Like most cities across the country, St. Louis is experiencing an increase in vacancies, a decrease in lease rates and a significant drop in absorption. However, unlike most cities, St. Louis is keeping its head above water. “[The city’s] advantageous mid-market size and diverse employment base are keeping vacancy increases mild and rental decreases modest compared to larger markets where vacancies have climbed past the 20 percent mark and lease rates have dropped dramatically,” says Lynn Schenck, vice president for St. Louis-based Grubb & Ellis|Krombach Partners.

However, while St. Louis is faring better than most, the softer market has had an impact on development. Developers have significantly halted speculative construction, which is down approximately 35 percent from a year ago. Instead, developers are focusing on build-to-suit projects, which constitute the majority of the almost 1.9 million square feet currently under construction. Development activity will continue to focus on build-to-suit projects until more office space is absorbed in the coming year.

Some of the larger build-to-suit developments taking place include A.G. Edwards’ 800,000-square-foot downtown campus, CitiGroup’s 515,000-square-foot campus in St. Charles, and Magellan Health Services’ 232,521-square-foot office in Riverport. The A.G. Edwards development will not have a significant effect on the market because it is being built primarily for future growth, and it will not be filled with tenants from other buildings. However, CitiGroup’s campus will leave a big hole in the Highway 40/Chesterfield submarket. Additionally, when Magellan moves in to its new offices, it will leave 197,228 square feet in the Riverport submarket, thereby increasing vacancy in the area from an already high 12.3 percent.

Office development in the St. Louis area is continuing to move westward. “In the last few years, St. Charles has seen unprecedented growth and witnessed its own land rush,” Schenck says. “Larger land parcels, lower ground costs, and a proactive government and business community have proved an enticing combination.” Employers are also attracted to the area for its strong demographics and labor pool. In addition to CitiGroup, some of the area’s largest employers, including MCI WorldCom, MasterCard International and Enterprise Rent-A-Car, have or will be relocating to new corporate campuses and data facilities.

In the last few years, both Scannell Properties and Opus Development Corporation have entered the St. Louis market with speculative projects.
However, many employers have been forced to either downsize or close their doors altogether because of the weakened economy, a volatile stock market and the threat of impending war with Iraq, Schenck says. “Consequently, there are not a lot of large tenants looking in the market right now.” DuPont’s Protein Technologies is one of the only larger prospects currently in the market, entertaining several options for nearly 100,000 square feet of office space, and 80,000 square feet of research and development space.

Despite the economic obstacles, there have been a handful of recent major transactions. These include Savvis Communications, leasing the 156,000-square-foot MCI WorldCom building in Chesterfield; Pharmacia Corporation, subleasing 90,000 square feet from Solutia; Magellan Health Services, leasing 232,521 square feet at Riverport Commons; MicroSoft leasing 50,000 square feet at CitiPlace III and Spectrum Brands leasing 80,000 square feet at Page and Scheutz roads.

Several portfolio transactions were also completed in 2002, including AFL-CIO Building Investment Trust’s sale of three buildings to Israel-based Honit Investments for $32.5 million. The Class A buildings totaled 252,000 square feet and were 100 percent leased at the time of sale. Toward the end of the year, the market saw a flood of deals in a short period. BGK Equities purchased the 12-building Corporate Square Office Complex in Creve Coeur for approximately $33 million. At the same time, TA Associates, which continues to expand its ever-growing presence in the St. Louis metro area, purchased three separate buildings in Clayton from a joint venture between Praedium Group and Insignia Financial Group. The space, which totaled about 300,000 square feet, sold for close to $29 million. Finally, HRPT Properties, a Boston area-based REIT, is finalizing its purchase of One Financial Plaza at 501 North Broadway from the bankruptcy trustee of the former Edison Brothers building. At closing, the deal is expected to fetch $35 million.

However, despite these transactions, vacancies remain in the area. Vacancy rates for the various types of space are 15.5 percent for Class A, 13.4 percent for Class B and 12.8 percent for Class C space.

Higher vacancies and an increase in supply have put downward pressure on rents. On average, lease rates are down approximately 15 percent from last year. Downtown, the Highway 40/Chesterfield submarket and the St. Charles submarket have been hit hard, with rates dipping substantially below normal asking prices. However, Clayton has managed to hold its own. Despite a 14 percent increase in its inventory last year, Clayton still has lower vacancies than most of the other submarkets. The older Class A buildings are suffering as they are now forced to compete with the Class B inventory and the additional sublease space.

“For those companies looking for bargains, Downtown St. Louis will be the best bet with the most economical space,” Schenck says. There will also be continued growth in St. Charles as companies relocate to strategic in-fill sites.

One of the key factors defining the St. Louis office market can be summed up in two words — sublease space. These challenging economic times are forcing businesses to reduce or leave their space before their leases are finished. Companies such as Cap Gemini Ernst & Young and Energizer are currently subleasing their space. MCI WorldCom is expected to put space back on the market in the coming year. Those submarkets posting the highest amount of sublease space include Downtown at 207,609 square feet, and the historically strong Highway 40/Chesterfield submarket with 388,226 square feet.

“Sublease space can also be a lucrative option for tenants as these deals have also been known to include the furnishings, telecommunication equipment and computer systems the previous tenants have left behind,” Schenck says.

As landlords struggle to keep their buildings full, they are offering free rent, shorter lease terms and lease buyouts for prospective tenants. Fortunately, low interest rates and declining cap rates are providing owners a cushion during these challenging times.

Lynn B. Schenck is vice president of Grubb & Ellis|Krombach Partners.

©2003 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.