Surging Seattle office market brings towering rent hikes

Companies are filling up local office space so fast that rents have reached a new high, surpassing the last peak in early 2008, forcing some downtown tenants to look elsewhere for affordable digs.

At the end of June, the rent for premium office space in downtown Seattle was $36.76 a square foot, 7.5 percent higher than a year ago, according to commercial real-estate brokerage CBRE. The vacancy rate was 11.4 percent, down nearly by half from its high of 21 percent five years ago, and is expected to fall further as tenants with new leases move into their space.

The tightening market in Seattle, Bellevue and the suburbs enabled landlords in urban areas of King and Snohomish counties to raise lease rates more rapidly over the past year than in any other metro, including tech and business hotbeds like San Francisco, San Jose, Boston and New York, according to New York-based market research firm Reis.

As with apartments, downtown Seattle and Bellevue are ground zero for the strong demand. Most of it comes from big technology firms that find the region appealing because its tech labor pool is the largest after Silicon Valley and its rents are still cheaper than in Manhattan, San Francisco or London.

“There’s a lot of confidence that this is a good place for their business to be long term,” said Pat Callahan, CEO of Urban Renaissance Group, which manages a large real-estate portfolio in Seattle, Bellevue and Portland.

Only two years ago, the conventional wisdom was that downtown’s high-rise towers couldn’t land tech tenants, who favored brick-and-beam space in Pioneer Square or midrise modern in South Lake Union or along Elliott Bay.

But in Seattle’s central business district today, a long list of tech firms have set up shop, including Dropbox, Twitter and DocuSign.

San Francisco-based cloud- computing giant Salesforce.com is reportedly in the hunt for around 100,000 square feet in downtown Seattle or Bellevue, brokers say.

Flush with demand for office space, landlords are hiking rents for new leases and renewals. Small tenants, both those in downtown and those trying to get in, are feeling squeezed out.

“With vacancy rates being what they are, the landlords have all the leverage, and I don’t blame them,” said Seattle attorney Jason Newcombe, who plans to move from downtown. “But it does make it difficult for small businesses like myself to maintain a presence here.”

A common gauge of demand, known as net absorption, tracks how much office space is newly taken by tenants. In the first six months this year, tenants absorbed nearly 1.5 million square feet in downtown Seattle — the equivalent of filling up the 76-story Columbia Center.

With six months left, 2015 already ranks as the fifth-biggest year for net absorption in downtown Seattle since 1981, data from brokerage CBRE shows.

Downtown growth

Downtown Seattle accounts for more than three-quarters of the office space newly occupied so far this year in King, Snohomish and Pierce counties, CBRE reports.

Matt Christian, executive director at Cushman & Wakefield Commerce in Seattle, said that a year ago, he represented a client that leased a top floor at 1111 Third Ave. in Seattle for around $30 a square foot. A Canadian investor bought the building in November, leased six floors to Community Health Plan of Washington and now is asking for $36 a square foot — a 20 percent increase — for a lower floor, he said.

“Prices are moving up because new owners are paying huge premiums (for buildings) in Seattle, coupled with large lease transactions that have happened in the last few months,” Christian said. Some brokers believe the new owner will flip the building to capitalize on the growth in rents, he said.

The biggest lease in square feet so far this year is Amazon’s 817,000-square-foot lease of Troy Block, a two-building project in South Lake Union that’s under construction.

And there are plenty of other examples of pre-leases for offices that don’t exist yet:

• Seattle firm Touchstone, which developed Troy Block, also signed Seattle-based Tableau Software to lease a new 210,000-square-foot building north of Gas Works Park that will open in mid-2016.

• Holland America Line, the Seattle-based operator of cruise-ship lines, has leased virtually all of local developer Martin Selig’s new 185,000-square-foot building opening next year at 450 Third Ave. W. in Lower Queen Anne.

• Seattle biotech firm Juno Therapeutics leased about one-third of Alexandia Real Estate Equities’ 287,800-square-foot building under construction at 400 Dexter Ave. N. in South Lake Union.

In the central business district, where vacancies soared during the last recession — nearly 40 percent of Columbia Center, Seattle’s tallest skyscraper, was listed as available at one point — big blocks of space are hard to find now.

“I think it’s become a landlord’s market,” said Stuart Williams, a managing director at commercial real-estate brokerage JLL.

A few big tenants have bought office space: Expedia bought Amgen’s 40-acre campus. Pemco Insurance paid $31.6 million this year for the former Casey Family Foundation headquarters at 1300 Dexter Ave. N. and hopes to move in by mid-November, a spokesman said.

Smaller tenants don’t have that option.

Looking at suburbs

Newcombe, the attorney who leases about 2,500 square feet at Seattle Tower at Third Avenue and University Street, said he’s expecting a 30 percent rent hike and scrambling to find space in the suburbs before his firm’s lease expires in October 2016. The small law firm moved into the space from Pioneer Square in 2011.

While Newcombe finds the location convenient for walking to Seattle Municipal Court and the King County Courthouse, he said his 10-person firm simply can’t absorb a steep rent increase.

“For a lot of small regional firms, it just doesn’t make sense financially, as convenient as it is,” he said.

Moreover, his working-class clients involved in bankruptcy, divorce or criminal cases aren’t impressed by a cushy office and can have a hard time finding parking, he said.

It’s not just small firms that are reacting to higher prices and moving employees out of the downtown core.

Seattle-based Washington Federal, which keeps a tight rein on its expenses, recently vacated a floor in a downtown Seattle office building. The company said it was able to move “certain functions to Everett and Bellevue, where we had existing available space and where it made sense for those employees and shortened most commuting times.”

Tenants shopping for a lease are finding that the few spaces available are pricey, said Seattle tenant broker Scott Driver. Tenants who were paying $24 a square foot are now being asked to pay $34 a square foot, he said.

“More tenants will be at the mercy of the market in terms of availability and pricing than we have seen in over 15, maybe 20 years,” Driver said.

One of his clients, wealth-management firm SoundView Advisors in Olympia, looked on and off for four years in downtown Seattle before landing a five-year lease at 1000 Second Ave. The eight-person firm moved in June.

“It is difficult to get small spaces in newer buildings because landlords understandably want to rent whole floors at a time,” said company President Kevin Slater. “For a smaller firm, you’re left with older buildings with split floors or an executive suite.”

But SoundView still wanted a downtown location. One employee takes the train from Tacoma. Employees in Bremerton and West Seattle ride the ferry and water taxi into downtown.

Slater takes a bus or light rail to work.

“If we were outside the core, you don’t get that ability for people to come together like that,” he said.

The dense transit lines serving downtown Seattle and Bellevue will keep attracting big tenants to the urban core, experts say.

Time to sell

The surge in rents is likely to make 2015 a busy year for sales of office buildings.

“There is absolutely a tightening going on, which is resulting in higher asking rates and a lot of investors coming into this marketplace,” said Mark Barbieri, executive vice president at Washington Holdings.

The company owns Two Union Square, where Apple is rumored to have leased 30,000 square feet. Barbieri declined to comment on that.

Last year, the region saw total office-building sales of almost $1.8 billion, according to real-estate brokerage JLL. So far this year there has have been nearly $2.2 billion.

Bellevue has had more sales activity than Seattle, with more than a half-billion dollars in sales from just three complexes — Civica Office Commons, The Summit and One Bellevue Center.

The statistics don’t include the record price Seattle developer Vulcan got last month for its 2201 Westlake building, or last week’s sale of Columbia Center to an affiliate of Hong Kong-based Gaw Capital Partners.

Seattle Tower is on the market again, four years since it last sold, as is the Broadacres Building at 1601 Second Ave. and the Dexter Horton building at 710 Second Ave.

Callahan, of Urban Renaissance Group, said the pipeline of prospects looking for space is deep enough that he expects the momentum to continue. He rejects comparisons to the dot-com era, insisting today’s tech companies are sustainable businesses.

“We’re going to look back and say, ‘Wow,’ ” he said.