Location, location and location may be the familiar mantra of commercial real estate, but the economic slowdown shows that there is an equally important element in the equation. Namely, jobs, jobs and jobs.

Employment had the biggest impact on the Cincinnati commercial real estate market in 2002 as it no doubt had similar effects on most metropolitan areas. As companies pared their payrolls, office and industrial vacancies increased. A wealth of sublease space put added pressure on the office market. Equally important, the down economy caused many companies to think twice about expanding.

While historically low interest rates brought some promise to the investment market, property values were not immune to the aftershocks of the economic fallout. Buyers looked for long-term value by focusing their sights on well-leased, first-class properties. These properties commanded top dollar as investors looked for safe alternatives that should yield good returns over the long haul.

Looking ahead, the outlook remains cloudy but signs point to an economic recovery that should start to bear results by year’s end. Continued low interest rates coupled with economic stimulus plans should boost business and add employees back to payrolls. Area economic pundits expect the tri-state area to fare better than the nation as a whole as the region begins to restore growth and strengthen confidence among businesses.
In short, the worst should be behind us. However, the lingering risk of a new terrorist attack or a prolonged war in Iraq could quickly alter the fundamentals of the economy’s fragile recovery.

Office

The office sector ended the year with vacancy rates at a 10-year high as demand for space waned and sublease space exerted even more pressure on landlords. In the suburban markets, the vacancy rate climbed to 20.3 percent by year’s end, well above the 16.5 percent vacancy rate at the end of 2001. Still, there was some good news as Class A space posted positive absorption of more than 150,000 square feet.

The increase in Class A absorption was fueled by generous leasing incentives offered by landlords, who fought to keep tenants and attract new businesses looking to upgrade their space. Free rent, moving allowances, increased tenant improvement allowances and lower rental rates dropped effective rental rates by 20 percent or more making Class A space more appealing to businesses that previously couldn’t afford a swankier address.

This movement was prevalent in the Blue Ash submarket. Class A buildings in the area’s leading office submarket posted positive absorption of 287,121 square feet in 2002. This was a marked improvement from 2001 when three new buildings added more than 600,000 square feet of Class A space in Blue Ash.

Duke Realty was the biggest beneficiary of this movement, a credit to the company’s ability to quickly adjust to the economic realities of the market. Using leasing incentives, Duke landed large deals with IBM (32,000 square feet at Alliance Woods) and Paychex (20,000 square feet at Pfeifer Place). Mercy Health Partners was also wooed to Alliance Woods, taking more than 90,000 square feet in early 2002. Both Paychex and Mercy Health Partners moved from Class B properties into Duke’s new Class A properties.

The Midtown submarket continued to be relatively strong, with its overall vacancy rate at only 8.5 percent and the Class A vacancy standing at a mere 5 percent. Several blocks of sublease space, though, pushed the area’s vacancy rate to 17 percent.

Downtown Cincinnati also held its ground. The central business district posted negative absorption of nearly 150,000 square feet. Most of that space came from four Class A buildings as companies either moved employees to the suburbs or to other downtown buildings. But many companies remained committed to downtown, giving the area a much-needed vote of confidence. Great American Insurance and Provident Bank renewed leases totaling 600,000 square feet. Cinergy expanded by leasing an additional 80,000 square feet in Atrium II. Ernst & Young and Pricewaterhouse Coopers also added space in the downtown market.

Other submarkets did not fare nearly as well. The tri-county office market saw vacancy rates increase in Class A and Class B space to 31 percent and 16.5 percent, respectively. Higgins Development Partners’ Centre Pointe Office Park added a third building with 92,000 square feet. The developer managed to gain at the expense of other buildings in the submarket as its Centre Pointe complex showed positive absorption of more than 50,000 square feet.

The Mason submarket ended the year with a 21.6 percent vacancy rate as two companies dumped space on the market. Lenscrafters, which moved to its own building in Mason, left 130,000 square feet behind. Additionally, Digineer dumped 60,000 square feet in two Mason buildings when the company went out of business.

Is there light at the end of the tunnel? Once again, it boils down to the economy and its impact on the job market. We expect a slow recovery this year, with companies beginning to dip their toe in the water during the first half of the year. This should pick up in the second half of the year as the recovery, barring any major setbacks, takes hold.

Tenants with good track records will continue to receive preferential treatment from landlords. These incentives will help boost absorption and lower vacancy rates. Colliers Turley Martin Tucker anticipates that the vacancy rate in the Cincinnati office market will drop to 19 percent by mid-year and possibly 18 percent by year-end.

Blue Ash and Mason are both well positioned to take advantage of improving economic conditions. Both submarkets offer large blocks of space. Tenants needing 20,000 square feet can choose from 12 locations in Blue Ash and seven locations in Mason. Companies needing 40,000 square feet have more limited options, with three locations in Blue Ash or four locations in Mason.

The office sector stands a good chance of recovery as speculative construction has all but stopped. Only one new speculative building will open this year, the 40,000-square-foot Kenwood Crossings developed by Neyer Properties.

Industrial

Cincinnati saw several new industrial developments in 2001 and 2002. Opus North opened a 428,000-square-foot bulk facility in March 2002, and MetLife brought a 400,200-square-foot bulk facility online the same month. IDI opened two buildings in January 2001, bringing more than one million square feet to the industrial market, and First Industrial followed with two buildings in September 2001, adding another 416,250 square feet of industrial space. The end result was too much space as the economy tightened. Understandably, developers have by and large shut off the pipeline until the industrial market has time to catch its breath.

Class A bulk warehouse space took the hardest hit. The greater Cincinnati area entered last year with more space available than at any time in the past 10 years. Duke, IDI, First Industrial and ProLogis, successful developers for years, had new buildings with some 2.2 million square feet of vacant space. When Opus North and MetLife joined the fray in the first quarter, even more space became available.

Most of the new bulk construction occurred in the airport market of Northern Kentucky and West Chester Market near the Union Centre interchange. This was perhaps the most under built major airport area in the United States. Developers spent the last five years reversing that situation especially as the airport grew into a major hub. Hundreds of prime acres of development made West Chester a great in fill site when the new interchange opened in 1997. But this development came when distribution customers, whether newcomers or existing businesses looking to expand or relocate, began to diminish in numbers.

In all, greater Cincinnati ended 2002 with 46 million square feet of bulk industrial space, with nearly one-quarter (24 percent) vacant. Developers have put plans on hold until this rate drops significantly, somewhere in the 12 to 14 percent range.

Service center/flex space fared much better. Also known as office/warehouse, the multi-tenant space attracts smaller users. Nearly three-quarters of the 13 million square feet of the area’s service center/flex space is located in Ohio. K&W Properties and DA Development delivered 165,000 square feet of new space to Ohio, with a majority of it leased. In Kentucky, Paul Hemmer Co. and Tappan Properties built three buildings near the airport. They, too, found success in leasing most of this 248,000 square feet of service center/flex space. The gains of the new service center/flex buildings were the loss of older properties, the latter of which contributed largely to a year-end vacancy rate of more than 16 percent.

Manufacturing suffered as businesses shifted production to Mexico and Canada, as well as overseas to Asian countries, particularly China. Cincinnati Gear shuttered two buildings totaling 175,000 square feet. Cincinnati Machine closed 1 million square feet, which is slated for redevelopment, and EDS/Centrobe shut down a 235,000-square-foot manufacturing facility.

Cincinnati’s core industries, though, remained strong. Consumer products and the automotive, food, chemical and paper companies either added or announced expansions to their facilities. Barr Laboratories/Duramed, Pacific Manufacturing/Takumi Stamping and Midwest Filtration completed major expansions in 2002.

Ford Motor Company announced an $81 million renovation to its Sharonville transmission plant, and Mubea in Northern Kentucky announced a $35 million expansion to its auto parts plant. Milacron plans to expand its plastics plant in Claremont County. Pierre Foods, Forest Pharmaceuticals, JF Steel, Cincinnati Black Oxide, Transcontinental and Lutz Tool also have expansions in the works.

The manufacturing sector still carries a great deal of the economy’s weight. Greater Cincinnati boasts nearly 180 million square feet of owner-occupied manufacturing facilities, with vacancy under 7 percent.

In Dayton, the lack of speculative development has steadied the overall vacancy rate at 15 percent — or 2.7 million square feet — of the 18 million square feet in the area. The vacancy rate in the bulk warehouse market has increased slightly to 18 percent as single-user buildings that formerly were for sale have become available for lease. The majority of bulk buildings, about 2.6 million square feet, are located in the northern portion of Dayton. The remaining bulk warehouse properties are evenly distributed in the south and central markets with about 2.2 million square feet and 2.1 million square feet, respectively.

The office/warehouse market remains strong with vacancy rates holding at 13 percent. The majority of the office/warehouse product continues to be located in the southern Dayton suburbs.

At year-end 2002, the greater Dayton market offered 85 industrial properties for lease — up dramatically from 45 properties at the end of 2001. These included industrial, warehouse and office/showroom properties.

Of the 85 buildings, only six properties had leases available for more than 100,000 square feet. The significant properties in this group included the former Dopaco facility in Carlisle, Ohio, 210,000 square feet; the Heidelberg USA property located in Dayton, 294,000 square feet; the former Mayo/Dayton Walter property located in Moraine, 106,000 square feet; and two Roberds properties located in Vandalia and Fairborn, 167,000 square feet and 243,000 square feet, respectively.

There are approximately 76 buildings in the greater Dayton marketplace for sale. About 70 percent of these buildings are less than 50,000 square feet, and only four buildings are more than 100,000 square feet.

These larger buildings are the Kadon Building in Moraine, 101,289 square feet; the former Roberds building in Dayton, 163,000 square feet; the Dopaco building, 210,000 square feet; and the Heidelberg Post Press, 296,000 square feet.

The sale of the former 101,000-square-foot Whirlpool facility in Vandalia was the most significant industrial sale in 2002. The International Brotherhood Workers Local 82 purchased the building, with plans to consolidate its Dayton facilities into this location.

Investment Market

Historically low interest rates did not offset the underlying fundamentals of commercial real estate. High vacancy rates, weak demand and a tenant’s market have dampened the investment market.

Though a positive factor for the economy, low interest rates also have a negative side. Many owners placed securitized debt on properties at then favorable rates but that are now well above the current interest rates offered. Consequently, investors have a tougher time earning yields that meet their requirements.

These factors affected sales activities, with investors focusing their efforts on premium properties — Class A assets with high occupancy rates, long lease terms and a stable of creditworthy tenants — or opportunities that offer value with the right experience and capital to help improve a property’s return.

Investment activity in the office market was light, but clearly favored solid Class A assets. An example was the sale of the PNC Center downtown. UBS Realty put the 497,000 square-foot tower on the market in the fall of 2001, and closed on the sale to the Harbor Group in February 2002. The building is more than 90 percent occupied, and its namesake anchor tenant still has more than 10 years remaining on its lease. The selling price was $52.3 million, or just more than $105 per square foot, well below its estimated replacement cost of $180 per square foot.

The nearby Chemed Center also had a change in equity ownership. Hines took complete control of the building when it purchased the remaining interest in the property estimated at 70 percent. Hines developed the Class A, 522,000-square-foot office tower in 1990 and had maintained an interest in the building.

A locally active developer and investor, the Crowell Co. saw an opportunity when it purchased the Park 50 TechneCenter from TIAA-CREF. Crowell bought the 17-building complex in May 2002, paying $14 million for the mixed-use park with office, office/warehouse and industrial buildings totaling 500,000 square feet of space. Though only 75 percent occupied at the time, Crowell has used its local presence and leasing/management experience to boost its return by double digits.

The industrial sector saw more activity than office properties, but the size of the transactions paled in comparison. Fifth Third Bank made the biggest deal when it purchased two office/warehouse buildings for $14.8 million from RREEF. The bank added the buildings to its expanded campus, with speculation that the buildings will be converted primarily to office space as Fifth Third continues to grow.

Other industrial properties also sold in 2002. For example, P-Can sold the Milton Can Building to CRICBW Anderson Trust for $9.8 million; Cincinnati United Contractors sold an unnamed industrial property in Mason to WAW Partners for nearly $7 million, and the Neyer organization completed an internal transfer recorded at $4.5 million for the new 125,000-square-foot Quick Pak building located in the tri-county submarket.

Retail properties generated a wealth of activity. Four of Cincinnati’s seven major enclosed malls changed hands last year: Kenwood Towne Center, 1.1 million square feet for $218 million; Forest Fair Mall, 1.5 million square feet for $52.5 million; Beechmont Mall, 595,000 square feet for $8 million; and Florence Mall, 920,000 square feet, which was part of a 3-mall portfolio purchase for $260 million.

Grocery- or drugstore-anchored strip centers in prime locations, as well as freestanding drugstores, also generated plenty of interest. Investors took comfort in the stability of these properties since they historically have been able to weather any economic downturn.

Overall, investment activity is poised to pick up as institutional and private investors look to capture favorable credit terms to receive the long-term steady returns of commercial real estate. That activity still hinges on three of the most important factors in commercial real estate: jobs, jobs and jobs.

Jim O’Connell is senior vice president at Colliers Turley Martin Tucker’s Cincinnati office. Norm Khoury, vice president of industrial sales and leasing for Colliers Turley Martin Tucker, wrote the Dayton industrial section.


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