Terry Coyne - Commercial/Industrial Real Estate Properties
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NATIONAL INDUSTRIAL TENANTS LANDING IN SMALLER MARKETS, LIKE CLEVELAND

April, 2017 - It has taken quite a few years during the nation's economic recovery, but the small town seems to have finally made a comeback.

We are seven years into our recovery and the hottest part of the Northeast Ohio industrial distribution market has been national tenants leasing space, ranging in size from 45,000 to 80,000 square feet. That size has always been the strongest segment of our market. Examples include: Berlin Packaging, Dunkin' Donuts (National DCP) and Bridgestone Americas (Tire Wholesale Warehouse).

The 20,000- to 30,000-square-foot tenant was typically as strong as the 45,000- to 80,000-square-foot tenant. However, during the recovery the smaller tenant did not seem to bounce back from the recession as quickly. 

In my experience, when these leases get done they are often for much shorter periods of time, and they are for national companies that have large requirements, including the necessity of a short-term deal until they find a larger space.

Yet, the activity in the past quarter has been strong in the large size range. Currently, we have a very tight 1.4% vacancy rate for big box properties that feature 24-foot clear ceilings and early suppression fast response (ESFR) systems. The overall industrial market is pretty tight as well, with our latest market report showing a 6.5% vacancy rate, the lowest it has been in the history of my company, NGKF, tracking real estate stats under its current methodology. I would forecast that Class A industrial vacancies will likely be virtually gone by year end, especially with the overall tightening of the big box market.

STAG INDUSTRIAL BUYS LARGE BEDFORD HEIGHTS WAREHOUSE FACILITY

March, 2017 - 26801 Fargo Road in Bedford Heights sold in the first quarter of 2017 for $7,636,651, or $44.13 per square foot, to STAG Industrial Holdings, LLC. Our team represented the sellers, a group of local Cleveland investors.

Fully-leased to two tenants, this 173,052-square-foot building originally functioned as a Sears distribution center.

This space is evidence of a still-robust industrial investment climate, even in secondary markets such as Northeast Ohio. Additionally, with vacancy now hovering around a generational low (NGKF Cleveland's 4Q16 Industrial Market Report indicated an industrial market vacancy of 6.8%, having dipped below 7% for the first time), this price is still far below the building's replacement value. In a rising market, this price may seem high today, but could prove to be a smart move in the not-too-distant future.

About The Property
26801 Fargo Road is a single-story, 173,052-square-foot masonry warehouse and office building. Originally built in the 1960s, the property was renovated in 2004 and underwent a major office build-out in 2016. The property features approximately 160,000 square feet of warehouse, 15,600 square feet of office, a building technician office and two loading dock areas that consist of 30 canopy-covered bays. Located in the heart of Bedford Heights, the property is near restaurants, leading medical facilities and offers easy access to I-271.


NORTHEAST OHIO SUBLEASE MARKET SHRINKING

March, 2017 - Contrary to national trends published by Newmark Grubb Knight Frank's corporate research department, the office sublease market in Northeast Ohio, normally a predictor of underlying momentum in most overall markets, continues to shrink.

NGKF's national statistics indicate that sublease space has been rising gradually, from the recent low of 81.5 million square feet available at mid-2014 to 97.1 million square feet at year-end 2016. Furthermore, sublease totals in some markets, such as Houston, where tenants, primarily oil and gas businesses, drove the sublease availability rate to 5.6%, well above the U.S. average of 2.0%.

As you can see below, Cleveland's office market fundamentals seem to be moving in the opposite direction. In fact, Cleveland's sublease availability rate is 0.6%, much lower than the U.S. average.

Based on NGKF's 4Q16 office market stats, sublease information is as follows:
Total Sublease SF Available: 226,662 SF (84,400 SF less than 3Q16)
Total Sublease Available %: 0.6% (down from 0.8% in 3Q16)
 
CBD Sublease SF Available: 70,285 (55,684 SF less than 3Q16)
East Sublease SF Available: 48,281 (5,769 SF less than 3Q16)
South Sublease SF Available: 71,011 (13,674 SF less than 3Q16)
Southwest Sublease SF Available: 25,547 (2,736 SF less than 3Q16)
West Sublease SF Available: 11,538 (6,537 SF less than 3Q16)
 
Class A Sublease SF Available: 91,144 (57,893 SF less than 3Q16)
Class B Sublease SF Available: 114,618 (15,273 SF less than 3Q16)
Class C Sublease SF Available: 20,900 (11,234 SF less than 3Q16)
 
Overall, all submarkets and classes saw a decrease in available sublease space from 3Q16 to 4Q16. So, the Cleveland market saw a healthy amount of positive absorption in the sublease arena in the second half of last year. Year-over-year from 4Q15 to 4Q16, sublease availability went from 320,308 SF to 226,662 SF (a decrease of 93,646 SF, or 0.2%). In the past 5 years (from 4Q11 to 4Q16), sublease availability went from 819,677 SF (2.1% availability) to 226,662 SF (a decrease of 593,015 SF, or 1.29%).

After giving back space in the third quarter, the overall Northeast Ohio office market made a comeback by the end of 2016 by posting 253,993 square feet of positive net absorption. The positive absorption dropped the overall vacancy rate by 70 basis points from the previous quarter to 17.3% for all properties. Leading the way in the fourth quarter was the Central Business District (CBD), which recorded 193,213 square feet in positive net absorption. This occupancy gain dropped the CBD's vacancy rate 9 basis points to 19.9%. To read NGKF Cleveland's overall 4Q16 office market report, click HERE.


HERE COME THE MARIJUANA GROWERS

March, 2017 - If the Northeast Ohio industrial market was not tight enough, here come the marijuana growers! Last year, the Ohio General Assembly passed legislation for a medical marijuana program in Ohio and Governor Kasich signed the bill.

While the licenses have not been issued yet, groups are attempting to secure space in anticipation of winning one. The will only be a small number licenses to be awarded statewide; rule proposals were filed in February, with a public hearing scheduled for March 20.

What is interesting about the requirements growers have outlined is that they are the opposite of what most industrial users are looking for today.

The marijuana growers are looking for approximately 60,000 to 75,000 square feet of space, with heavy amounts of power, low ceilings and air conditioning. The low ceilings are to keep utility bills down and the lights closer to the product. Facilities, however, cannot be closer than 500 feet to any residential dwelling, school or church.

Right now, the big unknown is location. Most cities will not permit this use, but it is expected that older, more-established cities (Elyria, South Euclid and Richmond Heights are already moving towards this) will likely agree to their use.

Whether you are for or against it, the advent of marijuana growers occupying industrial space will clearly make the market tighten even further.


MIDWEST INVESTMENT OPPORTUNITIES STILL HOT AS EVER

March, 2017 - New York, Chicago, Los Angeles and other big cities get far more attention than Northeast Ohio when talking about investment property sales.

However, as Newmark Grubb Knight Frank's 4Q16 Midwest Capital Markets investment report reveals, the market for office and industrial property sales in Cleveland, Columbus, Cincinnati, Detroit and Pittsburgh remain as hot as ever. Sales volume, prices and activity are at all-time highs. Additionally, rates have hit all-time lows and the buyer profile for these markets was more national in scope this time than during the prior cycle.

One question I have always wondered about is, if your debt costs the same in New York City as it does in Cleveland, why wouldn't more investors reallocate their capital to strategic second-tier or tertiary markets such as ours (Cleveland) and the others outlined in the aforementioned report?

Given the profile of the most recent buyers in the Midwest, it seems others have been thinking the same thing.

Institutional investors typically buy based on an IRR, which assumes an exit cap. Also, the biggest objection is usually a lack of rent growth or appreciation in the legacy Rust Belt cities.

However, those investors who were brave enough to invest in this Midwestern area during the economic downturn are now reaping the rewards. In fact, many investors could have purchased properties in these markets for what they are currently renting for now. In particular, Detroit has seen even more spectacular returns as car production has resurrected over the past few years.

Our markets have been through a good bit of up-and-down over the past 10 years but at least for now, despite the price increases, investors can still find opportunities.

MIDTOWN CLEVELAND'S SUCCESS CONTINUES

February, 2017 - As Downtown Cleveland captures the majority of recent commercial real estate news for its development projects, the city's Midtown area has quietly become a successful office submarket - specifically from East 57th Street to East 70th Street along Euclid Avenue.

Dick Pace pioneered the progression of this area's resurgence with his redevelopment of the former Baker Electric Building, 7100 Euclid Avenue, nearly 10 years ago. Public interest and prices have both elevated to new heights as a result.

Since then, Hemingway Development has developed over $40 million in three office and laboratory buildings in their MidTown Tech Park. Interestingly, a surprising result is that that these buildings, all built on speculation, are 93% occupied. Furthermore, Hemingway hasn't stopped - the company has announced its next 62,000-square-foot speculative office building will take place at the company's 11-acre campus known as Link59.

Family- and locally-owned automotive retail giant Dealer Tire's new corporate headquarters is well underway at 7012 Euclid Avenue. In fact, it is believed that the company is ahead of schedule on the 166,000-square-foot Victory Innovation Center renovation and will occupy its new facility from late-February to early-March of this year. This former Refrigeration Sales building will reportedly house 400 plus employees. This investment of over $25 million represents an enormous endorsement of the Health Tech Corridor and brings justification to the RTA's $200 million HealthLine investment to the street in 2007-2008.

Additionally, next to Dunham Square, a group of investors is planning a new hotel that will service this office submarket, as well as the families of Cleveland Clinic patients and visitors to the area.

What's remarkable is that in the year 2000, land in this area could have been acquired for under $10,000 per acre - and now if you can find any land at all it will most likely be above $500,000 per acre - and most land parcels near the Cleveland Clinic hover around $1 million per acre. Few markets in the United States have seen such appreciation - and the market continues to grow!


DOWNTOWN OFFICE 
CONVERSIONS IMPACT MARKET

January, 2017 - Over the past two years, the vacancy rates for Class B and Class C office properties in Cleveland's Central Business District (CBD) have declined primarily due to conversions of office space into residential apartments. The current market vacancy rates for Class B and C offices in the CBD are 24% and 22.4%, respectively. However, we have developed the "Zombie" office vacancy report which eliminates all buildings that are either currently being converted into apartments - or soon will be - to come up with forecasted vacancy rates of approximately 18.2% for Class B offices and 15.4% for Class C offices.

While these rates are still high - they do paint a different picture of the trends for rates and concessions for CBD office. Drilling down further into our "cool" office space (high ceilings, older buildings, exposed brick, wood floors) vacancy rate, we estimate an approximate vacancy of only 12.6% based on a sampling of downtown properties that amount to approximately 2.9 million square feet.

The overall health of the market is being driven by conversions. The annual net absorption of office space in 2016 was approximately 254,000 square feet. However, the absorption for "cool" office space is currently keeping pace with supply. Rates in these older buildings also rival newer Class B buildings at $16 - $17 per square foot gross, and are oftentimes higher, yet have lower tenant improvement dollars - netting the landlords a higher overall return. This trend has been spotted by a few perspicacious developers. The leader in this trend - the Caxton Building - has seen an increase in rents over the past year for both parking and office that other landlords can only dream about.

Rick and Ari Maron spotted this trend a few years ago when they leased approximately 80,000 square feet to our client, Rosetta Marketing, in the former PNC building on Euclid Avenue and East 6th Street. They converted old 1960s-type office space into space one might see in SoHo. The space was never marketed and the tenant moved from the suburbs into downtown to be closer to urban amenities; paying a rent at the high end of the B market.

Graystone Properties spotted this trend when they decided to convert the former Tyler Elevator building at East 36th Street and Superior Avenue - which they had owned since the 1970s - into loft office space. Without the use of tax credits, Graystone repurposed this million square foot plus property into a neighborhood of retail, office and warehouse uses called Tyler Village. The development is performing so well they are now able to charge for indoor parking in an area of town where parking is free and abundant.

Jim Doyle and Fred Geis developed a campus of buildings in Midtown at 6500, 6700 and 7000 Euclid Avenue called MidTown Tech Park. The entire campus is near-full and a majority of the tenants are either from the suburbs or are spinoffs from the Cleveland Clinic. Rents range from $10.00 to $15.50 per square foot net - equal to or higher than CBD or suburban rents; and two of the three properties were warehouse conversions.

Recent examples of this conversion trend can be seen in Quicken Loans' new space in the Higbee Building. This conversion of the former department store into "cool" office space now houses 450-plus employees who moved here from the old Post Office building behind Tower City. In fact, our office is now handling the leasing of the remaining vacant office units in this building - offering a similar work environment as the Quicken space; and suburban companies are beginning to take notice.

Similar examples are Joel Scheer's redevelopment of the former Sammy's building in the Flats. This building has one of the highest asking lease rates of any space in our market at $21.00 pfs NNN, or $32.00 pfs gross. It offers views of the river and a rooftop deck. Fred Geis recently announced he was partnering with the Samsel family and redeveloping several mostly-empty buildings on Old River Road on the East Bank of the Flats into predominantly loft offices. These properties are on the Cuyahoga River and will have porches overlooking the water.

2401 W. Superior Viaduct, a three-story building in a rapidly changing area, is under contract to a client of ours, and a start-up company is expected to move its operations there. The company was attracted to the "loft" feel of the building and the addition of new amenities in the area, such as a brew pub being built across the street. 

These developments were, on some level, predicted by Richey Piipparinen, Director of the Center for Population Dynamics at Cleveland State University, in his research regarding the growth of well-educated millennials attracted to the authentic city of Cleveland. This new population sees Cleveland's history as an asset and embraces it in many ways, one manifestation being the desire to lease space in buildings with unique features. Assuming his research is correct - and so far his predictions have been accurate - landlords would be wise to consider how they can accommodate these trends.

Articles have asked when the next new office building will be constructed. All the while, when most people were focused on the apartment market conversions, a few developers were counter-intuitively already building Cleveland's next office buildings through conversions rather than new construction.

So the question really should be: which office building is ripe for the next conversion? Two big properties stand out - the Rose Building, which currently houses Medical Mutual, and the former Huntington Building at 925 Euclid Avenue.

The Rose Building is currently an office building but it is ripe for redevelopment. Medical Mutual is rumored to be relocating, opening up an opportunity for the Rose Building's owner to reposition the property, embracing its magnificent architecture, ample window line and location in the heart of the city. Like the former Huntington Building across the street, this property would likely fetch rates above $20 psf and compete at the high end of the B market if properly repositioned.

The former Huntington building being redeveloped by Hudson Holdings will be a neighborhood unto itself and will earn office rents equal to or exceeding the Class A market. The company is planning a mixed-use redevelopment that encompasses retail, office, hotel and an apartment/condominium product.

Overall, these changes in our market present opportunities for both tenants and landlords, and understanding these trends helps both sides make better decisions.

If you would like further information, please feel free to contact me at tcoyne@ngkf.com.