Development Magazine Winter 2014

Development - Ownership

Edge Markets Go Mainstream

Sterling Bay is redeveloping the Fulton Market Cold Storage Facility, now renamed 1K Fulton, as high-tech office space in Chicago’s River West neighborhood’s Fulton Market corridor. The building will house Google’s offices when it is completed next year.

The residential population of San Francisco’s Mid-Market district has spiked by 38.8 percent since 2000. The typical Dumbo household earns $123,675 per year, which is among the highest incomes in Brooklyn. Slightly more than half of Seattle’s Belltown/Denny Regrade neighborhood is younger than 35. These and other noncore submarkets have witnessed phenomenal demographic change over the past few years, mirroring the return to urban areas. In turn, both commercial and residential investment in these areas has increased significantly, ultimately driving denser, mixed-use development aimed at millennials who want to live and work in walkable, transit-accessible neighborhoods with a sense of place. 

The key result: soaring demand for creative and alternative office space. Vacancy rates in central business districts (CBDs) have continued to decline faster than in suburbs; those in urban cores average just 13.7 percent, compared to the national average of 16.3 percent. Similarly, strong leasing demand has fueled rent growth of 16.1 percent as of the second quarter of 2013 in this segment of the market, after bottoming out in 2011. In many of the most active markets, rents for core space are posting double-digit annual increases and, with the exception of the Bay Area, Dallas and Houston, have yet to enter the peaking, high-growth phase of their rent cycle.

These are some of the drivers in the emergence of the next development frontier: noncore and fringe CBD micro-markets.  More and more, their growing identity as neighborhoods and activity centers in their own right is drawing interest from major developers hoping to capitalize on their potential. From the office perspective, Boston Properties’ 601 Massachusetts Ave. NW in Washington, D.C.’s Mount Vernon Triangle (whose anchor tenant is AmLaw 100 firm Arnold & Porter); Twitter’s relocation to Market Square in Mid-Market, San Francisco; and Amazon’s Belltown/Denny Regrade mega-development in Seattle illustrate the strong investor and tenant confidence in and appeal of these markets, as well as their transformation from outliers to viable business districts. 

rendering of outdoor space

The redevelopment of the Pike Place Market waterfront entrance will improve access to the Seattle waterfront and make the neighborhood a more appealing destination. Courtesy of Miller Hull

Over the coming years, the distinction between noncore micro-markets and CBDs is likely to blur, with these areas becoming extensions of the CBD rather than CBD-adjacent, accommodating the growing demand from nontraditional industries and market segments. Expansionary activity in the office market and the limited inventory in these niche areas will prove beneficial to investors in the long run, as the combination of location, variety of product and tenant preferences demonstrates itself to be highly valuable. 

While this phenomenon is not new, it is happening more often, as millennials and baby boomers alike seek an urban lifestyle. As a result, new noncore micro-markets are emerging with more frequency across the country. Three examples — from Seattle, Chicago and San Francisco — illustrate this trend and its impacts on the office markets in these cities.

Belltown/Denny Regrade, Seattle

Adjacent to Seattle’s CBD and along the Puget Sound lies the submarket of Belltown/Denny Regrade, which has a history long steeped in the shadows of the downtown core. The submarket has emerged in recent years as a lower-cost alternative to the more expensive CBD. Established by the Bell and Denny families during the gold rush, the area had promised to grow in prosperity as downtown Seattle grew larger and denser. The advent of the modern high-rise, however, allowed downtown Seattle’s growth to continue while Belltown/Denny Regrade became a lower-cost area for peripheral businesses, artists and eventually hippies.

Over the past few years, plans to revive the submarket have been boosted by a pipeline chock full of both public and private projects, including the demolition of the Alaskan Way Viaduct, the restoration of the Elliott Bay seawall and the redevelopment of the Pike Place Market waterfront entrance, all of which will offer greater access to the water and enhance the area as a destination. As shipping ports have become fewer and more consolidated in coastal cities, economic opportunity derived from redeveloping this real estate has proven highly successful. Anyone looking for a case study to support the removal of the Alaskan Way Viaduct needs look no further than the demolition of the Embarcadero Freeway in San Francisco, the resulting success of the reborn waterfront and the historic renovation of the Ferry Building, now a premier West Coast destination. With little development over the years, Belltown/Denny Regrade’s older building stock has now returned to fashion, and urban dwellers and creative companies are taking notice.

Recent commitments to the sub-market include companies like Amazon, Zulily and Popcap, which are providing an anchor for other high-tech companies to cluster around. As a result, total vacancy has declined to just 10.1 percent. Excluding available sublease space, vacancy falls to 9.6 percent, making Belltown/Denny Regrade the second-tightest submarket in Seattle. Subsequently, while rental rates remain among the lowest in the area at below $30 per square foot, the recent surge in popularity is pushing them upward. Rents have grown by 12 percent over the past year alone, compared to 2.9 percent across the metro area. Likewise, although the cost of living is ranked very favorably among other neighborhoods in Seattle, it is not the lowest-cost area in the metro, according to Areavibes (a web service designed to help people “find the best places to live in America”). With further improvements and enhancements, the premium for living in a waterfront location with walkable amenities and proximity to the urban core likely will increase.

River West, Chicago

Located west of Chicago’s downtown Loop and emerging as a result of spillover demand coming from River North, River West has become the city’s newest up-and-coming neighborhood, just a quarter mile from Wacker Drive and the West Loop of Chicago’s core business district. Formerly fueled by mom-and-pop retail and light industrial businesses, River West continues to maintain its old-school charm while welcoming new city dwellers and corporations that have begun to invest in the area. Once known as the setting for Oprah Winfrey’s Harpo Studios, it has recently grown in popularity as demand for urban living, interest from Chicago’s maturing tech sector and its resulting adaptive redevelopment have become a larger demographic and business trend. 

interior cold storage facility covered in ice

When Sterling Bay purchased the Fulton Market Cold Storage Facility in 2012, the building interior was completely frozen over.

Today, River West boasts a building supply largely consisting of warehouse stock that is slowly becoming commercial office space, loft residences, restaurants and boutique hotels, located primarily along the Fulton Street corridor. The neighborhood is supported by the Chicago Transit Authority’s Morgan “L” station, which reopened in 2012 after being inoperable for more than 60 years. That same year, after nearly 90 years of occupancy, the Fulton Market Cold Storage Company sold its formerly state-of-the-art facility to Sterling Bay, a Chicago investor and developer that has built a reputation for tackling challenging redevelopment projects in the area. The building, now called 1K Fulton and located in the Fulton Market corridor, is undergoing a complete renovation and will become the new home of Google, undoubtedly the area’s greatest win to date, when it is completed in early 2015. 

It’s not just Google that’s interested in River West, however, as companies like Uber Technologies, SRAM Corporation and others stake a claim on the submarket, making its continuing redevelopment inevitable. Occupancy gains amounting to 2.1 percent of total inventory (30,312 square feet) halfway through 2014 resulted from numerous firms flocking to creative and affordable space. With a supply of interesting structures and average rental rates that are 35 percent lower than those in neighboring River North, it won’t be long before activity increases further.

Mid-Market, San Francisco

Southeast of Civic Center and just blocks away from San Francisco’s Financial District lies the Mid-Market submarket, the newly coined name for a neighborhood attracting the attention and dollars of investors from around the country, while still very much in transition. In 2010, the city identified Mid-Market as a targeted area for redevelopment. Storefronts had been vacant and boarded-up for years, public vagrancy was common and there was virtually no public interest in the area. 

At the same time, San Francisco’s high-tech engine was beginning to gain speed, and the grit and character of the neighborhood fit the tech and millennial profile nicely. Companies such as Zynga, Dropbox, Airbnb and Twitter were growing rapidly, but were unhappy with the corporate office supply available at the time. While the city was on the brink of another tech boom, banks were maintaining a hard line on lending and developers were uncertain of the economy’s outlook. Adaptive reuse and renovation thus became attractive options for those who were looking for a way back into the development game. 

exterior view of office building
exterior view of office building

Top photo: Before. Bottom photo: After. Market Square, the redevelopment of a 1940s Art Deco complex that is now home to Twitter headquarters, has transformed a once blighted area and spurred additional economic activity in San Francisco’s now booming Mid-Market neighborhood. Both photos: Drew Kelly

The real boon to Mid-Market’s re-envisioning, however, was the result of two important events: the establishment of a payroll tax exemption area along the mid-Market Street corridor and the signing of Twitter’s headquarters lease at Market Square. Without the former, the latter was unlikely to happen, as Twitter entertained the possibility of leaving San Francisco altogether. At the same time that Twitter was closing its lease transaction, Shorenstein, a national real estate investor, was closing on the sale of Twitter’s new headquarters building and the neighboring building that comprised Market Square, a former wholesale furniture merchandise mart constructed in 1947. With two well-known companies taking a major stake in the submarket, the city’s plans for revitalization looked very optimistic.

Nearly four years later, Mid-Market is home to new businesses like Twitter, Uber and Square, as well as retail and residential space that caters to the city’s growing density and population. Although much is still to be done to regenerate economic activity in existing buildings and obsolete parcels, it has quickly transformed from an area of severe blight to one in which major investors and developers from around the country are now active players. Since the market trough in 2010, vacancy has declined from 32.7 to 14.1 percent, and rents across all classes have increased by 87.1 percent, from $28 to $52 per square foot. With development limitations governed by Proposition M and a current pipeline exceeding allotted development rights, many more investors likely will seek opportunities through redevelopment in the coming years.

Promising Transformations

More mature noncore submarkets also are hives of activity. Most are differentiated by a larger presence of major tenants or institutional investors than are found in emerging niche markets. In Brooklyn’s Dumbo (down under the Manhattan Bridge overpass) neighborhood, online art dealer Etsy took on 200,000 square feet in two buildings, a strong sign of confidence in an otherwise outlying submarket. Favorable demographics, a location between supply-constrained Manhattan and fast-growing Brooklyn neighborhoods, and creative space all likely played a role in Etsy’s decision to remain in Brooklyn. Outside of Dumbo, New York University has made notable moves into downtown Brooklyn as it seeks to renovate and build in New York’s third-largest business district. Local government offices are clustering in Long Island City in Queens, just one subway stop away from Grand Central and Midtown East.

Washington, D.C.’s Mount Vernon Triangle neighborhood transformed rapidly from a sea of parking lots to one of the city’s most active development areas. First came residential developments, which popped up along Massachusetts Avenue between 2004 and 2006, followed by the delivery of CityVista, a mixed-use project developed by Lowe Enterprises containing 568,000 square feet of apartments, condominiums and ground-floor retail space in 2008. Thousands of new residential units have been developed in large-scale infill projects on neighboring parcels over the past few years. 

Mount Vernon Triangle’s rapid residential growth and proximity to the core East End office market drew the attention of major owner-developers such as Quadrangle, Boston Properties, Douglas Development and Gould Properties, which are bringing with them equally large office developments and tenants. The American Association of Medical Colleges as well as law firms Arnold & Porter and Venable all have moved to or signed leases or letters of intent, respectively, at Mount Vernon Triangle office properties that command full-service rents from $75 to $85 per square foot, rivaling those at brand-new developments. (These rates trounce those at second-generation and lower-quality buildings nearby, which are commanding rents of only $25 per square foot.) The combined footprints of Mount Vernon Triangle office properties total more than 900,000 square feet and overall occupancy in the neighborhood is likely to surpass 2 million square feet over the next 36 months as companies continue to migrate farther to the east, expanding the traditional core. 

Denver’s LoDo neighborhood is yet another example of investor and tenant preferences shifting to mixed-use, urban areas not necessarily at the heart of traditionally nine-to-five CBDs. As of mid-2014, 780,676 square feet of commercial development is taking place there, representing almost half of Denver’s new office construction. Clustered around the revamped Union Station, LoDo’s Class A space commands an 18.3 percent premium compared to high-quality space throughout the CBD, while supply constraints mean that tenants in the market for Class A space contend with a single-digit vacancy rate.

Perhaps the defining ingredient in the success of these noncore submarkets is their capacity for new development that meets the preferences of tenants and landlords alike. Their location near CBDs ensures that employers can attract talent, while landlords can command elevated rents because of the area’s proximity to public transportation and an existing (and sometimes growing) amenity base. Meanwhile, they lack the sometimes rigid and sterile feel of many CBDs, blending historic and contemporary architecture and urban development better than traditional core areas. All of these elements provide “the best of both worlds” and ensure that these submarkets will remain attractive to investors, positioning today’s emerging and mature noncore submarkets for long-term success.

From the Archives: Development Ownership Articles from the Previous Issue

rendering of three new buildings and one current building

Brandywine Realty Trust: “Make No Little Plans” 

Brandywine Realty Trust closed 2013 with the best results in its 20-year history. Using a multiyear portfolio repositioning strategy, it pivoted almost seamlessly from its suburban office roots of the 1990s to focus on urban centers. Today, its urban and town center properties (those located in mixed-use areas and/or with access to transit) represent 48 percent of its portfolio and over 67 percent of its net operating income.

office building at night

DaVita World Headquarters: New Corporate Office Tower Promotes Healthy Living 

Situated at the base of Denver’s Millennium Bridge, across from Denver Union Station, sits DaVita’s new corporate headquarters. The iconic building, standing 14 stories in the Central Platte Valley District, has reshaped the downtown skyline and set a new precedent for world-class office accommodations.