HEARTLAND SNAPSHOT, FEBRUARY 2008

Cleveland Office Market

The Cleveland office market can best be described currently as one with steady positive growth, which is notable after many years of decline.

“What we’ve seen is a tightening of the market in the CBD in the past 2 years, particularly with Class A space. But vacancy should be back in single digits by early [this] year,” says Doug Leary, a senior vice president at the Cleveland office of CB Richard Ellis.

The vacancy rate for the downtown Cleveland Class A office market averages 10.5 percent, and has been continually improving. Leary adds that if the average did drop into single digits, it would be the first time since 9/11 that it has done so.

Class A suburban office space is seeing improvement, particularly in the eastern suburbs. In fact, the eastern market has already reached the benchmark of a single-digit vacancy rate.

“As Class A product improved, the Class B product actually got weaker,” Leary says.

Because of the opportunities available for Class A space, many office users have been stepping up from Class B to Class A offices. And with a lack of new users moving into the area, vacancies increased marketwide for Class B product. The segment is still showing some weakness overall, but vacancies have fared better in the eastern suburbs, where the market is fairly tight.

While new tenants may not being moving into the city in large numbers, Cleveland is seeing a lot of internal organic growth from established companies. The growth is being led by the legal and financial services communities in the downtown area, but is not restricted to those groups. In fact, PR Newswire recently created a regional office in Cleveland to cover the eastern United States, consolidating some of its other offices. By many cities’ standards, a 30,000-square-foot lease does not seem like much, but these smaller expansions are the norm right now in Cleveland, and are fueling the city’s modest growth.

And with vacancies decreasing, the talk of the town is that Cleveland may finally be poised for new office development.

“It’s been several years since we’ve seen any meaningful development in the suburbs, and it’s been 16 years since we’ve seen a new multi-tenant building downtown,” Leary says. “That’s about to change, we believe, in the next couple of years, and we think demand has picked up enough — and there’s enough meaningful discussion going on now — for new buildings to be considered, particularly for large users.”

Leary says that the supply constraint of the past few years allowed Class A building owners time to stabilize their properties and improve occupancies. These owners were able to capture the tenants that stepped up in quality, partly because no new buildings were coming to market to compete.

Nothing has broken ground just yet, but plenty of plans have been drawn up. Most of the more notable projects are located in the downtown market, and are being developed by local companies such as Forest City Enterprises, The Ferchill Group, Stark Enterprises, The Wolstein Group and The Jacobs Group.

“You’ve got people with tremendous credibility — who have real track records — talking about developing new product. What it is going to take is [for one company] to commit,” Leary says.

The skyrocketing cost of construction is proving to be a barrier for development, causing builders to secure an anchor tenant before breaking ground on any new project. Combine that with a market that is coming off of years of sluggishness, and it makes for a cautious environment for new development.

“You’re not going to see any kind of speculative space like we saw back in 1991, which was the last meaningful amount of construction, where we had 3 million square feet come online, with a fair amount of speculative,” Leary says. “You’re going to see buildings that are smaller in scale, that have major anchor tenants, that are efficiently constructed, and in some cases, are part of mixed-use developments.”

Wolstein and Fairmont Properties are developing the Flats area, which is aiming to be the catalyst for a 24-hour downtown district in Cleveland. Some site work has been performed, and the developers have the proper incentives in place. As of now, they are proceeding with the mixed-use development without an office component, and waiting to see if they can land a big tenant.

While the growth and development in Cleveland may be locally based, a lot of money is still flowing into the market.

“We’re seeing a lot of capital flowing into Cleveland from major metropolitan areas like New York and Chicago, where investors see Cleveland as a good opportunity to buy existing product…because the cap rates are better than what they’re seeing at the major metropolitan areas,” Leary says.

With vacancies decreasing and talks of new development on the horizon, the future looks bright for Cleveland’s office sector. Leary says that in the near term, the absorption of available Class A property will continue, especially in the south suburban market. This will be followed by new construction over the next 2 to 3 years in the downtown market to serve large users, and in the eastern suburbs, where there is pent up demand for office space. Most new product will also come online at least partially leased.

“I don’t think people have an appetite for speculative building at this point,” Leary says, adding that the current state of the capital markets are demanding pre-leasing in new office product.

Once the new office projects start breaking ground, Cleveland will once again become one of the more talked-about towns in the Midwest.

©2008 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.