About Time

After two straight years of negative absorption, Honolulu’s commercial-office market is making a slow, steady (and sane) journey toward recovery

March, 2004

In business, timing is everything.

When the California State Teacher’s Retirement System (CalSTRS) put its Honolulu office properties up for sale nearly three years ago, the timing seemed perfect: Hawaii’s tourism industry had just experienced a banner year in 2000, with record-breaking arrivals of nearly 7 million, and $10.9 billion in expenditures, the second-highest total in state history. In addition, Internet-bubble cash and high hopes were still percolating throughout the state, fueling unprecedented growth in a handful of local high-tech companies. As a result, Honolulu experienced its lowest vacancy rate for commercial office space in nine years, 12.2 percent at the end of 2000, down from 16.1 percent in 1999.

In the fall of 2001, the Davies Pacific Center and the Pan Am Building went on the market. It was the week of Sept. 11. With two invasions, a slew of corporate scandals, a recession and a worldwide case of SARS hysteria on the way, the timing turned out to be pretty awful.

“We got terrible offers, if we got any offers at all,” says Jamie Brown, president of Hawaii Commercial Real Estate, who helped broker the eventual sale. “Finally, in the first or second quarter of 2003, a year and a half after being put on the market, we started to get a lot of interest. We had a flurry of high-priced offers and went with The Shidler Group. I think the longer the deal took, the more convinced they became that Hawaii was experiencing an economic turnaround.”

During the last week of 2003, the San Diego-based real estate investment firm The Shidler Group purchased the Davies Pacific Center and the Pan Am Building from the CalSTRS for a reported $90 million, $58 million for Davies and $32 million for Pan Am. CalSTRS had paid $145 million for the two.

“There is no one thing that I can put my finger on that convinced us to buy. We are in the market every day, and rents seem to be going up and sublease space on the market seems to be disappearing,” says Larry Taff, managing partner for The Shidler Group. “This, along with a lowered purchase price and interest rates that were 25 percent lower than when the buildings went on the market, transformed a not-so-attractive deal into a quite compelling one.”

In addition to Davies and Pan Am, The Shidler Group owns four Honolulu office properties: The City Center, 33 S. King St., the Pacific Business News Building and Eaton Square. Shidler had also owned the Waikiki Galleria Tower, which it sold late last year. The Davies/Pan Am purchase was Shidler’s first large-scale office purchase in Hawaii in nearly 10 years.

According to Mike Hamasu, director of consulting and research for Colliers Monroe Friedlander, Shidler’s timing was impeccable. Company officials were negotiating the purchase as the first of a slew of optimistic economic forecasts for the state in 2004 were released.

“This [the sale of the Davies Pacific Center and Pan Am Building] is the start of something,” says Mike Hamasu. “We are still at 11 percent or 12 percent vacancy, which is not that great, but we are headed in the right direction. I think in the near future you will see a bunch of office properties come on the market.”

At press time, Harbor Court was scheduled to go on the market at the end of January, followed by Waterfront Plaza a few months later. Both were expected to sell quickly.

Ups and Downs
Greatest Positive Absorption
Building Name Square Footage Occupying Tenants
Queen’s Court 33,928 converted to condo
677 Ala Moana Blvd. 27,910 UH Medical School, Tissue Genesis
Waterfront Plaza 25,033 Aloha Airlines
Central Pacific Plaza 19,621 Central Pacific Bank
Alakea Corporate Towers 17,507 converted to condo
Greatest Negative Absorption
Building Name Square Footage Vacating Tenants
Bishop Square 49,328v KPMG, Gensys Telecommunications, (Pauahi Tower) M & E Engineering
Pioneer Plaza 28,018 Hawaii Community Foundation
Pacific Guardian Tower 25,334 Cheap Tickets
Pacific Guardian Center 22,437 Tesoro
1132 Bishop Street 20,843 Sprint Telecommunications

Source: Colliers Consulting

According to Hamasu, the current economic recovery, unlike previous cycles, has been steady and spread across several sectors. Tourism is on the rebound, while Hawaii’s red-hot residential construction industry is getting a multibillion-dollar boost from military housing privatization projects over the next decade. Meanwhile, a larger military presence, including the possible home porting of an aircraft carrier, is expected to pump hundreds of millions of dollars into the local economy for decades to come. This more sane and controlled growth bodes well for the commercial office market, whose fortunes ultimately rest on one economic indicator: job creation.

According to Hamasu, since 2001, office employment counts grew from 84,100 to 87,950, a gain of 4.6 percent. Consequently, at year-end 2003, Honolulu’s office market posted nearly 193,177 square feet of positive absorption (the first positive numbers in nearly three years). Oahu’s office-vacancy rate fell to 11.84 percent from 13.62 percent a year ago. Oahu average rental rates rose ever so slightly, from $2.13 in 2002 to $2.15 in 2003. Hamasu predicts that, in 2004, those rates will continue to remain relatively flat.

Local economists are also forecasting 2 percent job growth in 2004 for the state, as well as a 5 percent to 6 percent rise in personal income growth, which has local commercial real estate brokers bullish on Honolulu. They are members of a group that has had a very long decade.

Year-End 2003 Highlights
Net Absorption: 193,177 square feet
Oahu Vacancy Rate: 11.84 percent
Average Full-Service Asking Rate
Islandwide: $2.14 per square foot
Class A: $2.32 per square foot
Class B: $2.30 per square foot
Class C: $1.96 per square foot

Source: Colliers Consulting

“Cycles usually last about seven years or so, but our downturn lasted more than a decade. It ranks as one of the worst of them,” says Linda Gee, vice president and principal broker at PM Realty Group. “In the early ’90s, we saw a whole lot of product come on line (Harbor Court, 1100 Alakea, Alii Place and First Hawaiian Center, among others) while the economy went off line. It was a lot of space to fill. Now, we are seeing a confluence of economic indicators that will lead to an infill of vacant space and, eventually, higher rents.”

Gee says that, at the Topa Financial Tower, a premium, Class A property that she leases, vacancies were at 16 percent at the beginning of 2003. By the end of the year, that figure fell to 11.7 percent. The visitor industry was a big performer for Gee, with Norwegian Cruise Lines occupying an entire floor at Topa. However, reflective of the steady growth throughout the local economy, her other new, large tenants included a healthcare provider and a mortgage company.

“In the middle of 2003, over the course of a month, I saw the number of property tours double,” says Brown, who is the leasing agent for 1132 Bishop, a Class A property, which has been heavily populated by high-tech clients. “Toward the end of the summer, I was having conversations with tenants about expansion.”

Brown says that the vacancy rate at 1132 Bishop is hovering at 12 percent, about the same rate during the last boom, in 2000. The building has lost tech companies Worldpoint, Uniden Software and Digital Island as tenants, but has filled the spaces with Actus Lend Lease, Territorial Savings Bank and McDonald’s.

Brown is one of his own best customers. He started his business in January 2003, with one assistant in a 400-square-foot office. A year later, he has a staff of seven and has expanded his space by more than 1,000 square feet. “We are a very typical story that is behind this economic growth,” says Brown. “I’m buying office furniture, and I’ll probably need to hire a few more people throughout the year.”

However, even though his business has experienced phenomenal growth, Brown agrees that one of the most encouraging characteristics of the current economic upswing has been its slow, steady consistency. Across the board, the outlook is bright, from small businesses seeking to expand their staff to large investors like The Shidler Group, which are seeing suddenly profitable investment opportunities in downtown Honolulu real estate.

“I do foreclosure work, and I’m seeing drastic differences from the late ’80s, when things were reaching such crazy heights,” says Gee. “Our current growth is fueled by investors, who can truly afford what they are buying, as opposed to speculating on future value.”

Out of the Shadows

You probably weren’t aware that there is a name for the empty desk where your summer intern sits, or the corner where your IT manager stores his empty cardboard boxes. It’s called “shadow space,” areas in the office that can easily house extra personnel, but are too small to sublease to another company. In the commercial real estate world, shadow space is an often overlooked “x factor,” which can determine the speed at which a market recovers. As tenants begin hiring again, they will fill these dark areas before taking on more square footage.

Nationally, shadow space is estimated to constitute from 5 percent to 10 percent of unoccupied space. San Francisco’s commercial office market, which expands and contracts with volatile high-tech industries, is estimated to have shadow space that comprises as much as 15 percent of the market. According to an unscientific poll conducted by Mike Hamasu, director of consulting and research at Colliers Monroe Friedlander, Honolulu’s shadow space is roughly 3 percent to 5 percent of unoccupied leased space.

“Because we’ve been through seven or eight years of tough economic times, Honolulu managers have handled their shadow-space problems better than most managers on the Mainland,” says Hamasu. “After all those down years, they’re not going to hang on to a lot of space in the vain hope that things will get better. They’ve either figured out a way to sublease the space or they’ve filled it.”

Hamasu believes that Honolulu’s lack of shadow space will mean that the commercial office market, already on the road to recovery, will get healthier much sooner than many comparable markets on the Mainland.

“For a long while, we were bemoaning the fact that we didn’t have many high-tech industries here,” says Hamasu. “In this case, being insulated from the tech sector has actually been a good thing. I guess we should be careful about what we wish for.” n

-DKC

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