CITY HIGHLIGHT, JANUARY 2012

KANSAS CITY HIGHLIGHTS
By Nathan Anderson, David M. Block, Gary O’Dell, Ryan Schneider and Laurel Wallerstedt

Kansas City Office Market

Schneider

The fate of the Kansas City office market in 2012 looks similar to other major metros across the country. Tepid job growth continues to hinder robust demand for office space in Kansas City. According to Jones Lang LaSalle (JLL), the vacancy rate topped out at 20.2 percent in the second quarter of 2011, but declined to 20 percent in the third quarter. This marks the first time in 3 years that the vacancy rate has declined. 

Vacancy rates should continue declining in 2012, and Class A rents are projected to trend upward as tenant demand continues to rise. There is no new supply or speculative development coming on line in the market. Until office employment achieves measurable gains, however, vacancy rates will remain high.

Throughout 2011, leasing activity was divided into two categories: companies arranging short-term renewals, and financially strong companies signing long-term leases in an attempt to lock in low rental rates. As of the third quarter of 2011, 78 percent of all national markets were still considered “tenant favorable.” In 2012, however, most markets will transition to more neutral conditions, while 35 percent will remain “tenant favorable.”

 For local tenants, choices will continue to abound. However, given the lack of new supply under construction coupled with economic indicators pointing toward the stabilization and the eventual tightening of commercial real estate fundamentals, we expect supply and demand to realign in the latter half of next year.

Nationally, leasing conditions remain highly opportunistic for tenants. Asking rents, while no longer falling, remain significantly discounted and landlords are often willing to negotiate favorable terms, such as concessions. However, the window of time to take advantage of low rental rates is finite. The recent plateau in national vacancy left landlords feeling more confident as national average asking rents inched up slightly to $27.74 per square foot in the third quarter.

As with the national trend, leasing conditions in Kansas City are tenant-friendly. Average asking rents for Class A space rose from $20.30 per square foot in the first quarter to $21.37 per square foot in the third quarter.  

The market is approaching the bottom, and given the current flat rate of economic and employment growth, Kansas City will maintain its space at the bottom of the market. Occupiers still have opportunities to benefit from this strong tenant’s market. It is unlikely that the market will see an overall large-scale reduction in asking rents during the next 12 months. Now is the time for tenants with expiring leases to create leverage with landlords to lock in the most favorable rates possible.

We also expect tenants to enter into short-term renewal arrangements until they feel more comfortable with the nation’s economic outlook.

We also believe that the November 2012 elections could be an inflection point for the entire commercial real estate sector as businesses are currently in a wait-and-see mode.

Landlords should hold tight because their time is coming. We expect owners to see significant leverage in lease negotiations in 2013 and beyond.

Ryan Schneider is senior vice president and Gary O’Dell is vice president in Jones Lang LaSalle’s Kansas City office.

Kansas City Industrial Market

Anderson

After a three-year winter, the ground is thawing in Kansas City. We’re experiencing low vacancy rates, positive absorption and a lack of quality industrial product. As equity accumulates on the sidelines, the field appears set for an interesting 2012. CenterPoint Properties and the Allen Group are developing competing intermodal centers on opposing sides of the Kansas/Missouri state line. Both are aggressively pursuing large users, leveraging tax incentives and low land costs to attract big-box distribution to their parks.

Here are the factors that should contribute to a breakout year for Kansas City:

Low vacancy rates — The five-county Kansas City industrial market contains 256 million square feet, roughly 13 million of which is considered flex space. Removing the flex space from the equation, 2011 ended the year with 6.8 percent vacancy. It’s remained pretty static during the past 3 years, and is up only slightly from the 5.2 percent low experienced in late 2008. Digging in deeper to the numbers, the vacancy rate actually drops to 5.6 percent in buildings that can accommodate 150,000 square feet or greater. At 250,000 square feet, the vacancy rate drops again, this time to 5.3 percent — and then it gets ridiculous. Factoring in only buildings with 20-foot clear height ceilings that can
accommodate users of 250,000 square feet or greater, the vacancy rate dips to 3.6 percent. In terms of product, that’s only 1.2 million square feet of vacant space to accommodate larger users.

Dearth of Class A space — This begs the question, “Why hasn’t there been more Class A industrial development in Kansas City during the past cycle?” A deep bench of local brokers and developers has long controlled Kansas City, making it difficult for institutional developers such as
REITs, pension funds, and life companies to compete for market share. Names like Prologis, Bedford Property, Glenborough, and Liberty Property Group have all tried to build a presence here before taking an early exit.

Most local developers have little basis in their land cost, having held these sites for more than a decade. This advantage, along with their local knowledge, hasn’t led to much in the way of speculative development in Kansas City. The threat of lower-cost development, however, has served to dampen the enthusiasm of national developers eyeing the market.

From 2000 through 2008, the Kansas City industrial market averaged 1.97 million square feet of new development annually. Since 2008, we’ve seen only a total of 1.9 million square feet of new product delivered, and 1.1 million in a single built-to-suit for Coleman Distribution. This lack of new development mirrors national trends, but it has been exacerbated in Kansas City due to a lack of Class A product built from 2000-2008.

Excess equity needs a home — Institutional investors have a stockpile of cash. Private equity is fighting for a seat at the development table, but is handicapped by a lack of land
positions in Kansas City, as well as its need for a greater return on its investment.

On the Missouri side of the line, the California Public Employees’ Retirement System (CalPERS) and CenterPoint have spent millions of dollars in streets and infrastructure on Phase I of their 1,000-acre intermodal park. Served by the Kansas City Southern Railway, the park has shovel-ready sites but has yet to land a large distribution client. They’re targeting international shippers who may consider a shift from the western port cities to the port of Lazaro Cardenas, Mexico.

Along the I-35 corridor in Kansas, the Allen Group is moving dirt on its 560-acre intermodal park in conjunction with the Burlington Northern Santa Fe rail line. With the ability to offer a 75 percent tax abatement, low drayage costs and immediate access to the NAFTA corridor, it appears to be a front-runner in the big-box race going into 2012.

I’m projecting 2 million square feet in new industrial development projects to be announced in 2012. Let’s hope this signals the beginning of a nice 10-year run in Kansas City.

— Nathan Anderson, SIOR, CCIM, is managing principal of Lee & Associates Kansas City.

Kansas City Apartment Market

Wallerstedt

Kansas City’s apartment market showed surprising resiliency in 2011 on the heels of the Great Recession, says Monte Wendler, principal at locally based Price Development Group (PDG. Indeed, rents and occupancies have improved markedly in the metro area, according to Hendricks & Partners, a national multifamily investment banking firm. Net absorption totaled about 2,500 units in 2011, the highest annual absorption since 2000.

This trend away from home ownership, along with few new apartment completions for the year, has directly impacted the bottom line of apartment owners. Ward Katz, president and CEO of Dunes Residential Services Inc., another veteran apartment developer in the Kansas City area, says his properties are enjoying their highest occupancies in 10 years, and he’s seeing upward pressure in rents and significant increases in revenue.

The Kansas City metro area finished 2011 with an overall average vacancy rate of 6.1 percent, which is a 2 percent improvement year-over-year and the lowest level since 2001, according to Hendricks & Partners. Every submarket within the metro area showed improvement in occupancy. This increase in occupancy has not come at the sacrifice of rental revenue. Across the metro area, inclusive of all asset classes, rents edged up 2 percent year-over-year from 2010. The average rent at the end of 2011 was $727, up from $713 in 2010.

Time to sell?

Such good news on the operational front, plus historically low interest rates offered by willing lenders, spells opportunity for buyers and sellers. Many previously reluctant owners are finally recognizing the finite window of cheap, available debt that adds value to their asset at sale. As interest rates rise, a property’s net operating income must grow 4 percent for every 50 basis points that debt rates rise just to maintain the same property value.

Excluding transactions in nearby markets such as Lawrence, Topeka, and Columbia, 6,714 units sold in 37 Kansas City area transactions in 2011, up from 23 in 2010 and 16 in 2009. (The sales involved properties with 40 or more units.)

Investors for all classes of apartments are now seeking to buy in the Kansas City metro area. In the second half of 2011, the Kansas City metro area saw a flurry of seven Class A dispositions, with 1,850 units selling at an average price of $91,774 per unit and an average cap rate of 6.23 percent.

These sales included Stonepost Lakeside, Bella Palazzo, Dunes at
Falcon Valley, Wynnewood Farms, BarreWoods, Signature Place and The Trails. All but one of these properties, BarreWoods, are located in Johnson County. Surprisingly, it’s BarreWoods in the Northland that takes home the blue ribbon for lowest cap rate, reported to be 5.25 percent on actual trailing 12 months net operating income.

Among Class B properties, 2011 will be remembered as the year of the area’s largest portfolio sale by number of units. Seven of the nine Class B deals were part of the 1,395-unit portfolio sold by Bill Powell of the local office of Hendricks & Partners.

Despite their age, Class C apartments in 2011 were the belle of the ball, the driver behind the interest of investors seeking discounted, value-add opportunities. Sales of Class C assets accounted for 49 percent of all the qualifying transactions in the Kansas City area in 2011. Those 20 properties, comprising 2,926 units, sold at an average cap rate of 9.02 percent and an average price per unit of $29,132.

New construction

New apartment completions totaled approximately 550 units in 2011, down from 1,465 units in 2010 and below last decade’s annual average of 932 units. About 650 new multifamily permits were issued in the greater Kansas City metro area in 2011, up from 306 units permitted in 2010. Total volume of building permits for each of the past 10 years has averaged 1,993. 

In 2011, developers completed four apartment projects in Johnson County: West End at City Center in Lenexa, 309 units (built by Embrey Partners Ltd. out of San Antonio); The Fairways at Corbin Park, 276 units in the southeast corner of 135th St. and Metcalf (built by A.G. Spanos); and Stonepost Ranch III, 201 units in the southeast corner of 135th Street and Pflumm Ave (built and owned by Price Brothers). Local developer Pat Kelly has completed, and is leasing up, the 331-unit Kelly Park near 133rd Street and 69 Highway in Overland Park.

Additional suburban developments underway include Prairie Creek, 308 units in the northwest corner of 95th and Renner in Lenexa; 250 units at the northwest corner of 135th and Goddard in Overland Park; and The Greens at Corbin Park, 228 units in the southeast corner of 135th and Metcalf in Overland Park.

Citing his ongoing belief in the strength of the Johnson County apartment market, Kelly is developing Phase II of Kelly Park. It will consist of 85 units, bringing the overall unit count for the development to 516.

Price Brothers recently received city approval for its 177-unit development at 46th Street and Pennsylvania Avenue on the Country Club Plaza, a luxury development with a construction price tag estimated at $167,000 per unit.

Just west of the Plaza, the owner of Woodside Racquet Club is seeking permission from the City of Westwood to build 303 luxury apartments atop 35,000 square feet of retail.

According to John Foudray, director of development and pre-construction services at Neighbors Construction Co., apartment construction firms are busy pricing and estimating for developers looking to build in the area. Foudray says developers can play in this arena today, if they have the cash to satisfy lenders’ lower loan-to-value requirements for construction loans. 

Neighbors is building The Village at Mission Farms where Indian Creek Parkway meets Mission Road. This mixed-use project, which is under development by Terry O’Leary (who sold BarreWoods in September) will offer 213 residential units above 15,000 square feet of retail space. 

2012 and beyond

Hendricks & Partners projects employment gains of 1.6 percent in 2012 and 2 percent in 2013 in the Kansas City MSA. That translates into 35,146 jobs over the next 2 years.

If realized, the job gains will drive renter demand. Any significant rebound in the single-
family home market could temper that demand, however.

Peter Engelman, director of acquisitions at Kansas City Venture Group, which owns about 9,000 units in the Kansas City area and in Texas markets, says that investors in search of quality assets will have to pay to play.

“Interest rates are staying low, and everyone wants quality assets with cheap debt. Class A assets are becoming very expensive,” points out Engelman. However, now is the time to buy Class B and C product in the right
location, implement creative value-add strategies and plan your exit to take advantage of phenomenally cheap debt.

— Laurel Wallerstedt is a senior investment advisor with the Kansas City office of Hendricks & Partners.

Kansas City Retail Market

Block

Greater Kansas City’s retail activity continues with its upswing at a slow and steady pace. As a whole, the Kansas City market was not drastically affected by the national economic fluctuations during the past four years and has managed to stay relatively constant as it relates to jobs, housing, personal income, manufacturing, expansion and banking, as well as other market indicators.

Still, Kansas City has not been immune to the fluctuations on the national economic scene. The present financing environment has slowed the progress of new retail developments and proposed construction projects to a turtle’s pace. New retail developments are moving forward, but in many cases financing and tenant rents are delaying the construction process.

Leasing and Expansion

Due to the decrease in the number of new retail developments, the majority of the Greater Kansas City’s 15 counties are experiencing a strong increase in the leasing of existing properties. Rental rates remain reasonably stable while sales of pad sites to regional and national users are increasing. Most of these new retail users are occupying Class A and B shopping centers.

Some of the older properties are being redeveloped by drug stores, convenience stores, or restaurant users, or are being converted to service, medical or office uses. New housing, apartment complexes and elderly housing developments throughout our area also continue to drive retail leasing.

Greater Kansas City is experiencing retail expansion. Many of the new construction projects are anchored by grocery store expansions or involve relocations such as AWG, Price Chopper, HyVee, Aldi, Walmart Neighborhood Market, as well as two new Trader Joe’s that occupy existing buildings. This is Trader Joe’s first entry into the local market. Other large national retailers expanding in the Kansas City area include Walmart, Sam’s Club, T.J. Maxx, PetSmart, and buybuyBaby.

National retailers who recently entered the area include H&M, Nordstrom Rack and Trader Joe’s. A few chains looking to expand into the Kansas City market include Ross Dress for Less and Menards.

Restaurants continue to gobble up available pad sites throughout the area and have been very active in new construction and renovation. Some of the active restaurant chains in the include Red Lobster, Olive Garden, Chick-fil-A, Jack in the Box, Logan’s Roadhouse and I-Hop.

New development

Developers are set to launch several new construction projects in 2012, some of which have been planned for years. These projects include the Prairie Fire mixed-use development located at 135th Street & Nall Avenue in Leawood, Kan. Plans call for this project to include a national museum, theater, entertainment center, and high-end retail and restaurants.

Another construction project is the Gateway/Mission Mall redevelopment located at Johnson Drive and Roe Avenue in Mission, Kan. This development has had numerous anchor changes, but the latest plan calls for a Walmart Supercenter, an aquarium and other mixed-use components. 

Jack in the Box, located at Plaza at the Speedway in Kansas City, opened in November 2011. The 850,000-square-foot power center developed by Block & Co. Inc. Realtors is anchored by a Walmart SuperCenter, Best Buy and Kohl’s.

Other expansion plans include the Plaza at the Speedway, located at I-435 & Parallel Parkway in Kansas City, Kan. with a proposed Sam’s Club; Adams Dairy Landing, located at I-70 & Adams Dairy Parkway in Blue Springs, Mo.; and Summit Fair, located off I-470 & 50 Highway in Lee’s Summit, Mo., which plans to add a power center component.

The active retail players in the Kansas City market continue to include Red Development, Block & Co. Inc. Realtors, RH Johnson and Lane 4.

National tenants continue to ask developers and owners for increased tenant improvement allowances. At the same time, they are requesting minimal rent increases. These requirements continue to put a damper on new construction because of the financing difficulties and the effect on a developer’s return on investment.

Distress Update  

Three retail properties were sold out of foreclosure in 2011, one of which was the Corbin Park project at 135th Street and Metcalf Avenue in Overland Park, Kan. This project was sold to a local investor who is planning on completing this partially constructed development with current anchor tenants Von Maur and JCPenney. The development is expected to be about 500,000 square feet upon completion.

Foreclosures on retail vacant land have been slow as well. Bank pricing on these few opportunities has typically enabled new developers to acquire these properties rather quickly.

Overall, greater Kansas City’s retail segment is continuing to rebound. There is not one submarket drastically overshadowing another because nearly all remain stable, including Lawrence, and the future looks bright.

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

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