By Meghan Hall
Although the commercial real estate market is at what many consider is a more mature phase in this economic cycle, investors and developers are churning out projects at their highest rate yet, according to a second quarter office report recently released by brokerage firm Marcus & Millichap. However, while office deliveries are anticipated to reach their highest level in ten years in 2019, Marcus & Millichap predicts that the Seattle-Tacoma office market will remain tight as companies continue to pre-lease large blocks of space.
5.9 million square feet of office space is expected to come online during 2019, compared with 2018, when just 800,000 square feet of space was delivered. 900,000 square feet of space was delivered during the first quarter alone, and an additional 7.6 million square feet will be under construction by the end of the year, with deliveries scheduled into 2022. The ramp-up in construction, states the report, is in part due to how quickly tech and life sciences companies are taking up space throughout the region. This year alone, 1.1 million square feet of office space is expected to be finalized at Amazon’s Seattle campus; the company has also committed to 1.5 million square feet across four buildings in Bellevue’s Central Business District. Facebook is also making its mark in the region. The Menlo Park, Calif.-based company has leased the Arbor Blocks Building, a 900,000 square foot campus in South Lake Union also set to open this year.
Despite the amount of office space that has come online over the past several years, the Seattle and greater Puget Sound region remains one of the tightest markets in the country, compared to other major U.S. markets. Last year, vacancy in the region plummeted by 230 basis points; with vacancy rates in the cities of Bellevue and Seattle reaching 6.4 and 7.1 percent, respectively. This is despite the completion of roughly 11 million square feet of office space in Seattle over the course of the past five years.
Ultimately, the surge in inventory this year is likely to outweigh absorption, resulting in a 20 basis point increase and an increase in vacancy rate to 7.8 percent, Marcus & Millichap predicts. However, high demand for inventory — any inventory — is still high, and rental rates are expected to continue rising. The average asking rent is expected to jump to $36.13 per square foot by the end of the year, a 4.6 percent increase. Rents in the Puget Sound will still remain lower than other regions, such as the Bay Area, and will continue incentivizing many companies to move or continue expanding in the region.
In addition, the local economy is expected to continue to grow; job growth is expected to grow by 2.9 percent in the region, compared with the U.S. average of 1.3 percent. The Puget Sound region also allocates more office space per square foot per worker, with each individual employee using 322 square feet of space. The U.S. average is less, at 215 square feet per employee. Both fundamentals indicate that the region will continue to see steady demand for office space.
This bodes well for investors who are keen on maximizing their returns in the Puget Sound market. Marcus & Millichap states that the surge of construction means there is plenty of product to trade, which has attracted many international and out-of-state investors to the market. Newly delivered Class A properties preleased by expanding tech companies are expected to trade above $900 per square foot and at cap rates around four percent, according to the report.
Assets in Seattle’s downtown core, Kirkland and Lake Union neighborhoods were traded most frequently. However, improving economic conditions in the region’s suburban markets, plus solidifying plans for transportation links in Snohomish and Pierce counties, are increasing investor interest away from core markets, especially for Class B and Class C properties that will yield a higher rate of return. Marcus & Millichap states that older Class B/C buildings with less than 30,000 square feet will trade for less than $200 per square foot, but with cap rates in the seven to eight percent range. Additionally, the excise tax on sales over $3 million will increase to three percent, up from 1.78 percent in 2020. The rise could motivate owners who have been reluctant to sell to place their properties on the market, increasing the number of properties available to trade in the coming quarters.
Marcus & Millichap did not respond to The Registry’s request for comment in time for the publishing of this story.