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On The Verge of a Landlord's Market

Building owners rejoice

If the analysts are correct, 2005 should be a pretty good year for Oahu's office landlords. Not that 2004 was a bad year for them - with nearly 224,000 square feet of net absorption and a year-end vacancy rate of 10.3 percent (two years ago it was nearly four percentage points higher), it was anything but. Still, forecasts for 2005 are for an even rosier year, with analysts predicting the conversion from a tenants' market to a landlords' market.

"We've pegged the equilibrium point - when landlords and tenants are at an equal negotiation stance - at around a 10 percent vacancy rate. At that point, the landlord doesn't have to give as much concessions, such as free rent, tenant improvement allowances," says Mike Hamasu, director of consulting and research for Colliers Monroe Friedlander Inc. "So from a landlord's perspective, it's a great time, because we're forecasting vacancies to fall below 10 percent by mid-year of 2005, and by the end of 2006, vacancies will probably fall to about 9 percent."

Photo: Wes Funai

When (and if) the total office vacancy rate does dip below 10 percent, it will be for the first time in more than a decade. In some Oahu submarkets, however, the vacancy rates have already dropped well below the 10 percent mark. The East, Leeward and Windward Oahu markets, for example, each closed the year out with vacancy rates below 7 percent, and the Aiport/Mapunapuna area ended 2004 with a measly 1.57 percent vacancy rate. Yet while the tightness of these markets would seemingly make them prime candidates for new office development, experts say the current rental rates still don't justify any new construction.

Even though average rental rates increased 3.7 percent, from $2.14 per square foot in 2003 to $2.22 last year (the biggest increase in over a decade), rents are still about a dollar shy of covering development costs. "To create new office space, developers need net rents that are probably around $3.00," says Larry Taff, general partner of the real-estate investment firm The Shidler Group.

SOLD: The Shidler Group, which purchased Waterfront Plaza last year, now owns about 10 percent of the Oahu office market.Photo: Cory Lum

Hamasu concurs, although he says it shouldn't be too long before the tide turns. "At this point, rental rates aren't feasible for new construction, but if the projections for rental rates start to exceed $3 or $3.50, which you can see happening in five to seven years, developers will look at properties that can be redeveloped," he says. "I'd say redevelopment opportunities are definitely a likelihood in about five years."

In the meantime, expect to see continued investment into Oahu's commercial real estate sector this year, following two stellar years of commercial transactions. According to Colliers, $2.1 billion in commercial real estate exchanged hands in 2003, and more than $3 billion in commercial space was sold in 2004, including three prominent downtown buildings: Harbor Court, 1132 Bishop and Waterfront Plaza. Hamasu says a number of factors triggered the local commercial investment flurry, which began in 2003. "With the stock market volatility there's been an influx of people wanting to buy real estate and it's resulted in a shortage of potential investment properties - and thus, higher prices - on the Mainland, which makes [Hawaii] look more attractive," he says. "And then the low interest rates have pretty much maintained itself."

OAHU HISTORICAL FULL SERVICE AVERAGE ASKING RENTAL RATE

Save for a dramatic increase in interest rates, Hamasu and other commercial analysts are expecting this year's investment activity to keep on par with last year, with Mainland investment continuing to drive the market. "We're definitely going to see a continuation of investment into commercial real estate," says Daniel Jarrett, specialist with the Office Service Group at Grubb & Ellis. "Maybe we won't see The Shidler Group absorbing any more, but I think we'll see bigger groups from the Mainland coming down and picking up properties."

COLLIERS
SUPPLY vs. DEMAND MODEL
Source: Colliers Hawaii Consulting

With respect to Shidler, one of the most active commercial investors of late, Jarrett is probably right. After all, the company (which acquired roughly a million square feet of office space in the past two years) has already got a lot on its plate. It currently owns about 10 percent of the Oahu office market, including the Davies Pacific Center and the Pan Am Building, which were purchased in 2003, and Waterfront Plaza, which it bought last year. "We like to think of ourselves as pretty disciplined investors. So if we don't find anything in the near future here, we'd be satisfied with just continuing to improve the operation with what we've got," says Taff. "But, we can never say never. We always have our antenna up, looking for opportunities."

ARE THESE PROPERTIES UP FOR GRABS?


Look for these commercial holdings to possibly hit the market later this year:


CITY FINANCIAL TOWER
Earlier this year, Central Pacific Financial Corp. consolidated Central Pacific and City banks' operations into the Central Pacific Plaza, putting the 60,000 square feet of office space it evacuated at City Financial Tower up for sublease. With nearly a third of the total square footage in the City Financial Tower now unoccupied, the state Employee Retirement System, which owns the building, might take the opportunity to look for a buyer, or take an offer from whichever new tenant takes over the vacant City Bank space.

BISHOP SQUARE
According to an anonymous source, downtown Honolulu's coveted twin towers, Pauahi Tower and the American Savings Bank Building (known together as Bishop Square) is likely to hit the market this year. With ample parking, a central location and ground-floor retail space available, Commonwealth Partners, the owner of these prime, class-A buildings, should have no problem finding potential buyers in this sizzling market.

THE CAMPBELL ESTATE PORTFOLIO
The nearly 200 beneficiaries of the Campbell Estate trust have only two years remaining until the trust terminates. And although a separate entity, James Campbell Co. LLC, was incorporated last year to take over the trust upon termination, there's intense speculation that the estate will soon begin liquidating parts of its $1.1 billion in land holdings to appease family members who'd rather have the cash. "There might be a couple people who choose not to continue with the entity for whatever reason," beneficiary Wendy Crabb told HB in 2001. "So there will have to be a limited liquidation of some properties."

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