Information contributed by Shawn Langan and John G. Ruhl of NAI Ruhl Commercial
The office market remains stabilized both nationally and regionally. Nationally, new product has been constructed in larger markets with employment growth driven by the tech industry and the financial services sector. Markets without a technology employment component have not enjoyed as much growth in office space development and lease-up unless they have specific new employment entries to the market.
Nationally, overall vacancy is in the range of 13%, according to National Association of Realtors published statistics. This still is considered a healthy market as there is an adequate supply of space for a tenant to have options when considering a new space. However, it is not enough vacancy to define the market as a “tenant’s” or “buyer’s” market in which landlords must compete aggressively or lower pricing to attract tenants. In fact, in many markets we are
seeing a modest price increase. Nationally, lease rates have increased by greater than 11%. This is driven primarily by higher pricing as new construction fulfills the demand and new construction costs continue to rise.
From a regional perspective the office market is stabilized. There is limited vacancy in the Class “A” market class. The Quad City Area Realtor Association reports a vacancy of 13% but this is in large part based on future “proposed” projects which are still speculative and yet to be constructed. A more realistic vacancy rate would be in the neighborhood of 8% of actual existing product that is immediately available.
Class “B” product, which is considered well located and of good quality, is very much in demand. There is an abundance of Class “C” type space which would be defined as older construction, somewhat dated in appearance and perhaps not in as strong of a location. Tenants in previous years have taken advantage of softer markets and upgraded their locations into Class “B” facilities at attractive prices and have vacated Class “C” facilities creating the vacancies.
Owners of Class “C” type space have responded by offering more healthy tenant fit-out allowances to attract tenants. Some have made the decision to sell properties to entrepreneurial investors willing to upgrade the properties or to businesses moving out of a lease scenario into an owner occupied situation as a budgetary or financial strategy by business owners.
An important trend that our commercial real estate professionals have observed in the regional market is office size. We have seen the average office transaction compress in size significantly over the last three years. The
average office lease size in 2013 was 3,842 square feet. This average has dropped incrementally and our 2016
average market size in the Quad Cities is down to 2,639 square feet. This trend is occurring nationally. We believe
that this significant change is due to a combination of factors including companies being very mindful of
occupancy costs, more people working remotely or from home, more open office configurations with less
“hard wall” offices and less people doing more work, in general.
A major motivator for companies considering new and different space is attraction of bright young talent.
Research suggests that one of the biggest factors that young professionals consider when choosing an employer
is work environment. Savvy employers have recognized this and are responding with workspaces that possess a
“cool factor” in order to give them an edge in today’s competitive recruiting environment. Location also is key to
attracting young professionals. In major metro areas, there has been migration by tech and even more mainstream
businesses back to downtown and more urban locations from suburban locations which most companies flocked to in the late 90’s and early 2000’s. Young professionals are attracted to vibrant downtowns with interesting dining, drinking, shopping and entertainment options. Close proximity to amenity rich and unique housing options
also lessens the need and expense of owning a vehicle.
Medical office space continues to be a bright spot in the office market both locally and nationally. Changes driven
by the Affordable Care Act and competition among hospital systems are both factors causing this activity. Due to changes in styles of medical specialty practices, many medical users are constructing new office facilities versus
leasing existing product in order to design their facilities for efficiency and to secure locations that are close and convenient for their patients. Existing medical space is still in demand but landlords can anticipate having to update space and likely make floorplan changes in order to attract quality medical users for reasonable lease terms.
Genesis Health System announced a third HealthPlex facility in the Quad Cities. The $8-10 million dollar facility, which will be similar to the HealthPlex facilities in Bettendorf and Moline, will be constructed at the corner of West Kimberly Road and Elsie Avenue. Groundbreaking is anticipated to be in July of 2017. In an article published in the Quad City Times, Genesis’ Ken Croken described the facility as a “one stop shopping” approach to healthcare.
Croken went on to say, “we believe that consumers want more consolidation of services in single locations.
The current plan calls for lab services, imaging, physical therapy, primary care, and it’s still up in the air whether
there will be an urgent care office, which we call convenient care.” This project is a prime example of the wave of change that is ongoing nationally and locally.
There were 116 office leases completed in 2016 for a total of 306,217 square feet according to the Quad City Area
Realtor Association Multiple Listing Service. This is a 41% decrease over 2015. Total dollar volume of office leases and sales was $46,700,108 in 2016, down 49% from 2015.
Office lease rates in the Quad Cities remain stable and have experienced modest growth in the Class “A” and “B”
market segments with slight erosion of lease rates in the Class “C” segment. There are several factors in play that
have an impact on pricing. The first is supply and demand. The Class “A” and “B” office segments are in “balance,”
suggesting that Landlords are able to negotiate lease rates fairly close to their “asking” or “quoted” lease rates
without having to offer greater than standard tenant inducements such as free rent for a period of months or
greater than market finish allowances. Landlords also are negotiating annual rental increases of 2-3%. There are
new transactions that have occurred providing fresh comparable data to appraisers, brokers and landlords thereby
justifying increased pricing in the marketplace.
Looking forward, landlords should prepare for the need to subdivide larger spaces to keep their properties
occupied as we expect that the trend for smaller footprints will continue. This is not to say that we won’t continue
to see tenants with larger space needs but it is anticipated that the larger tenants will be less common and will be
pursuing open floorplan type concepts.
• Lock in lease rates for longer terms as rents are likely to increase over the years to come
• Negotiate options to renew with your primary lease negotiations in anticipation of market lease rates being higher in the future
• If possible, negotiate flexible floorplans and options to expand or contract square footages to adapt to changing work styles of employees going forward
• Consider location and amenities carefully in order to position your company to be able to recruit bright young talent
• List, market and negotiate based on current rental rates. Consult your NAI Ruhl Commercial real estate professional for the latest comparable market data
• Take advantage of today’s low interest rates to refinance and finance smart improvements to update your property to accommodate today’s changing working styles
• Negotiate 2-3% annual rent increases in today’s improved market in order to enhance cash flow and property value
• Consider selling Class “C” type properties to entrepreneurial investors willing to invest capital into the property to re-position and improve the property or consider selling to owner occupied type investors