CITY HIGHLIGHT, DECEMBER 2011

CLEVELAND CITY HIGHLIGHTS
Authors Terry Coyne, Michael Glass, Douglas Leary, Alec Pacella

Cleveland Office Market

After years of little or no new construction, the Greater Cleveland area is experiencing the construction of a broad range of major new projects representing more than $5 billion of new investment.

Some of the largest projects include a new convention center and medical mart, a new Caesars Horseshoe Casino, plus major new medical center facilities developed for the Cleveland Clinic, University Hospitals and the VA Medical Center.

There are four new office developments that include: a 450,000-square-foot multi-tenant office tower in the Flats East Bank area of the central business district; a 580,000-square-foot world headquarters complex on 53 acres in the eastern suburb of Beachwood for Fortune 500 company Eaton Corp; a 700,000-square-foot corporate headquarters for American Greetings in Westlake, a western suburb; and a 639,000-square-foot global headquarters for Goodyear Tire & Rubber Co. in Akron to the south.

Not since the 1990s, when we saw the completion of a half dozen CBD office towers and new stadiums for the Browns, Indians, and Cavaliers has Cleveland seen so much activity.

Build new or renovate?

In mature, established cities like Cleveland, the time comes for companies and institutions to decide between building new or renovating existing structures.

The new Flats East Bank Building being built by Scott Wolstein, former CEO of DDR, and his mother, Iris, along with Fairmount Properties, is part of a major mixed-use development on 24 acres assembled by the Wolstein family.

The property faces the Cuyahoga River with views of Lake Erie. Anchor tenants include Ernst & Young, which will occupy 140,000 square feet, and the Tucker Ellis law firm, which has leased 100,000 square feet. Both are vacating a 1930-vintage downtown building to take advantage of the efficiencies of large, rectangular floor plates, a new attached Aloft Hotel, new restaurants and a fitness center.

Eaton Corp. is creating a new headquarters campus, almost doubling the space it currently occupies in a downtown office tower. The project enables Eaton to consolidate a few of its suburban locations into its main office and plan for projected growth.

American Greetings, which has grown over the years in an antiquated facility, decided its future is better served with a consolidated complex that is adjacent to a major new mixed-use complex called Crocker Park that features retail and office space as well as apartments. Goodyear Tire & Rubber Co., another of the area’s Fortune 500 companies, is building its complex adjacent to the company’s Akron Innovation Center.

The central theme for all these company commitments seems to be a move to modern facilities with amenities to attract and retain quality employees. These firms are looking to create the best work environment for their employees in order to enhance productivity and move their firms forward.

Two other major tenants have recently chosen to renovate older buildings in the CBD. Rosetta, one of the nation’s largest independent interactive agencies, recently moved to a building on historic Euclid Avenue, adding a rooftop penthouse for training, entertainment and client meetings.

Rosetta employs more than 300 people, many in their 20s and 30s. The company’s move downtown near the new, hip East 4th Street entertainment district from its previous location in the suburbs was a perfect fit.

Also, a major law firm, Calfee Halter, decided its next home was best suited in a totally renovated, classic 1930s-era building near the new convention center and county courthouse.

Flight to quality

Higher-end buildings in the CBD and suburbs are performing well compared to the overall market. The top-tier buildings (top 20 percent) in both the CBD and suburbs are experiencing a vacancy rate of only 13.7 percent compared with an overall vacancy rate of 23.3 percent.

As in past recessionary markets, quality tenants can take advantage of depressed conditions to move into higher-quality office space as the rate differential between high-end space and other space compresses.

Capital market shifts

The challenging financial market has put well-capitalized owners in the driver’s seat when competing for deals. The ability to fully fund tenant improvements, and to maintain the quality of building systems, common areas and services has been integral to retaining and gaining tenants. There have been winners and losers.

In some instances, the losers end up shuttering their buildings or repositioning them for other uses rather than operate at a loss. This is what happened recently when the 1717 E. 9th Street building, formerly known as The East Ohio Gas Building, stopped renewing tenants, forcing them to relocate to other buildings downtown.

That winnowing effect has reduced the overall office inventory and helped fill vacancies in other buildings. Another example is the recent sale of the Commerce Park 1, 2, and 3 buildings in the eastern suburb of Beachwood

This 200,000-square-foot complex, which is 3.8 percent of the eastern market, will be torn down in 2012 to make room for condominiums. Office tenants that collectively occupied 110,000 square feet in those three buildings are now in the market for space.

Many landlords are working with their lenders to restructure their loans. Some building owners are structuring deals with lots of free rent in lieu of tenant improvements, while others are offering attractive “as is” deals, or significant signage opportunities as a way to attract tenants.

Where are we headed?

Duke Realty recently sold the Great Northern Corporate Center, a multi-tenant complex spanning 273,379 square feet, to PWA, an out-of-state investor, for $26.7 million. It’s a great example of the market starting its comeback to some sense of normalcy.

As long as the capital markets continue to improve and the economy doesn’t regress, it is likely that the momentum created by the current construction boom will pay dividends in the next year or two. Occupancy and rental rates should then start to show some improvement.

— Douglas Leary is senior vice president in the office specialty group of CBRE in Cleveland.

Cleveland Multifamily Market

Redevelopment initiatives in Cleveland’s urban core will attract rental households to the area, while healthy job growth and a lackluster single-family housing market will uphold modest demand in the suburbs.

Among ongoing projects in the urban core, the $2 billion redevelopment of University Circle, which includes the expansion of the VA Medical Center, Cleveland Clinic and University Hospitals, has created more than 4,000 jobs since construction started in 2005. The renovations are expected to be complete by 2015 and will support over 36,000 jobs in the area.

Surrounding neighborhoods such as Beachwood, Shaker Heights and Cleveland Heights will benefit most as roughly 30 percent of the employees live in these areas. Many of these young professionals occupy apartments and will delay purchasing
single-family homes, a trend that will sustain demand throughout the metro area. As a result, most submarkets will post vacancy decreases this year, providing many owners with enough leverage to ease concessions and lift rents.

Construction pipeline

Development slowed significantly during the last year, as only one apartment complex came on line. The 38-unit University Lofts was delivered in the Cleveland Heights/Shaker Heights area in the first half of 2011.

The first phase of the Uptown project will deliver 102 apartments in University Circle during the fourth quarter of this year. The completion will expand rental stock in the Cleveland Heights/Shaker Heights neighborhood by 0.8 percent.

Approximately 720 apartments are in the pipeline, although no start dates have been set. The largest project on the drawing board is the 330-unit Flats East Bank, which has been stalled due to the economic downturn. After builders completed an average of 350 units annually over the past five years, developers will deliver a mere 140 units in 2011.

Weak demand for single-family homes has kept residents in the rental community this year, which in turn has helped buoy apartment operations overall. As a result, vacancy dropped 80 basis points so far this year to 4.8 percent. Vacancy at Class A apartments has decreased 60 basis points year to date to 4.3 percent. In the corresponding period last year, upper-tier vacancy contracted 130 basis points.

An uptick in blue-collar job growth supported solid demand for Class B/C units in the past three quarters, driving down vacancy 100 basis points to 4.8 percent, the lowest level since mid-2008. In 2011, solid demand will underpin an improvement of 90 basis points in vacancy, reducing the rate to 4.7 percent. In 2010, vacancy tumbled 130 basis points, the largest annual decline on record.

Operators increased asking rents 1.5 percent in the first three quarters to $733 per month because vacancy continued to decline. Effective rents grew 1.9 percent in that time to $700 per month, tightening concessions to 16 days of free rent. Class A asking rents ticked up 1.1 percent year to date to a three-year high of $914 per month. In the Class B/C sector, asking rents rose 1.9 percent to $660 per month over the same period.

Owners in the Cleveland Heights/Shaker Heights submarket capitalized on the release of pent-up demand and lifted asking rents 2.4 percent this year to a record high of $680 per month, while compressing concessions to eight days of free rent. In 2011, asking rents will post the largest gain since 2008, surging 2.2 percent to $738 per month, while effective rents climb 2.8 percent increase to $706 per month.

Investment appetite

As lenders compete vigorously for market share in the multifamily sector, private, in-state investors will increasingly target performing lower-tier assets. The buyer/seller gap will modestly narrow in the coming months as overleveraged owners come to terms with market realities and act to dispose of properties.

Local and regional investors who sat on the sidelines and balked at high prices before the recession will capitalize on discounted lower-tier assets that produce solid income streams in areas where rent growth will outpace inflation.

High-vacancy properties will also garner attention as opportunistic buyers with relatively high-risk appetites offer to pay cash for troubled properties selling at attractive prices to execute strategies to add value.

Densely populated pockets of the Lakewood/Linndale/Brooklyn and Euclid/West Lake County submarkets could see the most activity as favorable demographics will support investors’ efforts to re-tenant buildings within a two-year period.

Stabilized Class C properties will produce yields of approximately 9 percent, while distressed product will trade between $10,000 per unit and $15,000 per unit.

— Michael Glass is vice president and regional manager of the Cleveland office of Marcus & Millichap Real Estate Investment Services.

Cleveland Retail Market

One of the hardest hit real estate segments, both in Cleveland and across the nation, has been the retail sector. A dramatic reduction in consumer spending during the past four years has caused significantly lower retail sales and resulted in a long list of bankrupt retailers and struggling retail centers.

While the pullback by the consumer has ultimately led to numerous instances of shuttered stores and bank-owned retail centers across the region, there have also been some noticeable trends that illustrate the underlying resiliency and strength of this segment.

Although the pace of retail development has been at a near standstill for the past few years, some projects have begun to take shape. The furthest along is a new 86,000-square-foot Giant Eagle in Broadview Heights, which is under construction and is slated for an opening in early 2012.

Meanwhile, The South Euclid/Cleveland Heights area also has emerged as a favored development location with two large-scale projects.

The long-planned expansion and renovation to the northern half of Cedar Center began in the spring with the construction of a new GFS Marketplace. When fully completed in late 2012, this project is expected to contain approximately 60,000 square feet of total retail space as well as residential and office space.

A much larger development, known as Oakwood Village, is close to breaking ground thanks to the recent successful rezoning of a portion of the project.

This 106-acre, mixed-use development straddles Cleveland Heights and South Euclid, and will include large-format and traditional in-line retail, as well a residential component and a 21-acre park. Construction is expected to begin in early 2012.

Finally, Crocker Park, a 1.2-million-square-foot lifestyle center in Westlake, was recently selected as the new home for the headquarters of American Greetings.

The project is expected to ultimately encompass 3 million square feet, including new office, retail, residential and hotel components.  The American Greetings facility will be completed by 2014.

Trading up

Depressed pricing in the general real estate market has provided clear opportunities for several strong retailers to improve their positioning in established, built-out communities.

McDonald’s is a great example. The fast-food giant has secured redevelopment sites with much better visibility and accessibility compared to their current locations in the densely populated municipalities of Cleveland Heights and Lakewood.

Cleveland-based KeyBank has also been active, constructing retail branch banks on in-fill locations in Lakewood, Lyndhurst, Highland Heights and Independence during the past 24 months.

Meanwhile, Sonic has continued its slow, but steady, expansion into the region by recently redeveloping a former KFC in Mayfield Heights. Wal-Mart also has stepped up efforts to freshen and expand several of its stores, most notably in Macedonia, Stow and Boardman.

Switching out

The storefronts left vacant by bankrupt large-format retailers have provided well-located, high-visibility locations for new retailers new to the market, or for those merchants looking to expand their coverage.

The Borders bankruptcy has opened the door for several different retailers to enter the market, including ULTA (Solon) and Books-A-Million (Cuyahoga Falls and North Canton).

Closed locations of Blockbuster Video have also been popular sites, with Advanced Auto, AutoZone, America’s Best Eyeglasses and Anytime Fitness, each snapping up at least one former location of the troubled video rental chain. Advanced Auto and AutoZone had existing locations in Cleveland while America’s Best Eyeglasses and Anytime Fitness are new to the market.

Pittsburgh-based Levin Furniture expanded its regional footprint by replacing a former Linens ’n Things junior anchor location in Avon, as did hhGregg, which replaced a former Circuit City in Mentor.

Branching out

Despite the continued struggles of many retailers, several chains have made aggressive pushes into the Cleveland market. In an odd paradox, two of the most active categories have been fitness facilities and ice cream/frozen yogurt stores.

Examples of the former include Fitness 19, CrossFit and, as previously mentioned, Anytime Fitness. Examples of the latter include Menchies, Yogurt Vi and Robeks.

All of these retailers have opened multiple locations during the past 24 months and continue to actively work on new locations. Nearly all of these stores have opened in existing storefronts rather in new developments.

The retail segment may be down, but these examples illustrate that it certainly is not out. The prolonged shakeout has been difficult, but a healthier, stronger market is emerging. And as the economy begins to improve, this market should be in a much better position for recovery.

— Alec Pacella, CCIM,  is a senior vice president specializing in investments with NAI Daus Commercial Real Estate Services in Cleveland.

Cleveland Industrial Market

When people manufacture products in the U.S., they manufacture them in the Rust Belt, and Cleveland is in the heart of the Rust Belt. Our manufacturing sector has experienced increased occupancy and decreased vacancy levels quarter over quarter for the past three quarters. Cleveland historically has been a manufacturing market, and when manufacturing is strong the Northeast Ohio market is strong.

In addition to the strength of manufacturing, the development of the
Utica and Marcellus shales is the biggest factor affecting Cleveland. The Utica and Marcellus shales have been big in the Pennsylvania market for the past five years, but development is now moving westward into Ohio.

As drilling increases, so too does the need for services for the drillers. The drillers and their service providers need real estate, and there have been dramatic increases in prices over the past four months in rural markets such as Steubenville, Ohio. That growth is beginning to move toward Youngstown, Warren, and up to the Streetsboro area. Employment is expected to grow dramatically over the next five years.

There are still challenges with properties that were modern in the 1930s and 40s, but which have little or no value today. Many of these properties are in the inner-ring suburbs.

With the increased demand for the ferrous metals required for the Utica and Marcella Shale, scrap metal prices have increased. Many functionally obsolete buildings are being torn down so that their steel can be reclaimed in local furnaces and remade into pipes for the Utica and Marcella Shale. So, there is a cleansing occurring as owners remove these blighted structures and provide good developable land.

Changing landscape

The largest industrial project under way is the redevelopment of the former Chrysler Stamping Plant in Twinsburg. This 2.2 million square-foot building on 167 acres was the world’s most efficient stamping plant.

During the restructuring of Chrysler, the plant was shut down. It was sold to used equipment buyers who auctioned off the equipment and resold the building to Independence Excavating, a local development firm, and Scannell Properties of Indianapolis.

Of the 2.2 million square feet, up to roughly 700,000 of it is going to remain standing while the balance has already been torn down. The site is going to be redeveloped into Cornerstone Business Park. It will be a modern manufacturing and distribution park with rail to most of the sites, and tremendous power capacity.

The City of Twinsburg is working as a partner with the developers and helped them to land Performance Food Group for a 135,000-square-foot warehouse/distribution center. Performance Food Group was looking to relocate out of the city, but because of the availability of this land the company remained in Twinsburg.

Based on projections, it is likely that this industrial park will employ more workers after it is fully built out then Chrysler did only a few years ago.

The two hottest submarkets are the Southcentral market where I-77 and I-480 come together and the Southeast market along I-480. Both have a large base of industrial properties with good highway access.

Over the next few years, the biggest trends will be the return of build-to-suits and a reduction in obsolete manufacturing facilities. As manufacturing stays strong, renovations and new construction will increase, creating a more modern industrial market.

— Terry Coyne, CCIM, is an executive vice president in the Cleveland office of Grubb & Elis Co.

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