CITY HIGHLIGHT, JULY 2004

MOST KANSAS CITY MARKETS AWAIT ABSORPTION
Jayland Wheeler, Lou Steele, Rosie Kiene, Brent Roberts and David Block

While construction is at a near standstill in most commercial real estate markets in Kansas City, the retail market is enjoying a high level of new construction. New centers under construction in the area include Zona Rosa and The Legends. The office, industrial and mutlifamily markets are waiting for the market to absorb vacant space before most new construction can begin.

Industrial

The Kansas City industrial market experienced a change in perception during the last year. Beginning in 2001 through the first half of 2003, the vibrant industrial market became stagnant as companies reacted to the economic downturn and global uncertainty. Real estate expansions took a backseat as companies were focused on becoming more competitive and efficient by implementing specific strategies to reduce the costs of producing their own products. Efficiencies in the supply chain, achieving greater productivity, and additional capital investment in automation are examples of the strategies employed to accomplish these objectives.

Industrial activity increased during the last 12 months. Much of the activity is in the form of inter-market relocations in buildings from 20,000 to 50,000 square feet. However, leasing activity is still slow for space greater than 50,000 square feet.

As a result of the lack of construction and incremental absorption, vacancy declined from 9.7 percent to 8.2 percent in the last year. This trend of declining vacancies is expected to continue at a moderate pace through the remainder of this year. The supply pipeline delivered less than 300,000 square feet of new speculative space during the last 12 months, the smallest 1-year total since 1995. It is anticipated that the upcoming year could introduce even less speculative construction to the market.

Speculative construction has been almost non-existent during the last 36 months. Only two speculative building completions of significant size were constructed in Kansas City, Missouri, since early last year, a 97,000-square-foot distribution building at 750 Wyoming and a 154,000-square-foot distribution building by Hunt Midwest at Interstate 435 and Parvin Road.

Several companies, motivated by low interest rates and a lack of suitable facilities, elected to pursue a build-to-suit path. Companies such as Amerisource Bergen, Asian Foods, and Bunzl chose to construct new industrial buildings in the Kansas City area.

The market is cautiously optimistic that activity is sustainable this year as landlords continue to work hard to secure tenants. The fundamentals are in place for a permanent recovery once decision-makers gain further confidence in the recent improvements in business conditions. Even though the economic downturn of the last couple of years did slow activity, there is not a large oversupply of space to contend with, which greatly assists recovery efforts. The market is not expected to enter the expansion phase until mid- to late 2005.

— Jayland Wheeler is research services manager with Grubb & Ellis|The Winbury Group.

Multifamily

The most pronounced trend in the Kansas City multifamily market is the increased attraction of living in an urban environment. Downtown development is exploding with a new performing arts center expected to break ground next year, the construction of

H & R Block’s new corporate headquarters and the development of an adjacent entertainment district. The downtown area is attracting a significant percentage of renters who were previously suburban tenants.

A second major trend in Kansas City is the widespread acceptance of condominium living. Kansas City has traditionally been a single-family, suburban market. Condominium lifestyles have only recently been accepted. Several upscale, suburban condominium projects are moving forward in Johnson County, and others are planned north of the river and in Lee’s Summit.

During the last 10 years, Johnson County has had an explosion of Class A apartments built, leading to occupancy problems. Recently, developers have been purchasing several of these properties for condominium conversion. This will reduce some of the submarket’s vacancy.

Areas in need of development include western Wyandotte County, which has had a major increase in employment since NASCAR’s Kansas Speedway opened. Major retailers, such as Nebraska Furniture Mart and Cabela’s, are located there. The Legends, a new 600,000-square-foot center is also being built in western Wyandotte. The area has generated substantial jobs but lacks the multifamily housing to accommodate the new workers. This niche needs to be filled.

Western Wyandotte County has several sites zoned for multifamily use, and developers are pursuing available sites. Fort Smith, Arkansas-based ERC Properties is developing a 288-unit multifamily complex in Delaware Ridge.

Eastern Jackson County sites have been difficult to zone for many years. This appears to be changing, and demand should be solid.

Overall rental rates in the area range from 70 cents per square foot to $1.10 per square foot. One-bedroom units are in greatest demand. Class A properties have been overbuilt in south Johnson County, and effective rates after concessions are still low for the product delivered.

Overall, apartment occupancy trends in the Kansas City area mirror the soft market throughout the country. Some submarkets, such as downtown and Country Club Plaza, show occupancy strength, yet the general market suffers from unemployment, overbuilding and low interest rates. Conditions are slowly improving.

The metropolitan Kansas City vacancy rate is estimated at less than 10 percent. Some submarkets, like downtown, have as little as 6 percent vacancy. Others, like south Johnson County, have as much as 13 percent [where overbuilding has occurred]. There is not much change from 1 year ago in vacancies.

In the future, the job growth in western Wyandotte County will raise development interest. Opportunities exist in Blue Springs and Lee’s Summit where little recent development has occurred. Developers are also watching for infill projects.

— Lou Steele is a principal and Rosie Kiene is a vice president of Prudential CRES Commercial Real Estate.

Office

The suburban Kansas City office market is well into its third year of inactivity, which is most apparent in the affluent suburb of Johnson County, Kansas. The submarket had close to a 10-year run of unbelievable growth when it was attracting businesses out of Kansas City, Missouri, and nearly tripled its size through new construction. Now, office building owners are experiencing record high vacancy rates.

The Johnson County, Kansas, submarket consists of nearly 16 million square feet spread through 350 buildings. Overland Park, Kansas, the center of this market, has a population of 163,000, which continues to grow at about 3 percent per year. The current unemployment rate is 3.9 percent, up from 1.7 percent in 1999.

The vacancy rate in Johnson County is currently 35 percent, a staggering number since the rate was about 5 percent only 4 years ago. This change leaves nearly 5.5 million square feet of space available. Only 440,000 square feet (3 percent of the vacancy) of available space is sublease space.

This market took a hit when Sprint built a company-owned world headquarters in Overland Park and put more than 500,000 square feet of sublease space on the market in the last 24 months. Most of the sublease space has expired and thus has become direct space available, but still remains vacant.

The vacancy rate continues to climb and shows few signs of reversing its course this year. Few new companies have entered the market, many filed for bankruptcies and others continue to downsize. In the late 1990s, a lot of the growth in Kansas City, as throughout the country, was fueled by tech companies. This year, there is little expectation for new tech companies to come to the market, and those that are in the market are finding that the landlords are more wary than they were 5 years ago.

There are a few bright spots in the market. Southcreek Office Park, which was a pioneer 10 years ago by locating further south than the main suburban stretch of College Boulevard, is beating the vacancy average. This park will have nearly 900,000 square feet when its 18th building is completed this fall. The current vacancy rate is 11.8 percent, but will climb to 18 percent (157,000 square feet) when the new building is completed.

In sharp contrast is Corporate Woods, a 2.2 million-square-foot office park with more than 645,000 square feet of available space and a vacancy rate of 29 percent. Just 3 years ago, this 300-acre office park was 99 percent occupied.

The difference between these two office parks is the current lease rates. Southcreek has maintained rates of nearly $20 per square foot, full-service, while staying higher than the market in occupancy levels. Corporate Woods, on the other hand, has pushed its rates down ($15 to $17 per square foot) during negotiations as well as offering lucrative tenant finish packages ($20 to $25 per square foot on 5- to 7-year leases). Southcreek had purposely refused to lease space to Sprint during Sprint’s growth in the 1990s, which in hindsight was one of the wisest landlord decisions of the past decade. Corporate Woods has watched Sprint vacate nearly 180,000 square feet in the last 24 months.

Without any significant job growth or new businesses relocating to Kansas City, the office market will continue to weaken. At this point, there continues to be increasing vacancies, which have led to a dramatic reduction in lease rates throughout the metropolitan area. Nearly 2.2 million square feet in Johnson County has been vacant for more than a year, with 1.4 million square feet vacant for more than 2 years. Traveling south between the downtown submarket and Johnson County, a tenant requiring 10,000 square feet or more has 153 options. New construction is limited to build-to-suits or pre-leased activity and with the current vacancy levels, not much is expected in the near future.

— Brent Roberts is vice president of brokerage with MC Lioness Realty Group.

Retail

Kansas City is one of the largest cities in the United States in land area, encompassing all or parts of 17 counties, which includes more than 35 individual cities. Steady retail development has been seen in nearly every market in the Kansas City metropolitan area. Shopping center development historically has been balanced, consistent and virtually unaffected by fluctuations in the national economy. During the past 24 months, the majority of retail development has been focused on big box shopping centers, small neighborhood retail centers and lifestyle shopping centers. The majority of the retail growth in the suburbs has been on the major commuter collector streets, and the typical super box, big box and junior box retailers continue to locate around each other on the major intersections of the suburbs.

For the past 20 years, Johnson County, including Lenexa, Leawood, Overland Park, Shawnee and Olathe, has been the hottest suburban area for shopping center and commercial development. In the past year, significant growth has continued in nearly every suburb.

One of the major new lifestyle shopping centers is in the Northland submarket of Kansas City, Missouri. Zona Rosa, a 1.5 million-square-foot lifestyle center located at Interstate 29 and Barry Road, has brought many new retailers and restaurants to the Kansas City market. Phase I opened in May, and Phase II is under construction.

With the continued fast-paced residential growth in the majority of Kansas City’s suburbs, commercial shopping center and restaurant development is on fire in greater Kansas City. Continued retail growth has spread to the remaining vacant land sites throughout the Northland, including Barry Road, Highway 152 and Liberty, Missouri.

In southern Johnson County, new big box and retail shopping centers continue to crop up on nearly every intersection on 135th Street. Sites are being considered all the way south to 200th Street. This includes Kansas City, Kansas, which has seen very little commercial development during last 20 years. Red Development’s The Legends, a 600,000-square-foot shopping center located at Interstates 70 and 435, is under construction. The center is being built in the middle of the new Kansas Speedway development. This location is a true regional destination with new hotels, a themed resort and new retail, with Cabela’s and The Nebraska Furniture Mart anchoring the center.

New retailers and restaurants recently entering the greater Kansas City market include Wal-Mart grocery stores, Ultimate Electronics, Forever 21, Red Star Tavern, Bravo Cucina Italiana, Party City, Ted’s Montana Grill, Abuelo’s Mexican Restaurant, Rib Crib, Track N’ Trail, Noodles, Panda Express, Qdoba, Robeks, Pei Wei, Famous Dave’s BBQ, The Atlanta Bread Company, The Granite Restaurant, Carrabba’s Italian Grill, Bonefish Grill, Cheeseburger in Paradise and Fleming’s Prime Steakhouse & Wine Bar.

The majority of the vacancy in the Kansas City market is mostly in big box stores through downsizing or bankruptcy filing. The majority of these vacancies came from Kmart, Payless Cashways, Phar-Mor, Montgomery Wards, Mattress Warehouse and Garden Ridge. These vacancies seem to be garnering strong interest and should be filled this year or by the middle of next year.

Big box rental rates have remained stable in the low teen range. Smaller, Class A shops range between $18 to $25 per square foot; smaller, Class B shops range between $11 to $15 per square foot; and Class A specialty and lifestyle projects range from $25 to $35 per square foot.

Land prices and lease rates are continuing to increase at major intersections in many of the suburbs, which are planned for future retail development. Ground prices for pad sites now sell between $15 to $25 per square foot. It has only been during the past 24 months that these rates have significantly inflated due to the demand for quality co-tenancy on popular corner intersections in strong fast-growing suburbs.

The suburbs of greater Kansas City contain the majority of new retail development. There are, however, sporadic redevelopments of centers in the inner core of greater Kansas City, but they are few and far between. The majority, if not all, of these new suburban developments in greater Kansas City are enhanced by favorable and available financing vehicles — including tax increment financing and transportation development districts — in different municipalities. These improvements have significantly reduced the developer’s expenditures thereby allowing the developer to pass these savings on to retailers.

The movement to the suburbs of greater Kansas City should continue for at least the next 24 months. Low vacancy rates and strong residential growth makes the overall market attractive to retailers and restaurants.

— David Block is senior vice president of Block & Company Inc. Realtors.



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