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May 2017 Thurston County Commercial Market Report

by | Apr 14, 2017 | Market Updates

As you likely know, less than sixty miles north of Thurston County, the King County real estate market is on fire. So much so that there are more cranes in Seattle than just about anywhere else in America. Prices are soaring, inventory is low and nearly everyone in the business is making money. It’s gotten to the point where talks of a bubble and the current rate of growth being unsustainability are in full effect.

So, the question is, what’s all of that mean for Thurston County?

Has any of that flurry of growth trickled down here?

Well, I’ve got good news and bad news.

The good news is that in some ways, yes, we’re experiencing the trickle-down effect (more on that in a bit).

The bad news is that in other ways, no, we’re not experiencing the trickle-down effect.

Thurston County has always been a different type of market than just about every other market in Western Washington, primarily because we’re a government town. As such, we don’t have to rely as heavily on the private sector to keep our economy going.

For decades, Thurston County has ridden the coattails of the State Government and for the most part it’s served it well.

But when the economy crashed and the government tightened its belt, our county felt the squeeze more than ever before.

And that squeeze, while starting to loosen up, is still tighter than it has been historically.

Thus, we still have a glut of office property sitting empty in the area, with almost no chance of our private sector absorbing it over the next five years.

 

The Office Market

To give you some context, in preparing to write this update I received some ROUGH numbers from the Assessor’s office (unfortunately, no exact data source exists for our market but this is enough for the sake of illustration) showing that there is approximately 11,000,000 square feet of office property in the Thurston County market. As of early February, we still had WELL OVER 1,000,000 square feet available for lease. I was saying the same exact thing EIGHT years ago!

Have we had some absorption? Yes, but not nearly enough.

Furthermore, the State continues to build brand new buildings and, in the process, vacates buildings that are 20-30 years old that are often at the end of their useful lives.

That creates an oversupply of mostly unleasable office properties that sit there for years waiting for re-development.

The result of all of this is oversupply and deflationary pricing. It’s Economics 101.

The effects of this problem are akin to a ship that’s anchor is dragging along the bottom of the sea as it tries to float down the harbor. It can still move but not nearly as fast as if the captain would just get someone to pull the anchor up.

To fix this problem, we need a more robust private sector. We need to implement policies that encourage entrepreneurship, development and a net in-migration of people to our area.

We live in an area where, for some reason, there is a negative stigma around all those things and that’s a shame.

In my mind, economic development and community development are one in the same. You can’t have one without the other.

A community that attracts new residents because it creates wealth, prosperity, and opportunity is a community that’s able to send their kids to great schools, have safe streets, provide essential services, eradicate homelessness and fill empty buildings.

Isn’t that what we’re all after?

It’s great that Thurston County is home to State Government but the solution to the problems I’ve outlined can’t come from the government, it must come from the private sector and I think we, as the private sector, can be problem solvers!

 

Moving on to the Thurston County retail market.

It’s is an interesting one. From the outside, it looks like the retail market has come back and in many ways it has, but those of us on the inside know that out there somewhere is a ticking time bomb waiting to go off. The problem is, we just don’t know when or how bad the damage will be.

 

Here’s what I mean….

In Thurston County, according to the Assessor, there’s approximately (remember, this is a ROUGH number meant to provide context) 12,800,000 square feet of retail space. As of February, almost 700,000 of it was listed for lease on the Commercial MLS. I’d venture to guess at that time there was likely another 300,000 or so not listed. That comes out to a total of about 1,000,000 square feet vacant in the county, or approximately eight percent.

Some quick math would lead you to the conclusion that the retail vacancy rate isn’t really much different than the office vacancy rate.

And you’d be correct.

The vacancy rate is lower than the office rate and it’s not necessarily bad if you look at it through a historical lens. The issue really has more to do with what’s vacant and why.

If you drive around the area, you’ll notice that newer, nicer retail centers are mostly full, while older centers are not.

Not only are new centers full, we’re building more new retail buildings for major, national tenants. These national brands, as a result of big data, have gotten so good at site selection that many of the older properties are simply off the table for them. They have it down to a literal science. It’s amazing.

On the flip side, the older centers are struggling and that’s because many of the second and third generation retail properties are full of local, mom and pop tenants.

With new business starts in America near a 40-year low, we’re just not seeing as many mom and pops venture into business and the ones that do are having a tough time competing with the major brands, which means it’s very difficult to fill these centers.

Thus, we end up facing the same problem as we face in the office market where we have too much supply and not enough demand.

The bigger issue, which is the ticking time bomb referenced earlier, is the fact that the retail market is changing so fast.

Big box retailers are shrinking and closing, shopping malls are doing likewise and the percentage of sales going online continues to increase every year. As a matter of fact, retail stores are closing faster than ever.

Additionally, the required footprints of retail companies are shrinking.

Amazon and other online retailers are disrupting the market to the point that there’s absolute uncertainty about what the future holds.

The one thing everyone in the retail business knows is that it’s changing faster than ever and that it will likely look much different a decade from now.

 

So, what’s all of that mean for the retail market in our area?

I think it means that retail property owners are going to have to get creative. But I also think that, as is the case in any market that experiences major disruption, there will be winners and losers.

I think the winners will be those with properties in great locations who have available capital to be creative, forward thinking and are able to change with the times. I also think those property owners with smaller, well-located centers will be just fine because it’s pretty hard to eat, do your dry cleaning, buy your groceries, see your chiropractor, dentist, and more and more your doctor, not to mention get your nails done online.

This is another reason we need a thriving local economy. As some of the traditional stores leave, we need service businesses to backfill the spaces and to do so, we need people who make enough money to be able to buy from those businesses, thus giving them a reason to exist.

And to be clear, I don’t believe the retail sector is going anywhere. I just believe it will shrink in terms of the per company square footage needed. In so doing, we’ll have to adapt how we’ve traditionally built and leased retail space to meet the needs of a world where people do more online (though not everything) and less in brick and mortar stores.

 

Moving on to better news

Now that I’ve gotten the doom and gloom out of the way, let’s move on to the exciting things that are taking place because there are some truly exciting things happening and we are benefiting from some measure of “trickle down”.

 

The Industrial Market

The industrial market is hot in Thurston County. If you don’t count the inventory attributable to buildings under construction, the vacancy rate of industrial properties is less than 3%. We’ve absorbed almost all the industrial space that sat on the market for years and have multiple large scale developments under way.

The I-502 processors were a big help in absorbing all that space. In what felt like one fell swoop, they came in and snatched up just about everything that was available.

Furthermore, increased pricing in some of our competing markets is driving companies to Thurston County where I-5 access is great and the location is sandwiched between Portland and Seattle, which is a major benefit.

The prospects for the industrial market look good for the foreseeable future.

 

The Multi-Family Market

The Thurston County multi-family market continues to be the crown jewel of them all!

Rental vacancy in Thurston County is the lowest in Western Washington and rents continue to rise, mostly on account of very low housing inventory, both owner-occupied and rental.

There are hundreds of new units currently under development and almost ready to come online. Depending on when these units come to market, we could see vacancy tick up a bit but honestly, a small uptick would likely be healthy for the market.

Another bright spot is Downtown Olympia’s seeming revitalization. I must give kudos to the City staff and the elected officials for being more development-friendly these last few years. Our community is reaping the benefits of it. I think we still have work to do if we want to attract more outside investment in our downtown core but what we’ve got going on now is a great start!

 

The Investment Market

The Thurston County commercial investment property market is where we are seeing the biggest trickle down from King County (and other major metro areas).

We’re seeing cap rates (the most commonly used metric to value commercial investment property) as low as they were in 2007 (the lower the cap rate, the higher the price), before the crash across all sectors for quality assets.

Cap rates are ranging from 5% to 7.5%, the former being for trophy properties and the latter being for older properties. There’s a lot that goes into that wide of a valuation range, but that’s part of the beauty of this industry.

Just like bond prices vary depending on the strength of the underlying debtor and their ability to repay their loans (as of the beginning of March, Treasury bonds were yielding less than 2.6%, AAA Corporate bonds – 3.5%, or CCC bonds – 10.3%), investment real estate prices fluctuate likewise.

For more information on how valuation fluctuates, you can request my Investor’s Lessons from previous market reports.

The reason we’re seeing cap rate compression is because there is so much money chasing yield right now. Yield chasers always start in the major metro areas, which is why those areas traditionally boom before tertiary markets (like ours) do.

When the major market yield chasers bid up prices, thus shrinking yield, some percentage of them start to venture into smaller markets, hence where we find ourselves today.

Prices in Seattle, Portland, San Francisco and Los Angeles are high enough that investors are looking for higher yields just about anywhere they can find them.

Compounding the issues is the fact that the stock market has been on a bull run for years and bond yields are in the tank. Investors are concerned about a stock market correction and don’t find the bond market very attractive so they turn more of their interest to investment real estate, thus causing an increase in competition and higher prices.

With interest rates beginning to rise, it is possible (likely probable) that the dynamics of the yield chasers will start to shift in the coming months. However, just because they shift doesn’t mean the commercial investment market will necessarily change. If you’re interested in knowing more about this, check out my Investor Lesson from this Market Report.

If you own an investment property in Thurston County and have been thinking about selling it, now is the best time we’ve seen in a decade to do so. If you’d like to get an idea of what your property is worth in today’s market, please give me a call or send me an email. I’d be happy to help you decide if now is the right time to sell.

 

Final Takeaways

2016 and the first quarter of 2017 were pretty good for the Thurston County commercial real estate market. We had some major wins, some great new developments, and started attracting more outside investment than we have in years.

At the same time, we continued to face challenges in the office and retail markets and those challenges don’t look like they’ll be going away anytime soon.

The regional and national real estate markets are, in some ways, having positive effects on our area and creating opportunity for us to capitalize on.

Interest rates are starting to rise and that will have some effect on the markets (all of them) but to what extent remains to be seen.

Most importantly, principals of successful investing never change. Regardless of the market is doing at any time, opportunity exists if you know where to look and what for. I’m excited to see how things unfold over the next few years and will keep you apprised as to how things are taking shape.

About The Author

Zach Kosturos

Zach Kosturos

President & Designated Broker

Zach Kosturos is the President & Designated Broker of Prime Locations.

He can be reached at 360.943.9922.

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