say one of the top reasons is that mid-market companies add diversity to the Seattle market. They employ less people than the mega tech companies and tend to occupy smaller spaces. This enables them to occupy buildings with smaller floorplates or those with partial floor availability, thus helping with market absorption and ultimately increasing overall rental rates. 

When working with mid-cap companies, what are some of the unique challenges or considerations that they must take into account to successfully navigate the regional CRE market? Why? 

We work with a broad range of groups who own office and land in a mid-cap price point. The owners that are most affected are the smaller-sized private ownerships. These groups are facing a number of challenges relating to potential cost increases, from excise-tax increases and proposed URM mandates they may not be able to afford, (even with a proposed government incentive program) to an inability to compete for quality tenants against new wealthier ownership groups that offer compelling incentive programs. Even with these challenges, the groups that have a very low basis heavily weigh the opportunity to sell against market availability for an exchange, and find it tough to answer: What’s next? What market could offer a suitable exchange opportunity if they did sell? And at what cost?

From an investor’s perspective we are seeing what by market definition is a non-core asset trade at core pricing. Mid-cap product in Seattle has become extremely competitive and investors who are looking to buy are not only submitting aggressive pricing, (underwriting extremely ambitious rental escalations) but are also attempting to do so off market – skirting the lack of marketed opportunities and competition. 

In your opinion, what were some of the most defining mid-market transactions in 2019?

There are two opportunities that come to mind and while the first stretches our $10 to $50 million mid- market definition, both are value-add office buildings in Seattle 

4th& Pike: This value-add asset in the CBD attracted strong interest from investors. Despite requiring a significant amount of capital for renovations, it traded at $568/SF (4.69 percent cap), core pricing and comparable to Park Place, a Class-A CBD asset which also traded in 2019 for $558/SF (5.00 percent cap). Core pricing in this asset class required an extremely aggressive market outlook and illustrates Seattle’s appeal to investors and the weight they are placing on its growth and upside. 

Washington Park: This off market, value-add transaction on the border of Pioneer Square and the recently demolished Alaskan Way waterfront was quietly marketed to a handful of groups. It ultimately sold for $259/SF, below market comparables for a building that has tremendous upside. This sale shows there are still value-add mid-market opportunities to be had in the area, which is why so many buyers are now aggressively pursuing off-market transactions. 

The first week of December of 2019 saw investment sales in both office and multi-family assets hit yearly volume records before REET laws changed in January of 2020. In your opinion, how has this impacted investment sales in the region thus far?

Given the volume of transactions that closed in late-2019 and implementation of the excise tax changes, we expected capital markets activity to slow slightly in 2020. This is what we’ve experienced. Sales volume has historically been slow in the first quarter, and this year is no different. The widespread outbreak of COVID-19 has amplified these trends and further dampened market activity locally in the last few weeks. How investors will react to the rapidly changing economic situation remains to be seen. We could see a slight pause as some investors pull back to assess the situation. Others could view the economic uncertainty as an opportunity to double down and acquire properties in one of the nation’s strongest markets.

What fundamentals do you personally track to measure the market? What do they indicate about where commercial real estate is headed in the coming 12 to 24 months?

Again, the timing of this question changes what would have been my response. Some of the larger landlords and institutional investors that were bullishly underwriting and pursing mid-cap assets in Seattle in early March are now distracted by the assets they currently own; modeling rent relief and finding ways to keep staff employed. My prediction is that, despite some of the lowest interest rates we’ve ever seen, we will see a slowdown in market activity until there are glimpses of economic stability. Once that occurs, I would expect a strong rebound.

In June of last year, you joined Kinzer Partners’ capital markets team after working for JLL in both Seattle and London. As you continue to grow into your new role, what are your goals? Why?

I started my career in Seattle and each time I’ve moved, I’ve furthered my career in real estate in a different capacity; first in tenant rep, then in strategic consulting within the EMEA market, and now in capital markets. Working with Stuart Williams and Alex Muir at Kinzer, we’ve fine-tuned an unconventional and consultative approach with clients. Lately, we have focused more heavily on the buyer side of our business – providing more consultative acquisition strategies for clients looking to invest in this market – rather than focusing strictly on ownerships and dispositions. 

As I grow in this role, I’m looking forward to working with our amazing team to build out a sophisticated platform that helps our clients target emerging submarkets and hidden opportunities.

What are you most excited about in 2020? Why?

The Kinzer Capital Markets division is an incredibly smart and capable group that really coalesced in the Summer of 2019. This year I am most excited about putting our unique plan into practice. In challenging and unpredictable times, finding the absolute maximum value for your client is exhilarating, and that’s what we aim to do.