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Suburban office space absorption headed for positive range; industrial in expansion mode

McCullough

By TED CARTER

Tenants of metro Jackson’s suburban office market are expected to begin filling up space at a pace that exceeds new vacancies, an outcome the market failed to achieve two of the past three years.

Credit a 10-year slowdown in new office construction for increased prospects that net absorption will move into a positive range and stay there for at least a few years, Integra Realty Resources Inc. said in its 2020 Viewpoint report on the metro and Central Business District office markets. The two markets began the previous decade with an inventory of 26.1 million square feet and ended it at 26.9 million square feet. A recent slide into negative net absorption began in 2017 with 185,243 square feet left vacant and another 96,678 square feet remaining empty in 2018, Integra Realty Resources’ market survey found.

Absorption is the difference between vacant space in a previous tracking period and the current available space.

A rebound to 145,506 square feet into positive absorption occurred last year but Integra sees negative absorption of 17,707 square feet for 2020. That should be the last venture into the negative range for at least the next four years, though none of the annual positive absorptions totals is expected to rise above 50,000 square feet, Integra said.

Ahead for the suburban market are decreasing vacancy and stabilized leasing rates, the report says. By contrast, the stagnation that has marked downtown Jackson’s occupancies and lease rates for the last decade is expected to remain, Integra Realty Resources said.

“The recovery of the suburban office market has been spurred along by a significant reduction in the number of new office buildings constructed since 2009,” reported Integra, a national commercial real estate valuation and consulting firm with an office in Ridgeland.

On the negative side, metro Jackson’s Central Business District “remains in the third phase of a recession,” said Integra, citing a failure of downtown Jackson to edge up either occupancies or lease rates.

Addressing the flexible warehouse and industrial market, Integra’s 2020 Viewpoint predicts the new distribution and supplier facilities built in support of Hinds County’s $1.5 billion-plus Continental Tire plant will make up most of the new supply of industrial space over the next 12 to 24 months.

Integra noted it has seen enough revived growth in the industrial sector to say the first phase of an expansion is under way.

“Positive absorption is continuing, and lease rates have remained stable,” Integra said in its annual market survey report.

Fewer Vacancies, More Options

Just how positive is absorption for Class A office space?

The last decade closed with The District at Eastover’s newly constructed five-floor, 120,000 square-foot multi-tenant office property with adjoining garage building 100 percent leased, Integra’s report noted.

A proposed 95,000 square-foot building just east of the Highland Colony Parkway is 90 percent pre-leased.

In the meantime, strong market prospects have led developers to propose a 40,000 square-foot multi-tenant building with a parking garage in Ridgeland along Highland Colony.

In addition, Highland Colony is set to gain several new office buildings at its intersection with Mississippi Highway 463.

“New supply will keep lease rates stable as occupancy rates are controlled by new supply,” the Integra report said.

As strong as absorption rates are expected to become, Integra’s 2020 forecast is for an 8.1 percent vacancy rate for metro office space. But after 2020’s negative net absorption,  the metro market won’t see  negative territory for at least the next three years, according to Integra.

Net absorption is forecast to grow positive by 9,159 square feet by the final quarter of 2021, Integra says.

The positive absorption is projected to continue through 2024, with tenants leasing 20,615 square feet above new vacancies in the fourth quarter of 2022; 24, 260 in 2023; and 32,732 in the final year of the forecast.

Those projections show strong improvement for the metro market from the start of the previous decade and the accompanying pain of the Great Recession. The fourth quarter of 2010 ended with 262,613 square feet of product above net absorption, a circumstance that led to a drop of 5.47 percent in asking rents and 10 percent vacancy rate.

Rebounds for absorption began the following year and continued through 2016. Whopping net absorption of 527,197 square feet occurred in 2014. The next year’s net absorption totaled 308,053 square feet, according to Integra.

Absorption went negative in 2017 and 2018, with 185,247 square feet left vacant in ’17 and 96,678 square feet in ’18. The market returned to positive absorption in 2019, with 145,506 square feet absorbed above new vacancy inventory. 

Today, the suburban market for Class A office closely parallels the rest of the South and nation, with landlords getting an average of $27 a square foot, compared to $26 for the region and $28 for the nation. Metro Jackson’s suburban Class B office space rents of an average $19 a square foot fall slightly behind the region, $20; and nation, $21.70.

Metro suburban capitalization rates – a measurement of risks in a deal derived as a ratio between net operating income and the value of the retail property – average 7.5 percent for Class A and 9 percent for Class B, surpassing both the region and nation in both categories.

Meanwhile, the 8.3 percent cap rates for Central Business District Class A space significantly surpass a cap rate of 6.7 percent for the South and nation.

However, Class A and B asking rents for the CBD are well below the region and nation at $20 and $15, respectively.

So are the CBD’s vacancy rates of 26.8 percent for Class A and B. CBDs in the region show vacancy rates of 15.2 percent and 15.8 percent for the nation.

Tenant Shuffles

Meanwhile, net office space absorption may increase, but commercial real estate broker Micah McCullough attributes that mostly to tenants shuffling around the metro’s 26.9 million square feet of office space, a recent example being Horne CPA’s exchanging of 80,000 square feet at the Butler Snow building in Ridgeland for 60,000 square feet of a 90,000 square-foot building it built nearby.

And, he said, it’s not like office jobs are growing on trees to create demand for more space. Nor is it a plus for landlords that the average space devoted to each office worker has dropped from 300 square feet to 200 square feet, noted McCullough, vice president and associate broker at NAI UCR Properties in Jackson.

“It’s a tenants’ market and probably will always be until we can find a way to produce new office-producing jobs,” he said.

As well as the Class A market is doing, said McCullough, it is hard to make money in a locality with low-to-no rental rate growth and rising construction costs.

With leverage belonging to tenants, the term “as is” is seldom heard in lease negotiations, the broker added, and lamented that landlords continue to have to invest $30 to $40 a square-foot in tenant space every five years. “It’s really hard to make money, at the end of the day,” he said, and added:

“If there was never another office building built in Jackson, it would probably be fine.”

Like McCullough, Jackson commercial real estate broker Scott Overby sees a suburban and CBD office market dominated by a lot of moving around, not new product.  “We’re just moving pieces of the pie around instead of growing it,” said Overby, principal of The Overby Company.

Overby said the “musical chairs” in which tenants are engaged makes sense for them. Long-term tenants don’t like the disruptions of renovating while still in the space. They also follow a natural tendency to want new quarters after 10 to 15 years. “You ask, ‘Where is the next location we can go?’”

They typically find new landlords willing to do the work to make things ready for a move-in, Overby said.

Some Activity for Industrial

Flex warehouse has been a slumbering workhorse but is showing signs of responding to a wake-up call, Integra Realty Resources said in the 2020 Viewpoint.  Steady new construction of flex buildings and the attractiveness of their office and warehouse options led to the Viewpoint’s faith in a recovery, Integra said.

James “Jim” O. Turner II, a managing director  at Integra, put the growth in flex space south of Pearl and north of Ridgeland.  But the industrial-dominated southern end of U.S. 49 from Jackson to Florence will need relief from prolonged highway work before it can expand, he said.

The upside is that the multi new highway lanes near Florence should give better access to the flex properties and could help spur tenant growth and new construction. “Florence and Richland should see a revival” in their flex markets, Turner said.

Add retail and commercial to the growth mix, he advised, and cited strong school districts and easier access between interstate highways and U.S. 49 as reasons why.  “Once it is easier to access employment centers,” growth in all sectors will follow, Turner said, reflecting on the impact of new large employers such as Continental Tire, which recently began operations on a mega-site off Interstate 20 east of Clinton with a workforce of about 3,000.

Continental’s impact on industrial real estate will be significant, said McCullough, the associate broker at NAI UCR Properties. But he said he has received reports that Continental won’t have the kind of economic ripple effects in east and south Hinds County that Nissan brought northern Madison County. Making tires for commercial trucks doesn’t require the lengthy list of suppliers and contractors that automobile manufacturing does, McCullough noted.

A similar expectation comes from Overby, the Overby Company principal. “I personally haven’t seen a huge spurt in growth,” he said. 

But Continental’s presence will have a positive impact by showing other industrial-space users “we have an employment base for manufacturers” and are a good bet for investors, Overby said.

The broker said he’s getting strong leasing from flex warehouses around Brandon and Gluckstadt and some sections of Jackson. Building owners like the ease of modifying the properties for different uses, Overby said.

“No owner is shackled to one kind of use when a tenant leaves,” he said, and noted he recently worked with an owner who easily converted space into a martial arts studio after an HVAC company moved out.

While Overby said he thinks the industrial market can accommodate new buildings of 25,000 to 35,000 square feet, McCullough said returns on rents must improve first.

“There is still probably a $2 a square-foot-to-$3 a square-foot difference in what new construction would cost versus if you can find existing product that would work for a user,” McCullough said.

That trend could change over the next three years or so, he said, as “e-commerce fulfillment continues to become more prevalent in Jackson and supply continues to become more and more restrained.”

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About Ted Carter