Tech, Investment, Construction: the Story of 2016
The U.S. economy created 180,000 jobs per month on average in 2016. The steady hiring, though down from 2015, helped to lower the unemployment rate to 4.7% by year’s end. State and local unemployment continues to outpace the national rate. In the Indianapolis MSA, 4,100 jobs were added in office-using industries – often a direct corollary to real estate. The direct vacancy rate for local office product held even at 15.4% amidst minimal net absorption and new construction. Even so, asking rents and new leasing activity are on the rise – up 3.2% and 13.0%. Investment sales activity reached record levels: a sign of increasing confidence in a changing office market landscape.
The Return of the CBD
The downtown Indianapolis office scene is the most telling story of the evolving market. In the past few years, large blocks of vacancy have plagued the CBD, specifically in towers. In Q2 2016, those availabilities became assets. Salesforce.com signed a new lease to consolidate operations into a mostly-contiguous 227,781-sf space at Chase Tower (to be renamed Salesforce Tower). The San Francisco-based company will take occupancy in early 2017, further diminishing a vacancy rate that spiked during the recession and has now fallen four straight years to 17.4% - its lowest since Q2 2009. Similar properties, such as BMO Plaza, are also in a position to capitalize in the next 6-12 months. The $22.63 per square foot (psf) average asking rental rate for class A product, while up 4.6% year-over-year, remains competitive with other tertiary markets. The appeal for companies to locate operations and draw from a growing population will help the CBD market.
A Shift in Tower Appeal
Building owners and developers are gearing to take advantage of the growing downtown office market by highlighting (or repositioning) the appeals of their assets. As companies grow and their real estate needs expand, towers (which have seen vacancy climb in recent years) can offer large blocks of space and draw operations to efficient floorplates. Conversely, the creative/character class of buildings have the unique type of space and small floorplans that are in demand by young companies. The final trend to watch in the CBD is capital investment into stale assets aiming to combine a tower appeal with the culture-driven feel needed for companies to recruit and retain talent. Market Tower, a property transformed in 2016, is the prime example of an asset repositioned for that purpose. The ability of these buildings to grow occupancy while raising rental rates could have a ripple effect.
Class A Suburbs the Hub of Activity
The north suburban submarkets, a larger and more traditionally reliable portion of the Indianapolis office market, experienced a healthy 2016. Significant transactions dominated leasing activity in the first half of the year. Most notably, Allied Solutions, Republic Services, and Ardagh Group combined for 217,218 sf of new leasing activity in brand new or to-be-built class A office product in the Carmel and I-69 submarkets. Sallie Mae consolidated to lease 75,558 sf in the Keystone Crossing submarket. A few large tenants downsizing contributed to a stagnant vacancy rate in the latter half of the year, including Roche’s exit from 193,000 sf. Even so, asking rental rates in class A space grew by nearly 7% year-over-year and outpaced the market average of 3.9%. The slight dip in a high occupancy, as well as higher average asking rental rates, are also a result of new suburban construction.
New Construction a Slow Reality
New ground-up construction, which had been very limited up until the beginning of 2016, is proving to have an impact on the suburban office market. River North, a 102,000-sf speculative project in the Keystone Crossing submarket with $25.50 psf asking rental rates, was nearly 100% preleased by the time construction was completed in Q3 2016. Two Concourse, completed in 2014 and the first recent development to take a chance on speculative construction, also leased up this year. The flight to quality space by suburban tenants also extended to smaller build-to-suit and mixed-use projects in 2016. Blue Horseshoe Solutions will move to a new, 60,000-sf property in early 2017, while Walker Information and Stanley Security are relocating to build-to-suits later in the year. The vast majority of tenants in all of these projects are shifting from nearby suburban buildings. With that in mind, and the additional vacancy created by unleased speculative projects like the one-story, 61,000-sf Lakeside Green development in Carmel, the north suburban vacancy rate ticked up slightly. Still, the high 86.3% occupancy rate could trigger development of at least one more large, speculative project in the market.
Investment Sales Reach Record High
Investment sales activity was slow to take off in the first half of 2016. The majority of the focus was on value-add downtown assets, including Mission Peak Capital’s purchase of the struggling Market Square Centers and HEARN’s entrance into the market with its acquisition of BMO Plaza. Combined, nearly $110 million in value-add assets traded hands through Q2 2016, with 90% of that activity in the evolving CBD.
In the second half of 2016, value-add transactions continued to occur, but the sale of stabilized assets led to a record level of investment sales volume. $590 million of office investment properties across 21 transactions were completed throughout the year. The 130% year-over-year increase far surpassed recent investment and can be predominately attributed to two major transactions: Duke Realty Corporation’s sale of Parkwood Crossing, and the disposition of Salesforce Tower and PNC Center by Equity Commonwealth. Private equity continued to be the dominant source of capital for transactions, including several first-time investors in Indianapolis. Positive fundamentals in the office sector will be hard to overlook in 2017 for yield-hungry capital looking to exceed gateway city returns.
A developing trend to watch in the Indianapolis market is the rising popularity of co-working space operations. Their absorption of vacant space is a positive for the market, and their ability to incubate new and smaller companies in short-term leases could help the start-up community flourish. That growth could also eventually feed traditional office assets.