Colliers Report: Construction and Occupancy Costs Drive Up Asking Rental Rates

Research & Forecast Report; Q4-2016 COLUMBIA | OFFICE

Key Takeaways

• The cost to construct and operate an office tower in the Central Business District is rapidly increasing, impacting the asking rental rate for office space in these buildings.
• The office market continues to see a trend of tenants moving to the Central Business District.

To download the complete report: Q4 2016 Columbia Office Market Report.

Rising Costs, Rising Rents

Landlords are increasing the asking rents on office space by three to five percent every year in downtown Columbia. Since the fourth quarter of 2012, the overall average asking rental rate for downtown office space has increased 28.2% to $21.06 PSF/YR. Over the next four-year period, average asking rates are organically expected to increase between 12% and 20%. The increase can also be attributed to two factors, rising operating costs and the higher cost to construct or up-fit space for new and renewing tenants.

The cost to operate an office building is included in the full service asking rental rate a landlord offers to tenants. This portion of the rent can be disaggregated into the cost for items such as utilities, building maintenance and services, property taxes, insurance, security and building management fees. Based on historical operating costs from ten office buildings over 30,000 square feet across the Columbia office market, the average cost to operate an office building increased by 10.4% from $6.94 per square foot in 2013 to $7.66 per square foot in 2015. The cost for utilities has increased by 8.5%, while general building maintenance and services has increased 13.0%. Property taxes vary by property but have increased by an average of 11.0%. If a tenant leased a 10,000-square-foot space in 2013 and the same space in 2015, the operating costs would on average contribute to an increase of $7,236 to the total rent of the space for a year.

Tenant improvements are customized changes to an existing, leasable space. These improvements can transform a space by adding anything from new paint and carpet to new walls and HVAC systems. The cost to the tenant is dependent on the amount of tenant improvement allowance offered by the landlord and the current level of construction costs. Because material cost varies over time, the largest driver of up-fit construction cost is labor. Increased wages are a result of fewer construction employees. In South Carolina, average hourly wages in the construction sector and rising demand have increased 28.5% to $23.00 per hour since November of 2007.

Higher labor costs are affecting the cost for tenant improvements to office space in Columbia. As one landlord in the Columbia market explained, $20.00 per square foot in tenant improvements ten years ago would pay for new paint and carpet. Today, $20.00 per square foot would not begin to cover the cost for any improvements; now the base is $30.00 per square foot.

Tenants entering the market, as well as existing tenants, can expect to see higher asking rental rates in Columbia as landlords are faced with higher operational costs, the office market tightens and construction costs continue in an upward trend.

Downtown Attracts New Tenants

Companies in many sectors are choosing to move from the suburban office submarkets to downtown. The centralized location of the Central Business District (CBD) in relation to the most desirable residential markets, the attraction of Columbia’s Main Street and the Vista as destinations to “live, work and play” and the aging inventory of the suburbs are the three drivers leading the shift of tenants.

Employers are increasingly focused on placing their operations in desirable locations convenient for their existing workforce to commute from and attractive to their future workforce. In Columbia, most of the workforce resides in Lexington District 1, Lexington Richland District 5, Richland District 2 and the in-town neighborhoods east of downtown. Columbia’s CBD is centrally located between these four districts, making it attractive to employers across the region.

Additionally driving the appeal of downtown Columbia is the new Main Street district and the well-established Vista. They are becoming an 18-hour downtown, attracting new hotels, bars and retailers. The Vista saw the redevelopment of City Market Antique Mall into retail and office space, a new Hyatt hotel and an Aloft hotel that is currently under construction. The Main Street district has added residential projects like the Hub and Land Bank Lofts. Nearly 5,000 new residents have moved downtown since 2015. This has encouraged new restaurants and retailers to redevelop older, empty or under-utilized buildings such as 1556 Main Street (Public House), 1635 Main Street (Lula Drake Wine Parlour), 1426 Main Street (The Hub and East Bay Deli) and the former Hennessey’s Building.

Finally, the age of the office inventory in the suburbs is a factor in a company’s decision to move to the CBD. The newest office building in the suburbs is 1074 Pinnacle Point, built in 2012. Prior to that, only three buildings 30,000 square feet or larger had delivered since 2005. There are currently no new buildings under construction or planned in any of the suburban submarkets. By contrast, the CBD has had three new buildings constructed since 2012 and substantial redevelopment at many of the others. The CBD offers tenants a variety of options for quality office space. Nearly 48% of the inventory in the CBD is Class A space, compared to only 20.3% in the suburbs.

Downtown is booming and employers are noticing when making location decisions. Office tenants are increasingly choosing to locate downtown to take advantage of its location, attract the workers of the future and move into more modern properties with more amenities.

 

 

Significant Transactions

Strong occupancy and absorption, along with rising asking rental rates, are attracting investors to the Columbia office market. Two investment sales occurred in the fourth quarter in Columbia’s suburban office market.

• RealOP Investments purchased three office buildings in the Westpark Center office park for just over $9 million or $99.77 per square foot (PSF). The three Class B office buildings include the 33,300-square-foot building at 3800 Fernandina Road, the 49,100-square-foot building at 107 Westpark Boulevard and the 8,000-square-foot building located at 111 Stonemark Lane.
• 2611 Forest Drive, a 45,000-square-foot, Class C office building in the Forest Acres submarket, sold to Sun City Investors for $1.5 million, or $32.29 PSF.

Market Conditions

The market vacancy rate in Columbia dropped to 15.4% at the end of the fourth quarter from 16.7% the previous quarter. The market average asking rental rate increased significantly to $16.63 per square foot per year (PSF/YR), a 2.7% increase from the third quarter of 2016. Considerably more significant, the asking rental rate for the market has increased 4.9% over the last two years and is expected to continue escalating.

Central Business District

The fourth quarter vacancy rate in the CBD was 11.0%, down from 11.5% at the end of the third quarter. The average asking rental rate was $21.06 PSF/YR, an increase from $19.50 PSF/YR last quarter. The delivery of two Class A office buildings in the CBD during 2016 has supported increased asking rental rates for similar spaces to a range of $20.00 to $28.00 PSF/YR. Before the delivery of these buildings, the asking rental rate for these spaces were between $19.00 and $25.00 PSF/YR. The average asking rental rate for Class A office space has increased by 11.2% over the last year.

Suburban

Increased leasing activity in the third quarter of 2016 led to a vacancy rate of 19.7%, down from 21.8% at the end of the previous quarter. While downtown is attracting a disproportionate share of tenants, the suburban office market in Columbia remains an attractive alternative due to larger available blocks of space and free parking. The vacancy rate for Class A suburban office space decreased from 12.9% at the end of the first quarter of 2016 to 11.6% at the end of the fourth quarter. Average asking rental rates for suburban Class A office space was $18.15 PSF/YR at the end of the fourth quarter, significantly lower than the $23.45 PSF/YR for class A office space in the central business district.

Owners of suburban office buildings are renovating the entryways and communal meeting spaces of their buildings to remain competitive with similar properties and attract new tenants. As office space downtown becomes increasingly expensive and parking availability becomes more restricted, suburban office buildings are expected to continue to see increased activity, higher occupancy and higher asking rental rates.

 

 

Office Using Employment

Office-using employment, those jobs related to the professional and business services, financial activities and information sectors, are growing within the Columbia, South Carolina Metropolitan Statistical Area (MSA). The most recent November 2016 data from the Bureau of Labor Statistics reported 500 office-using jobs were added over the last 12 months. Non-Farm employment increased by 1.3% over the last year, adding a total of 5,200 new jobs. Office-using employment accounts for 21.3% of total non-farm employment in the Columbia, South Carolina MSA and accounted for 9.6% of all new jobs added to the MSA over the last year.

Market Forecast

Strong residential population growth in the downtown area has led to an increased demand for retail space. To maximize revenue and capitalize on the increased demand for retail, landlords are looking to convert first floor office and service space to retail space. Additionally, the asking rental rates for office space are expected to continue climbing in 2017. Leasing activity will accelerate as a wave of tenant leases approach their expiration date in 2017 and 2018 and expanding tenants absorb the remaining spaces in the market. The market will be robust, with tenants who will look at options to relocate but will be faced with fewer available alternatives and much higher asking rental rates. The office market in the suburbs will begin to tighten as tenants lease the remaining large blocks of available space. Landlords are finding it necessary to retrofit their buildings to compete with other like properties in the market.  Recently renovated suburban office buildings will continue to see the most activity from tenants looking in the market. Overall, 2017 will be an active year for Columbia’s tightening office market.

Around South Carolina

Greenville, South Carolina

• Several office buildings in Greenville’s CBD sold this quarter including the Wells Fargo Building, Bank of America Plaza and the two Liberty Square buildings. In the suburbs, the Park Central and Park East office parks sold to RealOp Investments.
• Mixed-use projects have seen more success on Greenville’s Main Street than any other market in the state. Dense development has led developers to build office buildings off Main in the West End.

Charleston, South Carolina

• Charleston has become a burgeoning technology economy in four sectors: defense and security, aerospace, front-facing software for customer interfaces and back-facing software for corporate operations.
• Rising costs for office space is encouraging companies to increase employee density with creative floorplans.

For statewide commercial real estate news check out our market reports at: www.colliers.com/southcarolina/insights.

 

To download the complete report: Q4 2016 Columbia Office Market Report.