Home Commercial NAIOP Panel Sees Continued Strength in Puget Sound Market

NAIOP Panel Sees Continued Strength in Puget Sound Market

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As the nation reels from the recent activity in Washington, DC and the new administration, one thing seems for certain, according to a panel of expert commercial real estate professionals in Seattle, the Puget Sound region remains one of the most attractive markets in the country if not the world.

The event held last week titled Capital Markets, Are We Headed for a Correction, organized by NAIOP Washington State, packed a room at the Four Season’s hotel in Seattle for its annual industry overview breakfast. This year’s panel included Michael L. Wood, principal with Norris Beggs & Simpson Financial Services who moderated the event; Dean Rostovsky, an equity owner and acquisitions officer at Clarion Partners; James Payne, head of commercial real estate lending at U.S. Bank in Seattle; Tom Pehl, senior vice president at CBRE in Seattle; and David Young, managing director & west coast lead for JLL’s multifamily group in Seattle.

When you look at the overall health of the Seattle market in terms of credit quality, it’s hard to find a market in the U.S. that has a better inherent credit quality

“I think most would argue that we’re probably in the later stage of the cycle. Here in Seattle, we’re in the very earlier stage than other parts of the country. I think we’ve got a tremendous runway,” said Payne, who provided an overview on the market from his bank’s perspective and how U.S. Bank views the Puget Sound region to the rest of the country.

Overall, the banking industry has been on an upswing since the election in November. Payne cited the KBW Bank Index, an economic index consisting of the stocks of top 24 banks in the country, which had increased by 60 percent since November. The increase was a welcome sign by the banking industry that sees the new administration’s promises to dismantle regulation like the Dodd-Frank Act as well as the expected interest rate increases in 2017 as a sign of confidence in the sector. “We do expect interest rates to rise, at our bank we do expect two rate hikes this year, one in the summer and one in December,” Payne added, which would would serve as “jet fuel” for the baking industry. “That’s a good thing if interest rates continue to rise.”

Not everyone in the room shared that sentiment, but there was agreement that the region still had room for growth.

“If you exclude Berkshire Hathaway from the list of top five most valued companies in the U.S., your top five companies are Apple, Alphabet (Google), Microsoft, Amazon and Facebook,” Tom Pehl said. “So run through that list, and two of those companies are headquartered in Seattle, and two more have their largest presence outside of their headquarters (Google and Facebook) in this market, as well.”

Given those dynamics, he added, the region is doing even better than the Bay Area, because so much of the occupancy in Northern California is driven by venture capital-funded companies. The majority of these start ups are not publicly traded and there is very little, if any, visibility in their financial health or profitability. Conversely, the creditworthiness of tenants in Seattle and the region is very strong, and investors value that.

“When you look at the overall health of the Seattle market in terms of credit quality, it’s hard to find a market in the U.S. that has a better inherent credit quality, and we think that’s one of the reasons that investors like it,” Pehl concluded.

Dean Rostovsky of Clarion Partners who works out of the firm’s office in Los Angeles sees similar dynamics impacting the Puget Sound market. He compared the sprawling Southern California market and the one in the Puget Sound region, “One of the contrasts, you’ve got new, high quality office buildings leased full term to great credit tenants. We (Southern California market) actually, broadly speaking, don’t have that, and we almost don’t have the offerings that you have in this part of the world.”

That, in essence, was the main reason investors are willing to pay top dollar for assets in the Puget Sound market, even if they believe the market is nearing the top. “What I’ve seen earlier in the cycle, is that when things get volatile, it’s not so much that pricing adjusts, although it does in some lesser quality segments, but the quality band gets narrower. So, investors say, ‘OK, I’m just going to be a little more cautious, but I’ll still go and pay a mammoth price for something that I think is great and insulated,’” he said. “Some of the Amazon trades are an example of that, because you’ve got so much term, that you don’t have to worry.”

Of all the product types, industrial was one that all the speakers would agree still had potential for additional expansion in this cycle. “Industrial is not just going through a cyclical expansion, but it’s got a structural overlay,” said Rostovsky. These changes are actually making the current inventory almost incapable of delivering the services of a modern technology firm. “We’re changing our logistics pattern. We’re changing how we distribute, we’re changing the types of buildings we distribute out of. Some of the buildings we’ve had in our industrial inventory have become if not obsolete, less valuable to tenants,” he concluded.

Rostovsky and Clarion measure a 2.1:1 ratio in square footage demand to supply for industrial assets, over the last 4 years nationally. That compares to 1.7 times in office, 1.5 times in retail and 1.3 times in apartments. This is where he sees additional growth.

Pehl agreed. On industrial, his firm tracked record sales volume in 2016, and that record would have been higher if there was more product to buy he said. “There is an amazing abundance of capital trying to buy industrial, especially in key markets like Seattle,” Pehl said. Record low vacancy at 4 percent, and record rents are at above $0.60 on the shell, he added. “This is the wind in the sails for the investors.”

And in Seattle proper, the multifamily sector continued its strong showing. “We continue to deliver units, and they continue to get absorbed,” said JLL’s David Young. Vacancy actually declined as the market delivered units, he said, which was driven by a record amount of jobs in the region.

However, 2017 will be our first test year, Young said. Additional inventory will be delivered, and he is afraid that buildings may start to add concessions, lowering asset profitability. “2017 is the test year. We at JLL believe that we will have some concessions in the market, but that is something like a month free on a nine month lease, so nothing. Vacancy will stand around 5 percent, plus minus right there,” he added.

Yet challenges will remain in the market, and the effects of an affordability gap will continue to loom in the city. Although Payne said his bank is still very bullish on the multifamily sector. “There’s really no real red flags that we see … here [in] Seattle. We’re not too worried about the supply in the multifamily side. It’s being absorbed. I think the question is just how deep is that market and what the runway is,” he concluded.