Healthy market conditions continue into 2016

Key Takeaways

• The Charleston, SC office market rang in the new year with healthy demand for space despite the flat vacancy rate during the first quarter of 2016.
• Average asking rental rates, although among the highest in the Southeast, are flattening.
• Strong demand for office space is driving speculative office construction.
• New policy limits wetlands development and results in even fewer sites for construction.

Steady Start to 2016

2016 is off to a steady start following a very active, historic year for Charleston, South Carolina’s office market.  2015 was accompanied by declining vacancy rates, record high rental rates and the strongest construction activity in recent years, collectively paving the way for continued improvements into the new year.

The first quarter of 2016 ended with a total vacancy rate of 7.8%, unchanged from year-end 2015 but down from 10.5% one year ago.  Leasing velocity was slow during the first three months of the year despite robust interest in the market.  Tenants are seeking large blocks of quality space which are virtually nonexistent in the market, hindering leasing activity.  The slow quarter is not an indication of the market’s health but rather the result of strong demand for space leaving very few options for tenants looking to enter or expand within the market.

Occupiers are looking for quality space and are willing to pay higher rent for such space.  The Charleston office market has some of the highest rental rates in the Southeast, but rental rates are flattening after significant spikes over the previous year.  At the end of the first quarter, asking rental rates for the market averaged $23.30 per square foot per year (PSF/YR), holding steady over year-end 2015 but increasing 9.2% in just two years.  Asking rental rates for Class A space in the market averaged $27.18 PSF/YR with downtown and suburban Class A space averaging $35.51 PSF/YR and $25.17 PSF/YR, respectively.  Average asking rental rates held steady over the quarter and will likely remain stable through mid-year.

Strong demand for space throughout the market coupled with rising construction costs have contributed to higher rental rates than the past.  Tenants are being faced with higher occupancy costs as construction costs contribute to higher tenant improvement costs, which tenants are oftentimes required to pay a portion of out-of-pocket.

Healthy Demand Drives Speculative Construction

Healthy interest in the market and a lack of quality office space is driving new development throughout the market.  As of March 2016, there was more than 300,000 square feet of office space under construction with 168,000 square feet expected to deliver by Summer 2016.  This creates significant opportunity for new occupiers to enter the market and existing ones to expand.

Under Construction

• 80 Calhoun Street is under construction downtown.   The 3-story, 17,000 square-foot office building will be home to Southern First which plans to open a branch at the building.  Office space is available on the second and third floors, and the building is expected to be completed during the fourth quarter of 2016.
• Construction is underway on Courier Square, an 87,500 square-foot office building that is successfully pre-leasing.
• 101 Mill Street, a 43,000 square-foot, Class A office building in Mount Pleasant, is under construction and expected to be delivered in Spring 2016.  The building has secured its first tenant, MTAG Services with plans to occupy 10,800 square feet in the building.
• A second office building is under construction in Mount Pleasant.  349 Coleman is an approximately 28,000 square-foot Class A office building with 5,700 square feet of restaurant space on the ground level.  The building is expected to be completed by mid-year 2017.
• Faber Plaza, a 5-story, 125,000 square-foot, Class A office building, is under construction in North Charleston.  Sonepar North America will be the building’s first tenant and plans to occupy 25,000 square feet to establish its North American headquarters.  The building is expected to be completed in June 2016 and currently offers approximately 75,000 square feet for lease.

Although several projects are under construction, the total square footage to be added to the existing inventory upon completion is not enough to meet the demand for space, and additional construction is necessary for continued growth.  Developers are taking note of the need and additional projects are in the pipeline.

Planned

• 317 Meeting Street is a new, planned 50,000 square-foot office building overlooking Marion Square.
• The Offices at Belle Hall I is a proposed 36,500 square-foot office building in Mount Pleasant.
• Gateway Mt. Pleasant is a 60,000 square-foot office building planned for Mount Pleasant.

Despite a strong demand and need for new office space, future development will be limited given land constraints and new limitations on wetlands development.  While part of Charleston’s beauty is its ocean and wetlands, these features are also creating challenges for developers and future construction.  A new wetlands ruling implemented by the Environmental Protection Agency and enforced by the U.S. Army Corps of Engineers places additional wetlands and waterways under new federal jurisdiction.  The rule affects many lots in Charleston, making it difficult for developers to find new land sites.

Next Wave of Construction: New Life in Old Space

Given the increasingly limited land options for development, a great opportunity exists for landlords and investors to redevelop and repurpose older, less attractive office buildings.  Placing capital in their assets will generate a return as they are able to lease once vacant space at a higher rental rate.  Consequently, when enough buildings are renovated and offered at higher rental rates, they will drive up the market average.  Enhancing the quality of Class C space will help meet some of the demand for space throughout the market.

Office-Using Employment

Office-using employment, which consists of professional and business services, financial services, and information employment sectors, continues to grow.  According to the Bureau of Labor Statistics, approximately 69,400 individuals were employed by an office-using job in the Charleston-North Charleston, SC metropolitan statistical area (MSA) in January 2016, a gain of 1,400 jobs over the previous year.  Employment growth is a good indicator of vacancy as additional jobs typically correlate with a greater demand for office space and lower vacancy rates.  As the employment sector continues to grow, the market will experience additional demand for space.

2016 Outlook

Charleston’s office market is poised for continued growth and improvement in 2016.  Tight market conditions will remain as interest in the market continues.  Vacancy will continue to decline, and rental rates will inch upwards as tenants compete for vacant space and landlords maintain control of the market.  New construction will continue to gain momentum, but developers will face challenges securing developable land sites.  Older, lower quality buildings will provide an opportunity for investors and landlords to invest in building upgrades in an attempt to attract new tenants at higher rental rates.  A growing suburban population will likely drive new office construction north along I-26 towards Summerville, where a majority of the region’s new residential development is occurring.

Around South Carolina

A growing demand for office space throughout South Carolina is contributing to tightening markets and soaring rental rates.  Market conditions are optimal for investment as occupancy rates are high and interest in the market remains strong.

Columbia, South Carolina

Market conditions are tighter than ever in the Columbia, SC office market as occupancy and rental rates remain solid.  Activity was limited to smaller lease executions during the first quarter, beginning 2016 at a slow pace.  Limited options for space and a stagnant office-using labor force contributed to the slow quarter that ended with a total vacancy rate of 15.7%.  The Central Business District and suburban St. Andrews submarket continue to be focal points for the market.

Construction remains limited to two projects in the CBD.  Upon completion, Innovation Center in the University of South Carolina’s Innovista District and the First Base Building at BullStreet will collectively add 182,000 square feet of Class A office space to the market’s existing inventory.  Both buildings are expected to be completed during the second quarter of 2016.

Greenville, South Carolina

The Greenville office market has shown great improvement and has strengthened over the past 12 months.  Consequently, vacancy is on the decline and rental rates are escalating.  The market’s total vacancy rate was down to 17.4% at the end of the first quarter of 2016.  Two significant leases include Endeavor backfilling 20,000 square feet of former CertusBank space at the ONE development in the CBD and Concentrix leasing a 143,000 square-foot suburban office building.

Tenants in the market are facing higher occupancy costs due to rising rental rates as well as increasing construction costs.  Tenant improvement (TI) allowance is virtually unchanged although costs are rising.  As a result, tenants are oftentimes paying the difference out of pocket.  Additionally, parking rates in the CBD are escalating, contributing to higher occupancy costs as well.

The market welcomed a new office building early in 2016.  One Research Drive is complete at Clemson University International Center for Automotive Research (CU-ICAR).  The approximately 80,000 square-foot, speculative Class A office building adds roughly 27,000 square feet of Class A space to the market’s existing inventory.  The new building is home to JTEKT’s North American headquarters.

 

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

To download the complete report: Q1 2016 Charleston Office Market Report.