Skyline Transformed - The 2007 BTB Commercial Real Estate Report

The Atlanta skyline continues to evolve, but who's keeping the lights on? And who will be left behind?

Bailey Webb

December 1, 2007

From Brookhaven to Downtown, if you wind your way down Peachtree and add a few detours, a stark transformation is revealed.

Projects bandied about for the past five years or more are reshaping Atlanta's skyline – developments such as Cousins Properties' Terminus, Regent Properties' 3344 Peachtree, Barry Real Estate Cos.' Allen Plaza and 12th & Midtown, a mixed-use project under development by Selig Enterprises, Daniel Corp. MetLife and Canyon-Johnson Urban Fund. On the eastern edge of Downtown, Egbert Perry's Integral Group leads Sweet Auburn's resurrection. CRE_201.17th

Lest we forget, Atlantic Station's evolution changes a former Superfund site into the city's newest legal and financial center and a residential and retail oasis. If not an oasis, it's still better than a Superfund site.

In three other prime locations, a lunar landscape has replaced an aged apartment complex next to Oglethorpe University; Buckhead Village's bar district now is a nine-acre Brigadoon, awaiting the day the mist clears to unveil a cluster of luxury hotel, retail office and condo development; while the corner of Wieuca Road and Peachtree is in the early stages of preconstruction for more Buckhead mixed-use.

Adjacent to Oglethorpe, Sembler Co.'s Town Brookhaven will create a town center that's already attracted a number of Atlanta's tastiest casual restaurants (think Nuevo Laredo and The Real Chow Baby, and Barnes & Noble), while Ben Carter Properties' The Streets of Buckhead brings luxury brands Hermes, Etro and Hotel Monaco to a district formerly known for the likes of Lulu's Bait Shack, Club Chaos and Mako's.

At Wieuca and Peachtree, four of Atlanta's most formidable developers – Pope & Land Enterprises, Duke Realty Corp., Post Properties and Novare Group – have teamed up to develop condos, apartments and Class-A office at 3630 Peachtree. What's more, many of these developments incorporate Leadership in Energy Efficiency Design (LEED), green-building concepts, and Atlanta has more than 50 developments either LEED certified or on their way, according to the Urban Land Institute (ULI).

Atlanta, long known as the capital of sprawl, has emerged as an international beacon of mixed-use development. "In the past, we were the poster child for some bad things," says Jeff Dufresne, executive director of ULI's Atlanta chapter. "With mixed-use, mixed-income, green development, we're now setting the example of the way to go. People are becoming more enlightened both on the development side and the user side."

Of course, the question remains, especially with the new office development, who's going to keep the lights on, and who will be left in the dark?

Musical chairs

Atlanta closed the third quarter with 6.4 million square feet of office space under construction and 2.5 million square feet of sublease space (unoccupied office space still under lease), according to national industry tracker CoStar Group. Vacancy rates for the overall office market have hovered around 14 percent for two years and were 13.9 percent at the end of the quarter. Net absorption through the third quarter totaled 2.25 million square feet, while 2006's total was approximately 4.7 million square feet.

A handful of under-construction office buildings are significantly, if not fully, pre-leased, including Jones Lang LaSalle's 150,000-square-foot Stonebridge II in North Fulton and Greenstone Properties', Granite Properties' and Wells Real Estate Fund's Three Glenlake, the 350,000-square-foot future headquarters of Newell Rubbermaid in the Central Perimeter submarket. Cousins' recently delivered Terminus 100 at more than 90 percent leased, and next door, the 26 floors of office space at Regent's 3344 Peachtree are 36 percent preleased, according to CoStar.

At Atlantic Station, BB&T and law firms Womble Carlyle and Ford Harrison are anchoring 271 17th Street, the development's third Class-A office tower, which delivers in 2009 and is 45 percent pre-committed, while 201 17th Street, Atlantic Station's second office tower, delivered earlier this year with Nelson, Mullins, Riley & Scarborough as anchor, and was approximately 41 percent leased when it debuted in October.

Still, Cousins at Terminus 200, Tishman Speyer at Two Alliance Center and Pope & Land and Duke at 3630 Peachtree have approximately 1.5 million square feet of purely speculative office space under construction in Buckhead.

Dewberry Capital's Two Peachtree Pointe, at nearly 300,000 square feet, delivered empty, though it reportedly has lured Invesco to lease approximately 40 percent of the building, which would leave a big hole in Colony Square. Also, Daniel and Selig reportedly are nearing the start of construction on a 500,000-square-foot office building at 12th and Midtown. "Let ‘em build it, baby. It's great for tenants," says Andy Lechter, executive VP at tenant rep brokerage Studley. "In general, the best thing that can be said is the market is treading water. I don't know that net absorption is anything for developers to brag about."

In most submarkets, Atlanta has plenty of office space to spare for Studley and other firms specializing in representing tenants. In addition to new Allen Plaza development, Downtown has significant chunks of empty space at Cousins' 191 Peachtree, America's Capital Partners' Peachtree Center, and Richard Bowers & Co.'s 270 Peachtree.

In Midtown, you have Two Peachtree Pointe (or the hole Invesco potentially leaves in Colony Square); approximately 450,000 square feet of empty AT&T sublease space whose lease expires in 2010; and office towers in preconstruction by the Selig/Daniel team and Shailendra Group's 1400 Peachtree. In the Northwest submarket alone, Lechter's tenant rep team found 18 blocks of office space totaling more than 40,000 square feet while whittling down options for a Fortune 300 client looking to establish an Atlanta base.

The Central Perimeter submarket has no significant office construction outside of Newell Rubbermaid's headquarters, but CompuCredit, a year after signing for more than 400,000 square feet at the King and Queen buildings in one of the biggest leases in a decade, has approximately 75,000 square feet of sublease space back on the market. Additionally, HomeBanc's implosion leaves seven empty floors at Perimeter Summit, and AT&T is expected to opt out of its 325,000-square-foot lease at Cingular's former headquarters at 3.Glenlake

Glenridge Highlands Two and backfill AT&T/BellSouth sublease space at Lenox Park.

What's more, though the overall economy continues to grow and Atlanta's job creation engine hums along, corporate gains in efficiency slice many office space requirements. "A lot of corporations are still benchmarking, and the square footage per employee is going down," says Duncan Gibbs, a tenant rep broker and senior VP in The Staubach Co.'s Atlanta office, who recently closed large transactions for Verizon and Travelers. "The efficiencies corporate America is trying to realize, negates any gain from more bodies."

Some hot, some not

Some submarkets are mostly sunny, rather than partly cloudy. Due to a lack of new construction and steady leasing by firms like Duke, Highwoods Properties, Colonial Properties Trust and Jones Lang LaSalle, the North Fulton submarket has tightened considerably – to 13.6 percent to more than 20 percent a few years ago – especially with properties within two or three miles of Georgia 400. Fewer tenant concessions are offered; tenant improvement allowances are declining; and landlords now are asking for $21 per-square-foot for Class-A space, says Craig Flanagan, senior VP of Duke Realty Corp.

"The market is active and deep," Flanagan says. "The level of activity covers the spectrum from small requirements to multi-floor deals. People were feeling the market was in the doldrums. We went from a low of 83 percent [leased] in the market near the end of 2006, and at Northwinds we're now at 96 percent."

Similarly, office tenants are flocking to Gwinnett County's Sugarloaf corridor – some organic growth, some new tenants and a number of intra-market moves out of the Gwinnett Place Mall area. Duke's Sugarloaf and Huntcrest office parks have posted 200,000 square feet of net absorption through three quarters, and Koll Development Co. recently signed the University of Georgia Real Estate Foundation to a 60,000-square-foot deal at Koll's 150,000-square-foot, LEED-certified Intellicenter-Atlanta, which also is within Huntcrest. Next year, Duke plans to begin development of Legacy, a 110-acre office park at Georgia 120 and Meadowchurch Roads.

Sugarloaf and North Fulton fare well for some of the same reasons, Flanagan says. "Those markets that seem to be doing well have a few similarities – expressway access and a strong amenity base."

It all makes sense now

So, why all the new construction? Two primary reasons. First, we're likely in for more musical chairs. In the next three years, approximately 45 percent of Atlanta's office leases expire, according to CoStar, which is a considerable amount of space in a growing metro economy with more than 250 million square feet of office development.

And while Atlanta office market absorption has steadily improved over the past three years, average asking rents actually are less ($19.44 per-square-foot, per year) now than at the end of 2000 when they were $19.78 per-square-foot, according to CoStar.

"A lot of new space will be delivered in 2008 and 2009 in Midtown and Buckhead," says Bill Hollett, senior VP of Miami-based America's Capital Partners, which owns Piedmont 14, 10 10th Street, Two Ravinia and Peachtree Center. "There are Class-A buildings with some vacancy now. It's going to be very interesting to see what happens between absorption and rental rates. You'll always have corporate and financial services [tenants] interested in new projects, but the big test is what's the spread [between rates on their current lease vs. a new building]?"

U.S. real estate markets provide steady returns to pension funds and foreign investors, and Atlanta remains one of the nation's top commercial real estate investment markets. On the foreign investment side, Australian funds are running out of opportunities in their homeland and increasingly seek U.S. property. The wave of Middle Eastern, Norwegian and Russian oil money has to land somewhere, and U.S. commercial real estate is one of the world's safest bets. And a weak dollar provides opportunities for many European investors.

"There's a preponderance of money that's not going away," Gibbs says.

Through three quarters, foreign buyers have accounted for 20 percent of Atlanta's $3.5 billion in office investment sales, including Jamestown Properties' $127 million acquisition of 999 Peachtree Street. Last year, foreign investors accounted for 3 percent of Atlanta office buys, says Will Yowell, executive VP of CB Richard Ellis, who represented Equity Office Properties Trust in the $544 million disposition of its Atlanta portfolio and Cousins in its (then) record-breaking sale of Bank of America Plaza. "You're going to see more foreign capital because of the disparity between the Euro and the dollar," Yowell says. "On a risk-adjusted basis, they see the U.S. as an attractive investment."

The crystal ball

So, if you're an Atlanta developer and can build a Class-A office tower for $250 per-square-foot, lease it to 60 percent or 70 percent, and sell it for $300 per-square-foot to an investor that needs to find good properties to park a few billion dollars ...

Yowell expects 2007 Atlanta office investment sales to total more than $4 billion after a torrid $4 billion of sales in 2006 that included the $407 per-square-foot sale of 1180 Peachtree, King & Spalding's gleaming Midtown headquarters.

Atlanta's investment sales market did cool after sub-prime lenders' woes disrupted credit markets over the summer, bringing the real estate investment market to a brief halt. Nationally, prices are expected to drop perhaps as much as 5 percent, while cap rates (a commonly used value that measures first-year returns) are expected to climb about 50 basis points, to 6.97 percent for suburban office assets and 6.07 percent for central business district office properties, according to a recent ULI/Pricewaterhouse-Coopers study.

That means the cost of capital goes up and highly leveraged buyers may have some problems. Conversely, cash buyers – pension funds, oil money, etc. – have an opportunity to buy at lower prices than they would've seen two or three years ago. It'll just take some time to digest, says Steve Martin, managing director-Atlanta, at Dallas-based Granite Properties.

"A lot of capital is mindful of and watching pricing," he says. "The money still is out there. It's just trying to figure out pricing risk. It still has six or nine months to play out."

As for the credit market's woes impact on office tenancy, Atlanta's diverse economy should ease the blow, especially as more international firms seek a Southeast base and the state makes a big push to attract the biotech industry. Additionally, law, accounting and consulting firms are experiencing organic growth whether it's from the impact of Sarbanes-Oxley or helping clients navigate an increasingly complex business and technology environment.

"As history has shown, other industries will pick up the slack," Hollett says. "On a net basis, those events are going to offset some of the negatives from financial services' downsizing."

Industrial: A healthy sigh of relief

While commercial real estate's industrial sector isn't as sexy as its office kin – no one "oohs" and "aahs" over a giant warehouse in Jackson County – it's perhaps a better overall indicator of economic health. Not everyone needs a skyscraper, but the consumer products, appliance, clothing and electronics manufacturers making products integral to daily lives need a place to store their wares before shipping. While the market isn't at the heights of a decade ago – at 11 percent vacant and 9.1 million square feet of net absorption through three quarters – it's balanced.

"Vacancy's been running on average from 9 percent to 11 percent for 10 years, and that seems to be relative equilibrium for Atlanta," says Jay Mitchell, VP and regional development officer at developer IDI, which recently landed Mizuno's 300,000-square-foot requirement at Hamilton Mill Business Center in the I-985 corridor. HamiltonMill

Atlanta's 450-million-square-foot industrial market is primarily centered in the Northeast, Jackson and Gwinnett counties; the Southside, from the airport to Henry County; and the I-20 west and Fulton Industrial areas. Those three markets have absorbed more than 8 million square feet through the first three quarters. While 2007 absorption may end up less than 2006's total of 14.8 million square feet, the third-quarter, under-construction inventory was 5.4 million square feet vs. 10.8 million square feet at the end of last year, according to CoStar.

"It's a good sign," says Ray Stache, senior director and tenant advisor at Cushman & Wakefield, who represented Sears Logistics in its 772,800-square-foot lease at Raco General Contractors' Jackson 85 Distribution Center. "We needed to moderate our behavior."

The South submarket has its share of large blocks of vacant industrial space, but it's also the market that tends to capture big-box logistics requirements new to metro Atlanta. LG Electronics 611,930-square-foot lease at ProLogis Trusts' Park Greenwood in Henry County and Dick's Sporting Goods' 657,000-square-foot lease at Duke's Camp Creek mixed-use development are prime examples. CB Richard Ellis represented LG, while Staubach's industrial tenant rep group represented Dick's. The market also captured an existing tenant with American Building Supply's recent 635,000-square-foot lease at Majestic Realty Co.'s Airport Center 2.

Because the market is more reliant on new-tenant, blockbuster deals and speculative developments commonly eclipse 500,000 square feet, Henry County and the Southside are prone to peaks and valleys. That doesn't mean demand isn't there.

"While we have big boxes sitting empty, that doesn't mean they'll sit for years," says Steve Grable, senior VP and principal at Colliers Spectrum Cauble. "Some of these are leasing quickly."

While smaller than the South and Northeast submarkets, the I-20 west submarket continues to capture tenants leaving the Fulton Industrial corridor for newer, more efficient distribution centers. Recent big transactions include Publix's 354,620-square-foot lease at Resource Real Estate Partners' 425 Hartman Road development; and Exel Logistics' 585,000-square-foot lease at First Industrial Realty Trust's Terminus development in Douglas County, leased and managed by Colliers Spectrum Cauble.

Grable says as with office property investment, industrial investment activity slowed over the summer and continues to stall a bit as credit issues are sorted out, but there's still an enormous amount of capital chasing industrial real estate's steady returns and minimized risk.