City HIGHLIGHT, DECEMBER 2006

CLEVELAND CITY HIGHLIGHTS
David Stover, David Browning, Debbie Corson and Mark Escaja

Cleveland Industrial Market

The desire for property ownership is the engine that has fueled the turnaround of the industrial real estate market in the Cleveland area. Sales of manufacturing, warehouse and distribution centers increased during the year, while the length of time these properties were on the market decreased. Overall, vacancy levels have been reduced to 8.6 percent from a rate of 9.7 percent in 2005.

Not since the late 1990s has the Cleveland area experienced multiple offers for properties, bidding wars and even properties selling for amounts greater than the original asking price. One example is the recent acquisition of a 400,000-square-foot distribution facility situated on 19 acres by Weston Inc. Weston purchased the property for $12.8 million, or $32 per square foot, after the original owner filed for bankruptcy. The sale price was close to replacement cost. Just a few years ago, a similar scenario would have resulted in a property with a lengthy vacancy period and a drastically reduced sales price. Within weeks of the sale, Kaufman Container leased 180,000 square feet of the building’s available space.

Ironically, this positive industrial sales activity gained momentum shortly after Indianapolis- based Duke Realty Corporation succumbed to shareholder pressure to exit the Cleveland market and pursue more attractive markets in the South and West. Duke sold the majority of its Cleveland industrial portfolio, approximately 1 million square feet, to First Industrial Realty Trust. While Duke indicated the need to enter other markets, it may also have recognized a prime opportunity to sell its assets, as the aging industry portfolio traded at an average sale price of more than $50 per square foot. This transfer proved to be an excellent send-off for Duke.

A major contribution to the potential sales activity is the lack of available new construction. The cost to build new facilities has significantly increased during the last couple of years. Speculative projects are basically non-existent and the only new construction occurring is build-to-suit facilities designed specifically for a company’s use.

With limited new construction options available and numerous existing properties being acquired, some purchasers are tackling redevelopment projects. Cleveland entrepreneur Dan T. Moore recently acquired the former Tenneco/Gould property, a three-building complex consisting of 650,000 square feet that was constructed in the 1920s. Located on 56 acres, the facility was once a thriving industrial village employing thousands of workers in the construction of torpedoes. Since the early 1980s, the property has been mostly vacant until Moore’s acquisition. Redevelopment efforts have already secured tenants for more than half of the complex, which has been renamed the Cleveland Industrial Innovation Center.

One cause for concern is the slow leasing activity in the flex market. Vacancy levels have been reduced but still are high, measuring 18 percent vacant for this property type. Flex properties were overbuilt during the late 1990s and early 2000s, resulting in large vacancies. The next trend may be for users to purchase flex properties that are substantially vacant and convert them to single-tenant facilities.

During the last 3 years, the greater Cleveland industrial market has experienced single-digit vacancy rates, positive net absorption and a potent demand to acquire facilities. Should this trend continue, REITs may once again look to invest in the Cleveland area.

— David Stover, SIOR, is vice president of the Chartwell Group/TCN Worldwide in Cleveland.

Cleveland Office Market

It is a time of significant change in the commercial real estate markets of Cleveland and northeast Ohio. New owners, new tenants and new projects are all on the horizon.

Overall activity is at a level that has not been seen since the late 1990s, especially for the office sector downtown and in the prime suburban areas. Absorption for 2006 should be in the range of 250,000 square feet downtown and 150,000 square feet in the suburbs. Although these figures are modest compared to those posted in the 1990s, this is the first year of positive absorption downtown since 2001 and the highest number in 7 years. A market shift is currently occurring among office tenants that will drive absorption in 2007. We have seen activity from large and small tenants, as well as some firms that are new to the market.

Class A office vacancy downtown will end the year below 14 percent, and could drop below 12 percent during 2007. Class B vacancy is coming down, but the market remains soft at 26.46 percent. In the suburbs, the east side is tight with an 11.23 percent vacancy; the south side is active because of space availability in the 21 percent range; and the west side is soft with 18.82 percent of its office product vacant.

On the ownership side, there are several active entities, such as First Industrial Realty Trust, Mark Munsell, Behringer Harvard, and the Ross Farro/Spencer Pisczak Partnership. In 2007, many more investors will stake a position in northeast Ohio, as the balance of Duke Realty Corporation’s portfolio of office properties and numerous other assets will trade. The general pricing level of property in Ohio versus the nation’s top tier cities has created a favorable market, given the amount of active capital seeking quality commercial real estate. Cap rates are slightly higher than expected, but the market fundamentals look good right now in our region.

 The industrial market has been solid. Absorption in 2006 should exceed 5 million square feet, with significant activity in the 100,000- to 250,000-square-foot range. Construction has been modest, but things should ramp up as the market tightens. Ross Farro and Spencer Pisczak’s acquisition of Duke’s available land in Hudson, Glenwillow, Macedonia and Strongsville, Ohio, will result in new projects from an experienced, but newly formed, development firm.

— David Browning is the managing director in the Cleveland office of CB Richard Ellis.

Cleveland Multifamily Market

Downtown Cleveland’s renaissance began in the 1980s and was concentrated primarily on new office, retail and entertainment venues, while residential and multifamily properties were largely ignored. However, there is renewed interest in downtown living and residential development in the central business district is the dominant trend — so much so, that even though Cleveland is experiencing the same suburban population migration as other large midwestern cities, the population in downtown Cleveland actually increased 32 percent between 1990 and 2000.

Multifamily development in the urban core is concentrated on the conversion of existing commercial or office space to residential units and the development of mixed-use centers. Loft conversions abound in the Warehouse and Gateway Districts. Residential housing is flourishing in The Flats, known mostly for its restaurants, bars and nightlife, with the most notable development being Stonebridge. Located on the west bank of The Flats, Stonebridge includes both condos and apartments. Condos are priced from $149,000 to $499,000; apartments rents range from $850 to $2,200.

Mixed-use projects that combine residential units (both condos and apartments) with shopping, dining, arts and entertainment have been successful in other large midwestern cities, and are another multifamily development trend in Cleveland. A prime example is The Avenue District, a $250 million development by the Zaremba Group that is located on the eastern edge of the central business district near Cleveland State University. The first of three phases broke ground this year. This mixed-use project is planning 450 for-sale housing units, street-level retail and a parking garage, with projected completion in early 2008.

The Bingham, a historical building originally constructed 1915, has been redeveloped into an $80 million luxury apartment property comprising 340 loft-style units. Located in the city’s Warehouse District, the project is being redeveloped by Bingham Burnside LLP of Chicago. Rents range from $865 to $2,475 per unit.

The Pinnacle Condominiums building is the Warehouse District’s first luxury condo community. The project came online in 2005 with extensively amenitized units and lake views. The units are sized between 1,400 and 4,600 square feet and are priced between $350,000 and $1.5 million.

These developments are providing modern amenities not previously available in the downtown area.

Another significant development is Crocker Park, a $480 million lifestyle center located in Westlake that combines 550,000 square feet of upscale retail and restaurants, 250,000 square feet of Class A office space and 900,000 square feet of residential space, including luxury apartments, condos and single-family homes.  Apartment rents range from $975 to $3,025 per month. 

Like other cities in the Midwest, the Cleveland multifamily market has struggled with soft occupancy and widespread concessions. Occupancy rates that typically averaged between 93 percent and 94 percent dropped below 90 percent in 2002 and 2003. However, with the unemployment rate dropping and positive job growth, the market is gradually strengthening. Overall occupancy, which hovered around 91 percent a year ago, has risen to about 94 percent today.

Average rents range from about $600 in the Brooklyn/Lakewood submarkets to more than $1,025 per month in the downtown area. Rental rates have averaged growth of 1.6 to 1.7 percent per year.

Much of Cleveland’s population growth is taking place on the west side, so look for multifamily development to follow in areas such as Olmstead Township and North Ridgeville. As conversions and new developments in the downtown districts prosper, more multifamily growth should follow. 

— Debbie Corson is a principal with Apartment Realty Advisors in the firm’s Dayton, Ohio, office.

Cleveland Retail Market

In Cleveland, 2006 has been another very good year for retail development. For the seventh consecutive year, new retail construction topped the 1 million-square-foot mark. Because of this growth, the eight-county northeast Ohio market is now fast approaching an inventory consisting of 80 million square feet of retail space.

However, the market is not without areas of concern. Landlords of grocery-anchored properties have reason for concern. For example, Tops Stores has decided to leave the market. Though Giant Eagle has bid for 18 of the 45 locations, the balance of the properties will face an uncertain future and an obvious dilemma for their respective landlords. Therefore, 2007 will start with nearly 1 million square feet of additional vacancy until the remaining Tops locations are absorbed.

Among the new projects that have opened in 2006 is City View Center in Garfield Heights. The 600,000-square-foot, Wal-Mart-anchored project, which is being developed by Solon, Ohio-based McGill Property Group, opened on the site of a former landfill at Transportation Boulevard along Interstate 480. This property was in turn immediately placed under contract and is scheduled to be sold in 2007. Other new projects that have opened in 2006 include Lighthouse Village in Lorain developed by Liberty Development, DeBartolo Property Group’s Meadowlands Town Center in Chardon, and The Cascades in Brimfield by 3D Development.

The coming year promises to be an even better year for developers. In fact, it may well set an all-time record for new construction with more than 3 million square feet of new retail space expected to come online. United Commercial Property Group will break ground on the Shoppes at Diamond Center, a 400,000-square-foot power center located in Mentor. Near downtown Cleveland, First Interstate Properties will open Steelyard Commons on the 100-acre brownfield site of a former steel mill. The project will be anchored by Wal-Mart, Target and The Home Depot. Target will open a second urban location at Interstate 90 and W. 117th Street on Cleveland’s west side. New Plan Excel Realty Trust, Richard E. Jacobs Group and Transwestern Investment Services will open Westgate, the area’s largest redevelopment project, in Fairview Park. The new Westgate will include Kohl’s, Lowe’s Home Improvement Warehouse and a relocated Target store on the site of the former Westgate Mall. In addition, Westfield has announced plans to renovate and expand South Park Mall in Strongsville with an additional 250,000-square-foot component featuring lifestyle tenants and a new theater.

New and expanding tenants have also contributed to retail vibrancy in northeast Ohio. Among those actively expanding are Petco, which has opened its eighth area store and has plans for additional locations, as well as rival PetsMart. The emergence of chain dental clinics, lead by Allcare and Aspen Dental, signals the arrival of a new type of retail tenant. New restaurants include Chick-Fil-A, Abuelo’s and DiBella’s, among others.

From brownfield sites and redevelopments to urban projects and mall expansions, Cleveland is experiencing in the entire range of retail development. And that doesn’t include the relentless push of Wal-Mart across the market to open new stores, and reposition and expand existing locations. In the past year, the retailer has opened new locations in Oberlin, Brimfield, Chardon and Garfield Heights, and has announced more stores for 2007.

As long as the economy continues and interest rates stay within a marginal range going forward, expect that 2007 will prove to be another very active year for retail developers in the Cleveland market.

— Mark Escaja is president and CEO of Solon, Ohio-based United Commercial Companies.

Cleveland Investment Sales

Cleveland, like many of the major midwestern cities, is a slow-growth market less impacted by the highs and lows of the national economy than other markets on the East and West coasts. The real estate market’s steady performance in northeast Ohio has attracted an influx in investment capital over the past couple of years from around the country. According to James Doyle, president of Cleveland-based mortgage brokerage firm Capstone Realty Advisors, investors are drawn to Cleveland’s real estate market because it provides a safe haven that offers solid returns on invested capital.

“You may not get the wealth of appreciation that you get on the coast, but you’ll make a good return if you have the right location and the right product,” he says.

Nationwide, lending activity is occurring at a heavy clip. On the debt side, national institutional players have increased their amount of mortgage debt placed year-over-year from 2005 to 2006, and Wall Street continues to breathe new life into the financial sector with its aggressive activity. The affects of the national trend have been felt in Cleveland, where commercial real estate lending and acquisition activity is intense.

“We have seen quite a bit of sales activity in 2006,” Doyle says. “ A lot of our financing has been the refinancing of an acquisition loan or the refinancing of existing inventory.”

The asset classes garnering the most attention from investors continue to be multifamily and retail. Multifamily continues to get the best pricing and most aggressive underwriting. “It’s not overbuilt and vacancies traditionally range from 5 to 8 percent,” Doye explains. “I’d like to see rents climb a little bit, but they are inching up; you see a 3 or 4 percent bump in a typical year.”

The downtown residential market is driving the multifamily sector in Cleveland, as the city’s concentrated efforts to attract residents to the urban core has paid off. Even with the highest rents per square foot, the downtown market is the hottest residential ticket in town.

The retail sector is cooling off a bit after a torrid stretch of development and investment in the past few years. “Retail, while still an attractive asset class, has seen its momentum slow down,” Doyle says. “There is still good product in the pipeline, but not at the record pace that we have seen, probably appropriately so. It could get overbuilt, but it hasn’t and it is healthy at about 93 percent occupancy overall.”

The industrial sector is still a favorite of Cleveland investors and lenders. The area is even seeing some speculative construction, which is a rare occurrence and a positive indicator of the health of the market. According to Doyle, the primary challenge in industrial is that transactions often present too small of a loan size to lenders. With $40 or $50 per square foot loan proceeds, even larger properties can fail to offer great opportunities. Regardless of the challenges the industrial sector faces, it is a healthy and popular property type in Cleveland.

Even office, which boasts an overall vacancy rate of approximately 19 percent, is generating excitement from investors. “Quite frankly, it is a lot healthier than [the 19 percent vacancy indicates],” Doyle says. “If you strip away the old or obsolete inventory, you are really looking at a 9 or 10 percent vacancy in the real Class A inventory.”

— Kevin Jeselnik

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