Commercial market expansion: growth hampered by lack of money.

COMMERCIAL MARKET EXPANSION

Growth Hampered by Lack of Money

"It is the best of times, and the worst of times." Roger Boyer, chairman of the board of Boyer Co., the state's largest development firm, chose Charles Dickens' enduring words to describe the commercial real estate climate in Utah today. It is good, in terms of opportunity to make deals on distressed or troubled properties, but it is plagued by one immutable factor--a lack of available financing that is changing the face of commercial real estate nationwide.

Vibrant Growth Period

The overall improvement of Utah's economy over the past few years is evident in all three of the commercial real estate market's primary disciplines--industrial, office, and retail. Out-of-state companies, which have selected Utah for major expansions, and significant growth in local businesses have done much to diminish the widespread vacancy created by overbuilding in the mid 1980s.

The new development that usually crops up to meet demand, however, has been severely limited by lending conditions that have become more stringent than any time in recent memory. The savings and loan crisis--coupled with belt-tightening by banks, insurance companies, and pension funds--has brought speculative building to a virtual halt and placed major obstacles in the paths of even preleased projects.

Ironically, the financing crunch comes at a time when downtown Salt Lake City is experiencing one of the most vibrant periods of commercial construction in its history. Two new office high-rises, One Utah Center and the Broadway Centre, will bring approximately 650,000 square feet of additional space to the central business district when they are completed this year, and downtown is ringing with the sounds of construction on projects ranging from the Jazz Arena to new parking terraces at the Triad Center and Exchange Place.

According to Commerce Properties' Richard H. Nordlund, project manager for the Broadway Centre, the office market is experiencing an upswing in activity with an increasing number of companies looking at new space and expressing an interest in moving.

"We're seeing more and more people coming in from out of state, particularly legal and financial firms," he said, adding that much of the market's velocity is also being propelled by tenants seeking image upgrades through moves to a higher-class building.

Financing Gets Tougher

The Broadway Centre, currently under construction, has leasing commitments for 40 percent of its space. The project began with equity funding, but when the limited partnership developing the building saw its construction loan fall through, more than 200 lending sources were explored before the group was able to obtain financing through the International Brotherhood of Electrical Workers Pension Fund, Nordlund said.

"It held up the building at least a year--during that period banks had completely pulled back, and very few projects were being financed in any part of the country," he observed. "Now, and in the future, developers will have to put more equity into their buildings, and more space will have to be preleased before they can be financed."

In fact, buildings have to be 65-75 percent preleased before they are financeable, said Greg Gunn, office leasing specialist for Consolidated Realty Group. "The most significant change in this market is that money is severely limited for the financing of new buildings," he said. "This was caused by life insurance companies, banks, and savings and loans lending on buildings that were later given back or taken back by them and resulting in [the lending institution's] failure or reorganization."

The resulting chain of events impacts tenants as well as developers, Gunn said. Tenant improvement allowances, or costs allowed for finishing out space to the tenant's specifications, are being reduced, and longer-term leases are becoming requisite.

There's Gold in The Suburbs

Gunn indicated suburban Salt Lake, particularly the Union Park Center office park and surrounding areas, has become a prime market for companies which place a priority on being located near their employees' homes. "Downtown will always be home to the major law firms, bank headquarters, and to some extent brokerage firms, but for many companies a suburban location is important," he said.

Since little or no new office construction has occurred in the past nine months or is foreseen in the immediate future, available space in the suburbs is being "nibbled away" in small increments, according to Gunn, who predicts the scenario eventually will reach a threshold at which larger blocks of suburban space will be unattainable except through a "build-to-suit" agreement.

Correspondingly, rents in the suburbs are expected to rise and to become more competitive with downtown, where the advent of two new high rises will drive vacancy upwards. Overall vacancy in the Salt Lake Valley stands at about 21 percent.

Scott Wilmarth, vice president of office buildings for CB Commercial, indicated that build-to-suit construction, in which a developer constructs a building to meet a tenant's specifications, is becoming increasingly prominent in today's market. Wilmarth recently orchestrated such an arrangement for Sears Payment Systems, which will employ hundreds at a new Layton facility being developed by Price Development Co.

"Even custom facilities for quality tenants are becoming more difficult to work," Wilmarth said. "There has been a huge fall-out of developers in the last five years. Most banking institutions are reluctant to take the kind of risk required today," he observed, noting that only long-term leases with credit worthy tenants and developers with a track record for performance are able to get deals done.

Utah--a Good Deal

While Utah's economy is advancing, the economic difficulties of other states and regions has had an effect on this market, Wilmarth said. "Problems in other major cities impact us here. Companies looking for attractively priced deals will find a generous supply in depressed markets."

On the other hand, Utah's quality labor force, legislative climate, and favorable costs of living and of doing business have proved incentives for companies interested in relocating operations from states which are more expensive or which have adverse labor or environmental conditions.

Such was the case with Zero Corp., which is in the process of relocating a metal enclosures manufacturing plant from Burbank, Calif., to an approximately 280,000-square-foot facility it recently purchased in North Salt Lake. The new Utah operation will ultimately employ 500 to 700 workers.

Rad Dye, an industrial market specialist with CB Commercial, was instrumental in assisting Zero Corp. to relocate to Utah. After working with the company on a potential purchase of the former Tupperware plant in Jerome, Idaho, several years ago, he continued to pursue bringing them to Utah, eventually involving state economic development officials in the effort.

Dye indicated that while there is a definite trend towards California firms leaving that state for more attractive business climates, there are still obstacles for Utah to overcome before being considered a major contender. Executives with many out-of-state companies view Utah as being backward and provincial, and apprehensions about the state's predominant culture abound, he said.

In the late 1980s, Utah's absorption rate for industrial space lagged far behind the national average, but the tables have seemingly turned in this decade. Industrial vacancy currently stands at about 8.5 percent, while nationally, the rate averages 11.32 percent, according to Dye.

"With our economy picking up, we're seeing the gap closing now, and many of our vacant buildings are filling up," Dye said, adding industrial space alternatives are already dwindling in some portions of the market, particularly in the 20,000 square-foot to 50,000 square-foot range.

Industrial Buildings

Consolidated Realty Group industrial specialist Mike Farmer noted that while between one and two million square feet of new industrial buildings were developed last year, almost all of that space has already been absorbed. Out-of-state companies new to Utah were behind part of the absorption, but the majority was attributable to growth in local businesses, and most of the new buildings are owner-occupied, he said.

"We're experiencing a period of consistent, conservative growth and a positive business climate," Farmer observed. "There's no |big boom' here, but with the insurgence of out-of-state companies, local expansions, and less construction, vacancy has been headed down for the past two years."

Tenants are finding that there is less to choose from in some areas and that they must begin investigating opportunities for moves earlier than they would have several years ago. And though speculative development is a thing of the past, Farmer said, lending sources are available for build-to-suit construction for quality tenants, and loans like the Small Business Administration 504 are becoming viable alternatives for projects valued at less than $1 million.

The industrial market, be it for distribution, warehousing, or manufacturing, is centered primarily on the ease and ability of transporting goods and/or employees. Raw goods and manufactured material must be moved in and out by truck or rail, so access to the interstate system is integral.

Because of this factor, Salt Lake City is the prime market for industrial real estate in Utah, with Clearfield's Freeport Center running a close second. Freeport Center boasts the largest railyard in the state and more than 95 percent occupancy in some eight million square feet of space, according to Farmer, who was responsible for negotiating a new 80,000-square-foot facility for specialty plastics manufacturer CT Films at Freeport.

In Salt Lake, predominant industrial centers include Centennial Industrial Park, the Salt Lake International Center, Decker Lake, and the Wagner Industrial Park.

The New "Power Centers"

The insurgence of major retailers to Utah has altered the dynamics of retail development and leasing here over the past two to three years. National chains like ShopKo and Wal-Mart and specialty "category killers" such as Toys'R Us have the means to buy and build their own stores and are stepping into anchor positions in the new trend toward "power centers."

Power centers, which typically contain several large freestanding stores and a small amount of shop space, are dominating new development because they fill retailers' needs for expansion outside of regional malls, according to Pentad Properties' Tai Biesinger.

Biesinger indicated that the influx of new general merchandisers to the state, along with a trend toward one-stop shopping at major grocery stores that may include more than 20 different services under one roof, has driven down the amount of small shop space in retail centers.

"It used to be that builders maximized shop space because they could make more money, but now there are fewer merchants to go around," he said. Small "mom and pop" stores have declined in the wake of competition with national chains, and those who have survived have created niche markets based on price, service, or quality.

Financing for new retail development has been "non-existent" in the last year, according to Biesinger, who noted "one of the reasons the big anchors build their own stores is that they have the ability to do so." In fact, retail construction starts in Utah plummeted 86 percent in 1990 compared with 1989 due to tightening of credit by lending institutions.

Dave Winnie, a retail agent with CB Commercial, sees a trend toward more retail growth in the entire Wasatch Front region, rather than centered in the Salt Lake area as it has been in the past. New shopping centers under construction include Hermes Associates' Family Center in Riverdale; the Park City Factory Outlet; Wal-Mart-anchored centers in Layton and Roy City Center; and a ShopKo-anchored project in Spanish Fork. Work is also underway on expansion of the Crosstowne Centre in the Salt Lake area, along with the new Sugar House Center and Raddon Bros. Construction's Hidden Valley Shopping Center in Draper.

"In spite of tighter lending conditions, I think we'll see a lot more new construction coming on line spurred by the |big guys' coming in. As long as new retailers keep coming into the market and have a positive story to tell, we'll remain strong and will attract others who are looking to expand," Winnie said.

Retail specialist Bob Moore, co-founder of Consolidated Realty Group, says a number of factors led to the insurgence of major retailers to Utah. The Wasatch Front's population has grown enough to support the number of stores a retailer must establish to make distribution cost-effective, and Utah's bargain-conscious shoppers appeal to discount retailers, he said.

And though Utah has been home to many local and regional chains, until recently there has been no competition on a national level (with the exception of K Mart), making the state a field of opportunity for big retailers.

One paradox of the success many retailers are experiencing in Utah is a proliferation of "big box" space, or large buildings that have been vacated by tenants in search of bigger stores or more strategic locations. As tenants continue to reposition in the market, more and more vacant stores become available, leading to "rent wars" on existing big box space, Moore said.

However, he pointed out the chance of leasing big boxes is improving as new construction declines. "As less space becomes available, we'll see big boxes leased by a whole subculture of secondary users."

Tenants Call the Shots

For landlords of existing retail, office, and industrial projects, the dearth of new construction is a blessing in that overall vacancy in Utah is expected to decline substantially in the next three to four years. It's a mixed bag, however, for developers like Boyer Co., which builds and also leases its own properties.

"There's no doubt but what the spigot's been turned off," Roger Boyer explained. "Savings and loans, banks, and insurance companies have gone into the fox's den and won't come out until they see a better climate. What the future holds is anyone's guess."

Boyer indicated the lending market has grown tighter in the last six to 12 months than he has seen in the whole of his career. And though some herald build-to-suit construction for high-caliber tenants as the solution for weathering the storm, even those deals are becoming increasingly difficult to finance, he said.

Over the past three or four years, Boyer Co. has developed facilities to suit the specifications of Thiokol, Hercules, Novell, and 3M, among others, but lenders are demanding higher-equity dollars and a longer-term tenant commitment than ever before, according to Boyer. "We built one [build-to-suit] project recently that was considerably more difficult to put together than we've ever experienced. It required a seven figure equity amount to get it off the ground."

Overall, Boyer said, the changes in Utah's commercial real estate arena have created a tenant-driven market, with new construction dictated by the needs of individual companies. "It's a different world out there now, and the tenants are calling the shots."

Teresa Browning-Hess lives in Salt Lake City and specializes in business topics.