Commercial real estate.

THINGS ARE ON THE UPSWING WHEN IT COMES to the commercial real estate market in Utah--such was the general consensus of a handful of industry experts gathered for the annual Utah Business outlook discussion on the topic. Discussion points included Salt Lake City rental rates, the potential downtown impact of development plans of The Church of Jesus Christ of Latter-day Saints, RDAs, and the inevitability of big-box retail development.

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Participants: Jeff Gochnour, The Boyer Company; Scott Wilmarth, Richard Ellis; Mike Richmond, Commerce CRG; Anita Lockhart, Wasatch Property Management; Phillip Dunn, NAI Utah; Vasilios Priskos, Internet Properties; Mark Smith, Utah Industrial Depot; Fred Barth, Pentad Properties; Gary Mangum, Coldwell Banker Commercial NRT; Steve Bogden, Coldwell Banker Commercial NRT

Special thanks to moderator Kevin Murray of the law firm of Mabey and Murray, and sponsor Holland & Hart.

HOW HAS THE FINANCIAL MARKET PERFORMED IN THE LAST YEAR AND WHAT ARE YOUR PROJECTIONS?

RICHMOND: Industrial land sales are good to look at, relative to future development and how bullish people are starting to look at the market. Last year alone it was about four times the average of the previous six to eight years. The market saw closings on more than 900 acres last year, and developers acquired most of it.

Relative to the office market, absorption levels are coming back and vacancy rates are starting to decline. Lease rates are finally starting to increase, but probably not to the levels we would have expected.

You can't necessarily measure the incentives that tenants are offered to sign leases, and those are starting to diminish. We are seeing fewer concessions and fewer improvement allowances.

GOCHNOUR: The market is tightening significantly, coming out of a very difficult period from 2000 to 2003. We have seen that at The Gateway, with the sales there on the retail side.

Part of the problem in the past has been huge amounts of sublease space, which has been reduced significantly. I think that's an indication of a much healthier downtown office market.

WHY IS SUBLEASE SPACE AN ISSUE?

GOCHNOUR: It's an indication that companies are struggling. They have more space than they need or they are going out of business, so they have put their space on the market to try and just get out of it as best they can. And since it competes with prime space, and a subtenant or sublease space will typically be at a lower price, it creates downward pressure on the overall office market in terms of rents.

WILMARTH: A sub-lessee is trying to cut costs, where a developer is seeking a yield to investment. So when you have a lot of sublease space it fights against the developer. As big corporations down-sized through early 2000, they put an enormous amount of space on the marketplace in an effort to just cut costs, which dragged the rental rates down to the properties that were trying to lease on an investment basis.

HOW HAS THE CLOSURE OF THE KEY BANK TOWER AND THE TRIAD CENTER AFFECTED THE DOWNTOWN AND SUBURBAN OFFICE MARKETS?

WILMARTH: It could lower our vacancy rate at least five percent and possibly as much as ten percent, depending on where the tenants from the relocated buildings go--a pretty significant impact on the central business district and the periphery. If the LDS Church is successful in relocating these tenants, they are effectively right-sizing our central business district in a way that could have a pretty significant impact and would drive some pretty good demand.

Tenants recognize that things are tightening up and moving quickly on space. We are also seeing landlords trying to push rates up even though the vacancy statistics don't necessarily justify it. They are

projecting what this impact may have.

WHEN YOU SAY "RIGHT-SIZING" ARE YOU SUGGESTING WE STILL HAVE PLENTY OF SPACE TO ACCOMMODATE THESE TENANTS, OR IS THERE A NEED FOR ADDITIONAL SPACE?

WILMARTH: Probably both. You won't find a lot of it, but there are tenants in spaces that they probably can't afford going forward. As rents catch up, they will push down to the B and C properties, both of which still have a pretty significant amount of vacancy. So either you are going to have to look at class B properties or you are going to have to wait for some new construction. And I'm not sure that the rental rates today justify new construction.

BOGDEN: I think that's precluding Hamilton from pulling the trigger. Hamilton Partners has been talking about their buildings, saying. 'Let's go get them.' Gateway is finally in good shape and they are going. 'Where can we go? Wells Fargo?' It's a mid-block thing and some of the guys want the hard corner. You want that anchor tenant to take down property. I don't know if Hamilton can find that mid-block tenant that will go there that will be that anchor, because it's going to be pricey for them to build.

RICHMOND: They had to recently re-price their construction. The next high rise downtown will break the $30 per square foot rental barrier in order to provide a decent return.

WILMARTH: We haven't necessarily seen tenants step up to $25 rates yet. Only recently have we seen an interest in that. I think that's a function of there being so little vacant space available.

BOGDEN: Do you think that if we get to $30 rates, firms will abdicate the central business district; saying, 'To hell with it. I'm going to the suburbs'?

PRISKOS: People will pay it if they want to be downtown. I think we are seeing an in-migration of people to downtown again. And hopefully with what the governor is doing and the national economy, we will see more in-migration of tenants. That will help us get to the $30 level, because we are still relatively inexpensive compared to other suburban markets.

RICHMOND: If you are a tenant looking for quality space, even though there's vacancy and space available in Class A buildings, Hamilton will build and deliver space less than that in the lower portion of the building, so it's not like you are walking in the door at $30. But to get the premier space in the upper half of the tower, that's where the range will need to be.

WILL NEW TENANTS MOVE DOWNTOWN WITH WHAT IS GOING ON AT THE MALLS?

WILMARTH: Downtown is where everything is happening right now, but the fact of the matter is that the suburban marketplace still continually out-performs the downtown marketplace in absorption. I think that's because most corporate tenants are looking for efficiencies, both on a per-square-foot rate and on a cost-per-person basis.

The real question is whether the Church's investment in this new block will create a destination that users will want to come to. If it does, it will reverse a trend that we saw start probably in 1998 where absorption in the suburban marketplace began to outpace absorption downtown. We all hope the Church will make this investment, and that some new tenants will consider coming downtown.

RICHMOND: Some of the tenants that left downtown, left during freeway and light rail construction. So a lot of the tenants that departed left in the worst possible time, because downtown now is more accessible than ever. Light rail has surpassed expectations.

So I think that, combined with what the Church is doing, the malls, the redevelopment, downtown will be as appealing as it has been in the last 10 to 12 years, aside from rising lease rates--but you will see rising rates in the suburbs, too. The suburban buildings face the same construction cost issues, so lease rates will increase market-wide.

LOCKHART: It is very expensive to build new construction, but what about revitalizing other historical buildings in the downtown area that can achieve a class A feel but yet give the lower rental rates?

The architectural community loved our First Security building; the general public thought it was an eyesore. But with the monies that we got through the historical financing and working with the historical community to revitalize that building, we have taken a B and C grade building and increased it to a class A facility and kept or preserved the historic nature. And we were able to provide lower rental rates in the downtown area. We expect full occupancy by year's end.

PRISKOS: I don't think you can take a historical building and create by definition a class A building. But I do think it holds the community together. Just to take down an old building for the sake of building a better building or more profitable venture isn't the right way to do it.

BOGDEN: Renovation is the one thing you can do downtown that you can't do in the suburbs. There are few funky buildings in the suburbs.

BARTH: There seems to be a lot of revitalization in the retail market, too. A lot of our clients are from out of state. They are tired of paying the four and five percent cap rates on properties, and look to our market to buy an existing shopping center or property and redo it. They're finding a much greater return on investment.

WE HAVE LOST RETAIL ON MAIN STREET AND GATEWAY HAS PROVEN TO BE SUCCESSFUL. HAVE WE MOVED DOWNTOWN OVER FOUR BLOCKS, OR CAN WE EXPAND THE DEFINITION OF DOWNTOWN TO BE BIGGER?

SMITH: One of the things you are going to see in the overall mix here is that as the industrial side moves out of downtown--i.e., the mobile corridor of the rail service--it is going to open up additional opportunities for the entire downtown area. As that happens, you are going to see a whole redistricting of the entire downtown area and potential for growth.

Opponents argue that RDAs aren't necessary and the development will occur eventually; proponents suggest a sort of a "but for" situation--if we did not have them, the development likely would not occur.

HOW WILL RDAS AFFECT REAL ESTATE?

SMITH: I think RDA is a necessary tool and can be very viable to communities, not just to large communities but also to smaller communities. But the problem I think Senator Bramble was trying to correct was that when an RDA runs out or is paid out through the enterprising system, the cities take the RDA benefit and still use that taxing basis for parks and other infrastructure within the city. That's the part that he really set about to start to correct, but it mushroomed beyond that. It's wise that the legislature cooled this by allowing a year of introspection to go into the system and see if they couldn't forge an amalgamation of the thought process again to continue. I don't think we are through with RDAs at all. It's just that we have now politicized it and polarized the issues, and we have to go back to where it will work for everyone.

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BROADBENT: I have been involved in a number of RDA projects as an attorney. I see two effects: One, to provide a positive economic incentive. Whether it would ever get done or not done at all, who can say. But wait long enough, property will appreciate and demand might come. Two, an additional benefit it has provided, to the frustration of the development clients, is a means for greater influence by the community on the development and the outcome of the project. Preserving things of a historic benefit, for example. Or trying to put a greater emphasis on the neighborhood characteristics that they want to see maintained. Because there were economic incentives involved, the owner-developer would be able to go along with some of the strings attached that otherwise, as purely entrepreneurial benefits, they wouldn't. I see that as a benefit.

Some of RDA's bad reputation has come from abuse of terminology of "blight" and finding economic blight when maybe most of us wouldn't think it exists. But I don't think we should throw the whole tool out because it needs sharpening.

MANGUM: National retailers are not looking to come to Utah because they like people that ski; they are coming for economic purposes, and they've got a certain number of stores that they need to deliver to Wall Street in a given year. If those can't be economically viable here because of RDAs, they will go to other markets. And a lot of big retailers are looking for some real incentives.

BARTH: Many of our clients enjoy the Utah market because they can come here and go through the entitlement process, permitting, get a store open maybe in half the time that they can do it in California. So that's an advantage. If the costs continue to rise, and as we get more of the California planners and it drags out the time for them to get their permitting and whatnot, they will go elsewhere.

PRISKOS: On RDAs I think it comes down to balance. I agree it is an important tool. But our market is based on supply and demand, and when an RDA is thrown in there and disrupts it--I don't mean to pick on Gateway because luckily they are successful, but it caused an imbalance in the market because it was built without demand. It was built because of incentives and low cost of land. When we use RDAs to the detriment of other property owners and rights, there's a problem. So I think there does have to be balance.

DUNN: From my perspective, we went from Pawn Shop Landing to Jordan Landing. We went from Death Row to Retail Row. True, as Vasilios just said, there are going to be issues, leveling the playing field and fairness; and as Steve said, getting the legislature to see what reality is. We are just going to have to convince politicians to see the commercial real estate perspective.

Again, my view is as somebody new. But I see so many positive changes that if you take the changes and the positive things that have been happening and the challenges, the list is higher on what's going good than what is going wrong.

BARTH: We have to remember Utah is a very small market. Whatever we need to do as a community to bring these people in, I think we need to do it. You have an RDA project and you bring one of these retailers in, once they have committed to the market then they are committed to the market, and then they will hopefully expand and benefit everybody. So even though you are putting it above somebody else's property, or maybe a little bit more of an advantage over other property owners, ultimately I think that it's a positive thing.

I HEARD THERE IS RELUCTANCE IN LOOKING IN DAVIS COUNTY BECAUSE OF THE CONFIGURATION OF THE LAND AND THE MOUNTAINS AND THE CLOSENESS OF THE LAKE AND SO FORTH. WILL RDA GET SOME DEVELOPERS TO TAKE ANOTHER LOOK?

MANGUM: Absolutely. Retailers naturally look at what their trade area is, and it's not only the economic makeup but it's the number of people. When you get up into Davis County, do one, three, five mile radiuses and there aren't many people. So given the price of land, without some kind of incentives there is not going to be development.

Just last week in Farmington, they allocated almost $18 million in an RDA bond issue for the new station park that is going in up there. Without that, the whole public infrastructure would not get built. When that project is completed it will be comparable to The Gateway, and you wouldn't see that kind of a development getting built out there out of a private developer's pockets. There just isn't the resources and return on investment that would get anybody willing to step up. When that is completed, it will be the first completed stop on the commuter rail line, right across from Lagoon. There will be mixed-use development made up of housing, both for rent and for sale. It will have office, entertainment, retail, maybe even some city offices. That's all happening because of the RDA.

WHAT DO WE FEEL ABOUT MID- AND BIG-BOX RETAIL?

MANGUM: They are here to stay and they are going to expand and there will be more of them. The people that say they don't like them, I'd venture to say they still go in and shop.

BOGDEN: The biggest problem with some of the boxes is when they try this new urbanism where they want the big box out to the front of the street, and forget that you have to have semi trucks to service this stuff and things like that. But the big boxes are obviously here to stay. They are functional. Some people say they are eyesores, but how else do you do it? You have a conglomeration of little boxes? No. They are just here to stay.

HAVE THEY CAUSED THE LOSS OF THE MOM AND POP STORE, OR IS THERE A WAY FOR BOTH TO EXIST?

BOGDEN: I think there's a way for them to co-exist. There are opportunities where you can put in the big boxes, and yet have the high fashion, have the people with a clientele. Most of the mom and poppers that go out of business are poor merchants. They just don't get it. The good mom and poppers that can do it, they can make it and they can be regional in scope.

MANGUM: We have the most efficient economy in the world. There's an equalizing force out there with supply and demand, and you can't legislate an economy. You can't dictate that there has to be ma and pa out there, because the public determines what's going to happen by where they spend their money. And that's what's driven the growth of WalMart and Target and Costco and all of those; people seeking values, wanting to get more for their buck. And so to try and say that we are going to legislate big box away, it isn't going to happen because it's going to hit every consumer in the pocketbook.

WILMARTH: I hear you say that the big boxes need RDA funds because the rates are getting so high or the ground costs are getting so high that without the help of the RDA or some kind of incentive, it's impossible for them to come into the community. I'm confused, because in the office or in the industrial arena, we have seen not any real significant growth for at least five years, and yet retail has never even hiccupped. So I'm wondering to myself why are houses being gobbled up? Why are new retailers coming in? Where are these people going? Where is the disposable income coming from? Job growth has been stagnant, for the most part. There haven't been any huge announcements of big companies coming for a while. Is it just that there's this value customer that's there and now they are getting squeezed a little bit on their personal incomes so now they are taking advantage of that? What is driving all this retail growth?

BOGDEN: One of the things you have to realize is, you put together a center that's a 400,000 square foot power center, you've got a couple thousand jobs. Every time Target or Costco opens they hire 475 people. You hear about the hubcap plant in Oakley that will hire 150, and have ribbons and helicopters and sirens and the governor at the grand opening. You open four or five Best Buys and that's a couple hundred jobs.

But you are right; nothing has slowed down in the way of retail. When things were down, we were still nuts. But still, if you don't have the incentives that are out there, Target says, 'We are doing okay but I can go to Dallas and put seven stores in and hit my mark for Wall Street this year, I don't have the angst and the anguish because I can get the dirt cheaper and there are incentives in Texas that you can't do.' So when you look at it, retail has just been able to grow.

BARTH: You look at the sales they generate. Wal-Mart is attractive, as much as everybody hates them. They will do $1.9, $2 million a week in a small community. That's huge. And if they are saying, 'Well, you need to give us some incentives or we are going to Dallas,' these places are going to clamor to get it because you look at Springville or Payson, for heaven's sake, what else are they going to get?

MANGUM: The guys pushing to give those incentives are the city leaders that are trying to balance the budget, looking for where tax revenues are going to come from. The people there don't want to get taxed any more and they want better and more services and want parks, but they also want someone else to pay for it. Well, you've got to increase your tax base. You have to get retailers in there. You have to get manufacturers, those things to happen. Wal-Mart is a huge producer of tax revenues.

BOGDEN: Costco in Murray got some real bad press. One of the TV stations flew over, and they were talking about the RDA, and said, 'Here's a great example.' Well, Costco didn't get a dime in Murray and they are going to do probably $120 million bucks in volume, which is tremendous tax incentive. When you are in Murray or really in Salt Lake or Ogden, the infrastructure is crumbling. You have water lines busting and trees that are upheaving, and curbs and gutters and potholes. They need to get any kind of taxes they can get to preserve that infrastructure. Yet you get the school board, and I really identify with that as they are saying, 'You are taking money that we need for our education,' and stuff like that. We also need it for the roads and the sewers and we need it for the sidewalks and for our parks and stuff, too.

SMITH: You need it for the growth, too. All of us know and Sandy proved it, that you can't run a city as a bedroom community. It just won't work. In Tooele we use it. We have an RDA there, and we are using it to create 160 new jobs from one client coming in. They've put up 240,000 square feet since November, and now they are embarking on the second phase of their project. It hasn't been announced nor officially approved, but these are areas where it's an investment. The school board invests. In our RDA you have 75 percent that goes back to the school, 25 percent goes to the RDA with a cap, so no one is getting abused, no one is getting hurt. It's an investment of the community, it's an investment of the city, it's an investment of the school board, and it's an investment of private business. Without that, you don't have a valid concern.

CHARACTERIZE THE COMMERCIAL REAL ESTATE MARKET.

GOCHNOUR: I'm very optimistic where things are going. I think with this new administration and new governor, he is very committed to economic development, very committed to bringing new companies to the state. Things are going to improve significantly over the next couple of years.

RICHMOND: The type of jobs that he is trying to attract are going to be welcomed here. Job growth from February 2004 to February 2005 was 41,000 new jobs, the highest since 1997. I think that trend will continue and is going to help spur new development and demand for office space. With construction costs rising, I think it's going to help keep that supply and demand balance there. I don't think we will get overbuilt in a quick period of time. It should be healthy going forward.

BOGDEN: I look from Logan--which is extremely vibrant, they are doing a tremendous amount of things in Logan--to St. George, which as we all know is insane. We are seeing an extremely positive market. Many of our small communities in our state are feeling that, too. So job creation, we still have some pockets of areas that are a little tough such as Carbon County and stuff, but in most cases we are seeing expansion and growth. Certainly Summit County is great. So not only the Wasatch Front is feeling growth. And seeing how we operate throughout the whole Western United States, places like Bozeman and Pocatello are on fire. Jon Huntsman gets it, understands it, and we are going to be real happy with his work.

MANGUM: I'm very bullish on what is happening in Salt Lake and in Utah in particular. From a business standpoint, this first quarter of the year has been the strongest year we have had in a decade in the commercial real estate market. I see that trend continuing. There's just a lot of demand. Office space has been filling up in levels that we haven't seen since the late 1990s. New buildings are starting to come on line.

You will see a lot of new mixed-use communities that will spring up around the upcoming transportation hubs. West Valley has done an RFP and has a number of proposals in for total redevelopment of that downtown area. You have one going in up in Farmington. You will see those throughout the Salt Lake and surrounding areas in the coming years.

BROADBENT: It's been a great time to be in real estate. I, too, see that continuing. We have had more clients than ever contact us from out of state wanting to get into the Utah market or expand their presence in here, and our traditionally local clients are doing more. The only frustrations we hear here are people wanting to buy a project that can't find the projects.

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We also benefit in the real estate trade from being a great game when the rest of the environment for investment in the country is dismal. We have seen a lot of dollars flood into real estate that traditionally would have gone into the stock market, for example. That's been a great benefit. As the markets improve, we might see dampening of enthusiasm. But this is not a doom and gloom, it is reality. We have benefited from that and when it starts to level out, people will take their investment dollars and consider other options. We always need to keep an eye on a bit more global perspective than what is happening here in our own backyard, but still looks quite positive.

WILMARTH: I wonder if on the real estate investment side it's a bit of a bubble. I don't think it's going to take much, if the stock market comes back a little bit, for people to moderate their enthusiasm, so I think you'll see cap rates go up a little and that will be partially a function of the spread between interest rates and the yields. You are going to see a more vibrant office community, leasing, than you have seen in the last probably three years, primarily driven by the fact that there's not a lot of good quality space out there. Landlords are probably going to be a lot less shy about asking for more from their tenants. In fact, tenants are going to have to get used to a landlord's market, which is something they haven't experienced for five years. I think that the real estate economy will still be viewed as a positive thing, although as the national economy comes back, Utah will take its place as a secondary market, and that can be frustrating at times when you are trying to sell a smaller community.

I like the fact that the Governor believes in jobs driving the economy. That's ultimately going to fuel our infrastructure and ultimately what is going to provide our children jobs.

BARTH: I think there are a lot of eyes on Utah. As many other markets have expanded and filled out, there are a lot of retailers that are looking here, and they are very excited about our market. There's great residential growth here. There's a highly educated work force here, which is really exciting and it's a nice place to operate a business. If we can be smart from a government standpoint and as a community, we can continue to be strong here for a long, long time.

LOCKHART: I'll speak from a landlord's point of view. In the past it has been tough on the landlord; it's been a tenant's market. With the absorption of the vacant space and all the activity that we have going, it's going to tighten up for the landlord and they are going to be able to command a better rate and make fewer concessions. In the past, unfortunately, some landlords had to take the lower value leases that hurt the value of their building.

Before we have hardly any space available, I think it's time for tenants to start their renewals early and lock in the rates because they are going to increase.

PRISKOS: In downtown Salt Lake, the Church of Jesus Christ of Latter-Day Saints is going to be investing nearly $2 billion in this market, a small geographic area, over the next five to six years. The repercussions that will have, we will never see in our lifetime again. It's going to be unbelievable. I can just say hold on. We are going to go on a great ride downtown, and it's going to be great when it is finished. Our skyline is going to change. It's good times downtown, finally.

SMITH: I'll address the alternative markets outside the core area. Where the residential market is strong--Tooele County, Riverton, Draper, etc.--the marketplace there is blue-collar, looking for manufacturing and other opportunities to create long-term new jobs that will benefit retail and eventually office space out there. Right now it's purely an alternative market, but as 1-80 continues, and we have all talked about the closeness of the transportation market, and the land issues and the land there is more open and available, I foresee the whole infrastructure of the Salt Lake Wasatch Front being a viable market for the next ten to fifteen years