CITY HIGHLIGHT, JANUARY 2010

KANSAS CITY — CITY HIGHLIGHTS
David Block, Michael T. Mayer, Paul Licausi, Robert O. Schock, William G. Powell

Kansas City Retail Market

Greater Kansas City, which encompasses 15 counties and has a population of more than 2 million, is continuing to cruise along at half speed, on a little bit of a bumpier road. Though Kansas City has typically felt little effect from the fluctuations on the national economic scene, the present financing environment has delayed many proposed retail developments that were in the works prior to 2008/2009. In spite of these delays, several of these developments are nevertheless moving forward toward completion.

The active retail developers in Kansas City that currently have major projects in the works include RED Development, Lane4 Property Group, RH Johnson Company and Block & Company Inc. Realtors.

It is common for retail developers to follow a city’s residential growth. Many of the current developments in Kansas City by aforementioned developers follow this trend and are designed to fit the needs of the surrounding demographic from which they draw.

Block & Company Inc.’s Best Buy at The Plaza at the Speedway, which is located at the intersection of Interstate 435 and Parallel Parkway in Kansas City, Kansas.

Some of the larger retail developments include RED Development’s 500,000-square-foot Summit Fair, which is located at the intersection of Interstate 470 and Highway 50 in Lee’s Summit, Missouri, and anchored by Macy’s and JC Penney; Block & Company and RED Development’s 600,000-square-foot Adam’s Dairy Landing, which is located at the intersection of I-470 and Adams Dairy Parkway in Blue Springs, Missouri; Omaha, Nebraska-based Cormac Company’s 1.1 million-square-foot Corbin Park, located at the corner of 135th Street and Metcalf Avenue in Overland Park, Kansas; and Block & Company’s The Plaza at the Speedway, a 850,000-square-foot retail center located at the corner of Interstate 435 and Parallel Parkway in Kansas City, Kansas. These centers offer a bevy of retailers including Wal-Mart Supercenter, Kohl’s, Best Buy, Lowe’s Home Improvement Warehouse, Books-A-Million, Barnes & Noble and Lifetime Fitness. All of these developments and their success will set the standard by which future retail developments will be designed, laid out and sized.

In the next 2 to 3 years, the market should see the absorption of existing retail space instead of a great deal of new development projects. Consequently, these existing new developments may likely be the last large retail construction projects Kansas City will see for a few years. Future development will continue at a much slower pace than in the past and will only be created to fit market needs, or until construction financing becomes readily available for new projects.

Macy’s is one of the many tenants at RED Development’s Summit Fair in Lee’s Summit, Missouri.

Despite the slowdown in new retail development trends, construction and new plans continue to grow in one part of the metro—the Kansas City, Kansas, Speedway district, which is a major tourism destination project. The Speedway district has a significant amount of planned future activity, including Schlitterbahn Vacation Village, the proposed Kansas City Wizards soccer stadium and event center, the proposed Hard Rock Hotel & Casino and numerous other anticipated plans. The area is especially unique because residential growth is following these developments, a rare departure from the typical Kansas City trend.

Today, the Kansas City market as a whole remains stable with a very low vacancy rate, between 8 percent and 13 percent depending upon the submarket. These percentages do not take into account the numerous enclosed malls, which are proposed for redevelopment but have yet to announce a formal redevelopment plan and construction schedule. Junior box development has been very slow throughout 2009, but 2010 looks to be brighter based upon recent negotiations and transactions. Tenants looking to lease space during this year enjoyed a buyer’s market with regard to lease rates and tenant improvement options. Lack of viable tenant interest has negatively impacted rental rates, placing the lessee in a favorable position to arrange a below-market lease rate. Adding to the decrease in lease rates is the significant loss of retail sales due to the job market and current global economic condition.

Even so, Greater Kansas City remains economically sound. As the economy continues to recover, the influx of new money and new jobs will see new residential development following closely behind, reflecting a much brighter future for retail developments in Kansas City.

— David Block is president of Kansas City, Missouri-based Block & Company Inc. Realtors.

Kansas City Office Market

While the Kansas City office market continues to struggle as the economy regains momentum, there was some positive movement during the third quarter of 2009. Net absorption for the nearly 47 million-square-foot office market moved into positive territory for the first time in a year.

The 4,000 square feet of net absorption did not necessarily mean the tide had turned. Rather, most of this was triggered by a few larger moves that had been in the works for some time. These moves produced 223,000 square feet of positive absorption during last year’s third quarter. Kiewet Power Engineers moved into its 150,000 square foot build-to-suit in North Johnson County. Kansas City Power & Light expanded its footprint by 45,000 square feet as part of its move to 260,000 square feet in One Kansas City Place in downtown. Such moves, though, were offset by negative absorption of 219,000 square feet in the Class B office market as tenants shed space or upgraded.

Kansas City’s office market had a strong 4-year run heading into 2009, with occupancy increasing by 5 million square feet from the third quarter of 2004 through the third quarter of 2008. Needless to say, it would have been difficult to sustain such momentum even without the economic downturn. As the calendar turned to January, there were a few construction projects proceeding, with some 820,000 square feet entering the market. Fortunately, most of these were build-to-suits. This included Kiewet Power’s new 95,000-square-foot Farmers Insurance building, a new 200,000-square-foot headquarters for JE Dunn Construction and a 160,000-square-foot US Bank Technology & Operations Center.

The only speculative projects were the 110,000-square-foot Two Hallbrook Place and the 105,000-square-foot Pinnacle Corporate Center III. The second Hallbrook building was developed for Hallbrook Office Center LLC, which is owned by several trusts of the Hall family. It opened in mid-May in search of tenants. Its amenities and premier location in the South Johnson County submarket position it to attract tenants looking to make a statement. Its sister building is 96 percent leased. The Pinnacle Corporate Center opened in early 2009. The new building also is in Leawood, Kansas, part of the South Johnson County submarket that now boasts nearly 15 million square feet of office space. The building is nearly 60 percent occupied.

With nearly one-third of the area’s office space, developers have favored South Johnson County for its locations along major thoroughfares. That being said, this area will need to take a breather during the next couple years. The vacancy rate for Class A space has risen from 9.8 percent at the start of 2009 to 13.8 percent by the end of the third quarter. There has also been an uptick in sublease space, putting further pressure on landlords.

As the economy took its toll on office space and the financial markets also tightened standards, one major project was stymied. Trilogy Development’s West Edge office project on the west side of the Plaza submarket has been stalled. The 200,000-square-foot property, which features office, retail and hotel space, is nearly 75 percent complete, but work was halted when its developer filed for Chapter 11 bankruptcy.

With higher vacancy rates and increasing sublease space, landlords certainly face pressures. Lease rates for Class A space fell from an average of $22.22 per square foot as of the third quarter 2008 to $20.70 per square foot by the third quarter of 2009. Subleases, which make up about 1.2 percent of the Class A market, offer even bigger discounts to tenants. The average asking rate for such sublease space hovers around $16.39 per square foot.

Against this backdrop, tenants with good credit and confidence in their business can trade up to Class A space at favorable terms. Many also are looking at renegotiating existing leases before their term expires. Moving forward, no new construction is on the horizon for general-use office buildings. One sector, though, continues to see robust activity. The medical office sector has been active with three buildings completed during the first half of 2009. Several more medical projects are nearing completion, and the University of Kansas has two medical office buildings totaling more than 223,000 square feet, which are scheduled for completion in 2011.

As for the overall office market, the market is forecasted to experience increasing vacancy in the coming months and continued pressure on lease rates. Activity will center on tenant upgrades and renegotiations. While economists predict that Kansas City will recover earlier than many areas of the country, they also caution that the recovery will be a slow, gradual process. Patience and perseverance will serve building owners well in the coming year.

— Michael T. Mayer, SIOR, is a principal and director of office and sales in Colliers Turley Martin Tucker’s regional office in Kansas City, Missouri.

Kansas City Industrial Market

Despite a weak economy and the continued challenges in the real estate market, the Kansas City industrial real estate market is holding steady. While the majority of the country is experiencing double-digit vacancies, the overall vacancy rate remains in the single digits at 8 percent, which is a testament to the consistency of the market. The prevalent thinking has been that the coasts, the southwest and the southeast, are the hot spots for market activity. While this is true when the economy is doing well, these are also being hit hardest during the current recession. Meanwhile, Kansas City remains relatively stable with very little upward movement in vacancy rates. The constancy in the  Kansas City market is appealing to corporate users and investors that are interested in developing in a market with long-term stability.

The lead stories in the market continue to be the major investments by the railroads. Kansas City Southern Railroad has completed a major investment for its new intermodal hub in southeast metro area at the CenterPoint Intermodal Center. The facility will serve rail traffic from the deepwater ports on the Mexican Pacific coast, inland Mexico and a large area of the Southeast and Southwest United States. Additionally, Burlington Northern Santa Fe Railway (BNSF) is preparing to commence construction on a new Intermodal Logistics Park, which will be located in Edgerton, Kansas. The project will be a major intermodal facility covering more than 350 acres and will serve ports in the Western United States as well as a large portion of the western part of the country. In addition to these two major intermodal facility investments by the railroads in Kansas City, both Union Pacific and Norfork Southern have major intermodal facilities in area as well. The new rail infrastructure adds to the significant existing rail facilities in Kansas City. Serving as a hub for all the major railroads, Kansas City is the second largest rail hub in the country.

Although there is significant investment occurring in the market, new development has remained limited for the last 2 years. The market is dominated by local developers, and industrial development activity has been at a measured pace that has allowed the market not become overbuilt. This restraint by the local development community allows vacancy rates to remain in the single digits and lease rates to remain relatively flat, while other parts of the country are seeing lease rates decline. Lease rates for second-generation or older warehouse facilities are averaging from $3.25 to $3.75 per square foot. New warehouse facilities offering available space exceeding 20,000 square feet will average from $4.25 to $5.00 per square foot. Flex space has experienced the largest decline due to the down economy, with vacancy rates exceeding 10 percent and lease rates averaging in the mid-$8.00 range per square foot range.

One bright spot continues to be the large box distribution sector of the market. The activity from large corporate users continues to grow, and the market is on the radar for most of the large box distribution center requirements. Large box activity is occurring in South Johnson and North Johnson counties in Kansas, the KCI submarket and Eastern Johnson County in Missouri. Some of the more notable large box developments include the 450,000-square-foot Pure Fishing facility, Kimberly-Clark’s 450,000-square-foot project, the 440,000-square-foot Pac Sun facility, Musician’s Friend’s 700,000-square-foot project, Case New Holland’s 500,000-square-foot property, Kessinger/Hunter’s 600,000-square-foot spec building and The Coleman Company’s 1.1 million-square-foot project. Kansas City is projected to see continued growth in the large box distribution sector. Developers with projects either under way or planned include LS Commercial Real Estate’s Midwest Commerce Center and Carefree Industrial Park, CenterPoint and Zimmer Real Estate Services’ CenterPoint Intermodal Center, Kansas City Logistics park developed by BNSF and Allen Group, Block Real Estate Services’ 175th Street Logistics Park and Trammell Crow Company and CB Richard Ellis’ KCI Intermodal Business Center.

Supporting the distribution and warehouse space in the market is a well-established manufacturing sector. Kansas City is home to two car plants, General Motors and Ford, as well as a multitude of supporting manufacturers for the plants. Additionally, Kansas City has one of the greatest concentrations of manufacturers in the animal health sector, with more than 100 companies in the region. Finally, announcements were recently made for a new $600 million Department of Energy production facility that will replace the current facility in Kansas City and will be operated by Honeywell Corporation. These are just some of the highlights for the manufacturing sector in Kansas City.

What can we expect during 2010? The industrial real estate market in Kansas City will remain steady with improvement during the last half of the year. Lease rates will remain flat throughout most of the year, with possible growth toward the end of the year. Flex space vacancies will trend downward and should be less than 10 percent by year-end. Warehouse and manufacturing space will remain stable, and vacancy rates will continue in the single digits, which is well below the national average.   

— Paul Licausi is president of LS Commercial Real Estate in Overland Park, Kansas.

Kansas City Multifamily Market

From a general outlook perspective, most observers agree that Kansas City’s apartment market was impacted less than other Midwestern cities by the recession because supply and demand were in relative equilibrium when the economic downturn began. Owners and investors in the Kansas City metro apartment market believe market occupancy and rents have found the bottom, but will not necessarily see significant improvement over the next 12 months pending job market recovery. Currently, there is not an oversupply of apartment assets in deep distress or foreclosure, though the watch list is growing. The development pipeline is all but shut down. Employment levels have not begun to rebound so we can expect vacancy and concessions to continue at current levels over the winter and into the 2010 leasing season.

In 2008, new construction totaled just 497 units, while 653 units are scheduled to come on line by the end of 2009. About 400 units will enter lease up in 2010 followed by deliveries averaging 650 units annually from 2011 through 2013, if announced plans become reality. Though that seems a modest amount, there is a shadow market to keep in mind—more than 7,000 homeowners received foreclosure notices during the first half of 2009, as reported by Realty Track. The challenge for the apartment industry is the additional rental units that this represents. Though the market struggled to show rent growth of 1.9 percent in 2008, so far we have seen that given back in 2009 with a projected 1.5 percent rent decline by year-end. Rent growth, if any during 2010, will be minimal. It is anticipated that rents will slowly increase at a very modest 1- to 2-percent range from 2011 through 2013.

Occupancies are also correspondingly flat. Not too many years ago, the Kansas City apartment market was included among those enjoying the lowest vacancy rates. With the current recession and job losses in the area comprises demand, that picture has been altered. According to Reis, the current forecast calls for a year-end rate of 8.6 percent; however, there are a number of areas that will be impacted because of a large percentage of lower tier space, mainly Class B and C properties, which are showing vacancy rates closer to 11 percent. Either way, the market is still under pressure from generally weak demand as more and more renters are doubling up or moving in with family to reduce costs, which is causing owners to raise concessions in an attempt to maintain occupancy levels.

The economic malaise has impacted all submarkets including, to a lesser degree, Johnson County, Kansas, which is the region’s job growth engine. Class A assets continue to lease aided by concessions, though the government’s housing rebate program has also caused some softness in that tier. Class B and C assets have been impacted more by rising vacancy that correlates strongly with job loss, which is already equal to the previous recession. Kansas City’s Northland area was in the midst of a building cycle at the onset of the recession that has impacted absorption, occupancy and effective rents. The booming downtown expansion included a number of condominium projects that are now being absorbed as rentals including 400 new units that are due to come on line at the first of the year.

Sales velocity for apartments is at all time lows from the market peak experience in 2006 and 2007. This lack of sales is a direct result of the correction that occurred in the pricing, underwriting and investor interest focused on the more distressed coastal markets. There have been few Midwest sales to establish firm cap rate benchmarks, though Kansas City is trending toward the 8- to 8.5-percent range. There is a growing amount of REO related inventory on the watch list or in the pipeline where the flow has been delayed by loan modifications and extensions, as has occurred in many markets across the country. Overall, apartment sales velocity in Kansas City should increase in 2010 as distressed properties finally find the way to the market. With the recession winding down and improved third and fourth quarter results being reported, some non-distressed owners may begin to test the market in late 2010.

To summarize, though Kansas City’s multifamily market is relatively healthy compared to other markets around the country that have suffered from boom and bust cycles rather than Kansas City’s more stable economy, 2010 will still be a challenging year. With occupancies flat and continuing to decline, the pressure will be on to maintain operational efficiencies in an attempt to at least maintain a flat bottom line. Sales velocity may pick up as distressed properties start to come to market; however, the trend for now has been for the lenders to pursue a workout strategy with their borrowers rather than for foreclose. This is a segment that will be watched very closely by both property managers and brokers alike.

— Robert O. Schock is senior vice president director of property management at The Yarco Companies in Kansas City, Missouri. William G. Powell is an associate partner with Hendricks & Partners in Kansas City, Missouri.

©2010 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.