Class B makes its return
Commercial tenants that flew to quality now 'fly to economics'
Portland Business Journal - August 31, 2007
by Wendy Culverwell
Business Journal staff writer
Just two years ago, recruiting tenants to Montgomery Park was a challenge. The massive building in Northwest Portland is at the edge of downtown and was about 30 percent empty. Tenants were enticed to nicer space in Class A buildings by stagnating rents.
Today, the 750,000-square foot office complex in Northwest Portland is essentially full with a 98 percent occupancy rate. Brokers say they regularly field inquiries from prospective tenants but have to turn them away.
The tide has changed not just for Montgomery Park but for most of its Class B brethren.
With little space available in the Class A market and rents rising, tenants that just a few years ago sought out A spaces are increasingly turning to Class B.
"With Class As pushing their rates and the decrease in availability, it's a good time to be the owner of Class B buildings," said CB Richard Ellis broker Trevor Kafoury, who represents both Montgomery Park and Albers Mill, on Northwest Naito Parkway.
Montgomery Park has been full for almost a year and Albers Mill has just one space, about 5,000 square feet, left for rent. Both buildings are owned by Bill Naito Co.
Loosely defined, Class B offices are older, well-maintained buildings with smaller floors, lower rents and fewer amenities than the newest buildings. If Fox Tower is king of Portland's Class As, then Montgomery Park, both because of and despite its massive floors, is king of the Bs.
Class B has dominated leasing activity since the start of the year, according to research by Colliers International and generally confirmed by rivals Grubb & Ellis and NAI Norris Beggs & Simpson.
For the first six months of the year, the Portland office market absorbed more than 726,000 square feet of Class B office space, the vast majority of it in the second quarter alone. In the same period, the Class A needle scarcely moved, with fewer than 15,000 square feet coming off the market.
Class B continues to have the highest vacancy rates in the market, at 12.4 percent, but it also posted the greatest rent increases, about 8.6 percent.
It's a stark change.
As recently as two years ago, rent in Class A buildings was stagnant and even tenants on limited budgets could afford first-class digs. The moving-up phenomenon even had its own term: flight to quality.
It was easy to see why. Six years ago, some Class B offices were leasing for $20 or even $21 a square foot, comparable to asking rents for Class A space.
But now the Class A spaces are nearly full and large tenants have few choices when it comes to finding a full floor or even two adjacent floors in a single building. Rents may climb as much as 8 percent this year.
Today, Class A offices that previously rented in the low $20s now command rents in the high $20s, if not more.
For tenants who signed leases four or five years ago, that means the rent bill will climb significantly if they renew and stay put, explained Eric Haskins, an office broker and vice president with Grubb & Ellis. For many, that's not an option.
"They're faced with a flight to economics," he said.
This year, he said, he hasn't seen any one signature Class B deals, just a bunch of 5,000- to 20,000-square-foot deals. But last year, he helped a client, Web MD, move customer support operations to Montgomery Park, from the Old Town/Chinatown neighborhood.
The growing business was up against the limits of most Class B buildings, he explained. In Old Town/Chinatown, they were spread across several floors.
The company wanted the efficiency that comes with consolidating in a single space and looked across several classes before settling on Montgomery Park.
But that's unusual.
Most B buildings have floors of 10,000 square feet or smaller. For a growing office with concerns about being spread out on several floors or even several buildings, Class B can pose a challenge.
Then too, so can Class A.
"There aren't too many good places to choose from," Haskins said. "That forces people to look at both A and B."
Mark Fraser, senior vice president with GVA Kidder Mathews, has seen B buildings fill up. The Mohawk Building, at Southwest Third and Morrison, is a perfect example; Interface Engineering recently signed a 28,000 lease to stay in place and expand. The company liked the building and the way it's managed. More telling, when Fletcher Farr Ayotte Architecture moved out of the Mohawk Building, its old space didn't stay empty long. Two prospective tenants competed for the space.
Fraser said the Class B trend is especially noticeable with local firms.
"If you are a national or international company and you're comparing rent to Seattle, Los Angeles, San Francisco or New York, it's not a big deal to pay Class A. But if you're a local company and you're spending your own money, that rent differential is big," he said.
The strength of the market is prompting building owners to invest in updating older buildings as well.
For example, Haskins represents the office space at 620 S.W. Fifth Ave., which is above the downtown Ross Dress for Less store. The current owner paid $11.35 million for the building last fall. In addition to two floors of retail, it has 104,000 square feet of office space.
The owners plans to renovate the exterior facade in keeping with other neighborhood improvements, including the revamping of the nearby Macy's store, Haskins said.
"You improve the building today to enable yourself to get a higher rent category," Haskins said.
Kafoury, of CB Richard Ellis, agreed it's a good time for owners to consider reinvesting in older buildings.
"There's still competition in that Class B market in downtown. The owners who are investing money are going to be the first in line," he said.
wculverwell@bizjournals.com | 503-219-3415
http://portland.bizjournals.com/port...ml?t=printable
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