The Portland-area industrial market continues its year-long trend of slow growth, but no speculative development is in sight.

The industrial vacancy rate for the metro area dropped 10 basis points to 8.7 percent through the second quarter of 2011 and 20 basis points since this time last year, according to . The vacancy rate dropped due to 271,965 square feet of positive absorption recorded during the second quarter, the second largest quarterly absorption since the third quarter of 2008, and the market’s fourth consecutive quarter of positive absorption.

A total of roughly 15 million square feet of industrial space remains vacant in the entire market, with the most available space in Westside (5.9 million square feet) and North/Northeast (5.3 million square feet) submarkets respectively.

The North/Northeast and Central submarkets were the only two to see rises in vacancy over the second quarter, with the North/Northeast submarket raising the most, from 7.68 percent to 8.7 percent. This is partially inflated considering the 175,000-square-foot space occupied by Subaru at 158^th Commerce Park has come back on the market as the car manufacturer awaits the completion of its new space at the Rivergate Corporate Center, also in Northeast Portland.

In addition to the 413,700-square-foot space under construction for Subaru, which is slated for completion in November 2011, Boeing Chemical has a 60,000-square-foot facility under construction in Northeast. The Boeing facility is slated for completion in December 2012. Also coming into the construction pipeline is a new facility being proposed by solar manufacturer SoloPower, which is looking to construct a 400,000-square-foot facility in North Portland in the coming months.

While there are some major tenant-driven construction projects under way or in the pipeline, speculative industrial development remains nonexistent. That trend isn’t expected to change until 2012 at the earliest, according to the Colliers International market report.

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The office vacancy rate in Portland’s central business increased slightly in the first quarter of 2010, sitting at 12.82 percent at the end of March.

According to a , the central business district had 38,742 square feet of negative absorption, which is a drop in the bucket considering there is nearly 15 million square feet of inventory in the district. The number is somewhat distorted as all of the negative absorption came from the building at 1881 S.W. Naito Parkway being placed back on the market as Vestas, its current tenant, gets ready to move into its new digs in the Pearl District.

The downtown office market vacancy rate barely moved over the past year as there was very little activity other than some reshuffling within the district. Class A space in the district has also remained at a near standstill, sitting at 8.45 percent at the end of the first quarter.

Major lease transactions in the central business district during the first quarter of 2011 include Wells Fargo Advisors leasing 25,439 square feet at the KOIN Center and 14,200 square feet of space being leased by Bullard Law Firm at the 200 Market Building.

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Only three industrial buildings larger than 200,000 square feet are available to lease in the Portland-metro area, and just one is within Portland city limits.

While leasing activity is still slow, commercial real estate brokers in the region say availability is decreasing for specifically sized spaces and those in certain areas. A limited supply and a lack of construction in the foreseeable future are driving up rents for these spaces and leaving the area at a disadvantage in the competition to attract large businesses.

Tyler Sheils, an associate industrial broker with , said it’s simply a matter of supply and demand.

“In Portland you’re going to have a hard time finding any industrial space 200,000 square feet or more,” he said. “With this lack of supply, and it still being hard for new construction of these types of spaces to pencil out, you are starting to see some upward pressure on rental rates.”

Inquiries are starting to pick up for this size of space, Sheils said, but most are from tenants looking at locations around the country. Other parts of the U.S., he added, offer plenty of available buildings at least 200,000 square feet of space.

“If we get one or two serious inquiries and at least one of them bites, there’s literally going to be no space available,” he said. “And while these larger tenants like to be close to ports, they won’t be able to, no matter what they鈥榬e willing to pay.

“If this happens, rents will come up enough for developers to start building these sized spaces, and we will actually start to see some construction.”

Large office spaces also are in short supply.

With First & Main and the Meier & Frank building almost full, a potential tenant looking for at least 50,000 square feet of Class A office space near downtown is going to be hard-pressed to find it, said Jeff Borlaug, vice president and director of brokerage with . And tenants can expect to pay a premium of about $2 per square foot for such spaces, he said.

“Each deal is always going to be very situational, and it’s hard to find a rule of thumb in office real estate,” Borlaug said. “But unless you’re willing to wait for Park Avenue West to be completed, you’re going to have to look towards the suburbs.”

That would reverse the trend of businesses leaving suburban spaces for cheaper spots downtown, which occurred in the Portland-metro area early in the recession. Those abandoned areas, such as the Sunset Corridor and Kruse Way, are now seeing a resurgence of interest, Borlaug said.

Meanwhile, smaller retail spaces – between 800 and 1,000 square feet – are becoming rare finds in the metro area, according to Kathleen Healy, a senior associate broker with .

“Well-located spaces that fall into that size range tend to lease up faster, and for a higher rate, than larger spaces,” she said. “It’s hard to generalize, but those spaces will usually lease for $2 a square foot more on an annual basis than larger spaces.”

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Hillsboro will consider cutting land use and planning fees by half for improvements made to downtown storefronts.

The Hillsboro Planning Department will present the fee cut to Hillsboro City Council in order to help businesses receiving money from the city’s storefront improvements grant program. The fee cut would only apply to projects that qualify for the grants

“Considering funding for the grants comes mostly from the general fund, grant recipients are really just getting money from the general fund and paying right back into it with the fees,” said Colin Cooper, planning supervisor for the planning department. “This move will let the grant money do what it’s supposed to do – improve storefronts.”

Any business looking to make a storefront improvement within the city’s downtown local improvements district can apply for the $25,000 grant program.

The fees that would be cut include development reviews and sign permit fees. A development review currently costs between $315 and $5,775 in the city of Hillsboro. A sign permit costs $60 per sign face.

The Hillsboro City Council meeting will be held Sept. 7 at 7 p.m. in the Hillsboro Civic Auditorium.

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Matt Thomas is a businessman with a passion for loose-leaf tea.

With teahouses in Northeast Portland and Bend, and plans for a second Portland location, Thomas wants to expand his business, Townshend’s Tea Company, across the entire Northwest.

But while his 2011 expansion plans are focused on some of the usual suspects – Seattle, Eugene and Corvallis – a push by the city of Gresham to fill its vacant storefronts has Thomas strongly considering a town he didn’t before.

In April, Gresham started offering new businesses, and existing businesses looking to expand into Gresham, a number of financial incentives. For one year the city will waive initial business license fees, development-related fees and all system development charges for businesses moving into spaces less than 5,000 square feet in Gresham’s downtown, Civic and Rockwood neighborhoods.

But in order to promote the program, Gresham city staff and city councilors are taking the next few weeks to visit various Portland businesses and explain the program to the owners.

“I had never considered Gresham before this,” said Thomas. “But the population there would be a good market for my business, and when the city offers this kind of opportunity, it’s absolutely worth looking into.”

Community Development Director Eric Schmidt and City Councilor Josh Fuhrer made their first stop on Wednesday, a 30-minute visit with Thomas at his shop on Northeast Alberta Street and 22^nd Avenue.

“It’s quite a piece of bait you’re throwing out,” remarked Thomas after the city representatives made their pitch. Thomas paid about $3,000 in city fees to open his Portland location and paid slightly less in Bend.

While the program had some success within Gresham, city staff wants to make sure anyone in the region looking to possibly expand knows about Gresham and the various incentives.

“We want to let business owners know about the value proposition in Gresham,” said Fuhrer. “Downtown has all the walkability and charm of any neighborhood in Portland.

“Combine that with the incentives and lease rates half of those in Portland, and the value here is great.”

Fuhrer and Schmidt are going to spend a few days during the next week walking up and down Northeast Alberta Street, North Mississippi Avenue and Southeast Hawthorne Boulevard. They will target restaurants and coffee shops specifically but are interested in talking to any business that would like to make the move to Gresham.

“A restaurant would be great because they can be catalysts to bring all types of other businesses,” said Schmidt. “And ultimately we are looking for diversity.”

After pitching the program to listening business owners, the duo is inviting them to a Sept. 15 information meeting where the incentives program will be explained. Also at the event will be a panel discussion with a representative from the Mt. Hood Community College Small Business Development Center, government officials, local business owners, commercial real-estate agents and developers.

“A big part about this program has been working with not only people at the city, but local business organizations, businesses and real-estate agents,” Schmidt said.

The fee program is working. More than 20 businesses have used the incentives, and 39 businesses have used the business license fee waiver. The incentives saved these businesses nearly $47,000 collectively.

While the city is losing this money, Fuhrer and Schmidt believe the return to the city will be on the back end of the incentives program, when property taxes increase due to a revitalized downtown core.

In late April, three new businesses moved into the 3^rd Central Building in downtown Gresham, a 5,436-square-foot premium retail building that sat vacant for almost a year after it was constructed. Since the incentives program started, Bella Cupcakes, KZME Radio and Lillian’s Natural Marketplace have filled the building. These businesses alone have saved a total of $35,000.

“We’ve been working closely with the city to promote these incentives,” said Sue O’Halloran, a principal broker with Kohler Meyers O’Halloran, a commercial real-estate firm with 15 properties for lease that fit into the incentives program, “and it’s really helped us out.

“In the next week or two, we will be closing on a lease deal for one of the large, long-vacant downtown spaces. It wouldn’t have happened without the program.”

But Gresham still has plenty of vacant spaces left. And until they’re full, Schmidt and Fuhrer will let people know the city is open for business.

“We’re going to promote our businesses and give them the tools to be successful,” Fuhrer said. “Because if we can get good businesses and help them be successful, we’re going to minimize our risk.”

And while Thomas hasn’t committed to anything yet, he’s adding Gresham to the top of his list.

“It’s great that a city is making the effort to come so far to attract locally-owned business development,” Thomas said. “It’s especially welcome in a time when getting expansion loans via traditional methods can be difficult.

“It’s a very smart position for a city to take, in my opinion.”

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The city of Gresham and two business associations are repeating a tactic they tried last week to fill vacant storefronts.

The city opened up several downtown vacant storefronts during its monthly Third Thursday event, where it showcased art and music and offered local wine and snacks. The event is an effort by the city, the Gresham Downtown Development Association and the Historic Downtown Gresham Business Association. The team plans to use the same marketing tactic from here on out.

“We haven’t found out if anyone is going to lease any of the available spaces showcased at the event,” said Megan Braunsten, executive director of GDDA. “But the turnout was excellent and we definitely got some good prospects.”

At the event, city staff are on hand to explain the city’s Vibrant Storefront Incentive program, a development-related fee holiday for businesses that locate downtown. A representative of the Mt. Hood Community College’s and real estate agents explained the amenities of the spaces.

Two to three storefronts will be showcased at each Third Thursday event, Braunsten said.

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Four lease deals in May brought the occupancy rate at the Wilsonville Business Center up from 83 to 91 percent. The occupancy rate at the industrial/distribution and flex facility now leads the market-wide rate of 88 percent.

“Even though the overall Wilsonville market isn’t as healthy as we would like it to be, and the southwest submarket as whole continues as the only submarket with double-digit vacancy, the Wilsonville Business Center’s occupancy is on the rise,” said Stuart Skaug, sales professional with CB Richard Ellis who represented the landlord on the deals with Andy Kangas, also of CB Richard Ellis.

More than 41,000 square feet of space was leased in May at the facility: A lease for 17,924 square feet was signed by the Tualatin-based SAM Medical Products, a lease for 13,558 was signed by the Cascade Wind Corporation of Portland and two 4,800-square-foot leases were signed. One by the touch-screen development firm, Perceptive Pixel, and the other by the wireless network company Velocitel of Arlington, Va.

These lease deals make up four of the seven industrial leases that have been signed in Wilsonville this year. The Wilsonville Business Center is located just west of Interstate 5 in Wilsonville on Southwest 95^th Avenue and Southwest Hillman Court.

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The occupancy rate at the historic Morgan Building in downtown Portland climbed last month to approach the average for the Portland Central Business District.

During the month of May, Urban Renaissance Group, the Seattle-based commercial real estate firm that owns the building, completed eight leases totaling more than 42,000 square feet, 14,100-square-feet of which is newly leased space.

The new leases and existing tenant expansions brought the occupancy rate from 75 percent to 85 percent. The average occupancy rate in the Portland CBD, where the Morgan Building is located, is 88 percent.

The building, located at 720 S.W. Washington St., is an eight story office building originally constructed in 1912. There is a total of 143,576 square feet of leasable space in the building, with retail space on the ground floor and office space on the additional seven floors. Urban Renaissance Group purchased the building for $27.5 million in 2008.

Kim Fuller, general manager for Urban Renaissance Group’s Portland office, believes the increase for demand at the Morgan Building is due to the firm’s focus of sustainable management and the building’s proximity to public transit. There has been a growing demand for accessible spaces in the Central Business District, she said.

New leases include 7,063 square feet being leased by Carollo Engineers, an environmental engineering firm based in Walnut Creek, Calif., and 875 square feet being leased by McMillen, a Boise-based engineering firm.

The Cadmus Group, a Boston-based consulting firm, renewed its 18,039-square-foot lease and leased an additional 5,456 square feet. Also expanding their leases were the Seattle-based law firm, Scheer & Zehnder, and Portland’s Grantmakers for Education.

Kearns & West, a West Coast strategic communications firm, and the Portland-based investment advisers, Lateef Management renewed their existing leases. Documart, a printing services company, also renewed its 1,058-square-foot retail lease on the bottom floor of the Morgan Building.

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Historically, when the amount of vacant office space grows, landlords are forced to make more concessions and lower rent for proposed tenants to stay competitive. But depleting building values and capital constraints have forced a number of Portland landlords to reduce concessions and hold their lease rates steady.

This trend, combined with high foreclosure rates, is rendering some buildings unleasable. Such spaces are being labeled “zombie buildings” by Robert Bach, chief economist with Grubb & Ellis.

“Now that (values of) many properties purchased during the peak of the market have fallen below the balance due on the loan, some landlords are too capital-constrained to offer the tenant improvement allowances and other concessions necessary to attract tenants in today’s marketplace,” Bach said. “That’s good news for landlords who are in a good capital position – they have much less competition than the reported market statistics would indicate.”

In downtown Portland the vacancy rate for office space is at its highest point since mid-2006.

Ryan Pennington, a broker with Colliers International, said the problem is twofold. Some landlords don’t have the capital necessary to attract tenants and stay competitive. But other landlords with capital would rather maintain their current lease rates and concession packages and wait to fill vacancies. For these landlords, getting tied into a bad lease is more damaging than having vacancies, he said.

This trend may be skewing the vacancy rate somewhat, Pennington said.

“The vacancy rate is what it is,” he said. “What we are trying to get at now is: Why is it like this and how can we get businesses in buildings?

“If businesses can understand these constraints, they can work with landlords and create stipulations in the lease that offset them.”

The bankruptcy filing of John Beardsley‘s Fountain Village Development has left 18 downtown properties in limbo. This one bankruptcy case has rendered 15 percent of the Class C space in downtown unleasable due to their financial uncertainty.

Eric Haskin, a broker with Grubb & Ellis, said a business owner can protect itself by looking into the financial standing of the landlord and building owner.

“In large lease deals the proposed tenant could go as far as requesting a credit report and other financial documents,” Haskin said. “At the very least they should ask around and look at how the landlord’s other tenants and buildings are performing.”

Haskin also suggested putting tenant improvement and commission money into escrow accounts when the lease is signed. Then tenants will still get those funds if something goes wrong and the building doesn’t perform, he said.

Also, stipulations can be added to the lease. For instance, the amount of time landlords have to make improvements can be shortened, and lease termination agreements can be included if the building goes into foreclosure or is sold.

“The best way for capital-constrained landlords to still be competitive is rent abatement,” Pennington said. “This lowers the tenant’s effective rate but doesn’t lower the value of the building.

“What we are trying to do that is proving effective in these sorts of situations is creating more transparency between the tenant and the landlord. We are bringing the two together and discussing the actual economics of a lease more than we would in the past.”

Bach noted that foreclosure rates over the past year haven’t been as high as expected. This has actually increased the trend’s prominence because banks have been renegotiating loans instead of taking buildings back. As a result, owners maintain control of buildings, but also still face financial constraints.

“I think you are going to see this trend get worse until the leasing market hits bottom,” Bach said. “We are predicting that vacancy will hit bottom at the end of this year and lease rates during the first two quarters of next year.”

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KRUSE WAY STATISTICS

Fourth quarter of 2009
Direct vacancy: 19.7 percent
Total vacancy: 21.1 percent
Net absorption: 30,928 square feet
Year-to-date net absorption: 181,335 square feet
Asking rent for Class A space: $24.62 per square foot
Asking rent for Class B space: $18.61 per square foot

Information courtesy of Grubb & Ellis

For many years, the Kruse Way submarket was the prettiest girl at Portland’s real-estate dance. With 2.3 million square feet of Class A office space built from 1981 to 2009, quick access to Interstate 5 and proximity to executive housing in Lake Oswego, the office campus appealed to a number of companies.

But these days, many suitors are abandoning Kruse Way in favor of more attractive prospects.

According to Patricia Raicht, vice president at Grubb & Ellis, Kruse Way’s vacancy rate for the fourth quarter of 2009 was 21.1 percent, one of the highest in the Portland-metro area. And when numbers for the first quarter of 2010 are released later this month, she doesn’t expect them to be much different.

“Kruse Way had been our bulletproof submarket for many years,” Raicht said. “But the financial services, mortgage and other firms that clustered there were hit hard by this slowdown, and they closed, consolidated or reduced their space.”

Other firms are leaving, too. Northwest Evaluation Association, presently in Kruse Woods Tower, recently signed a lease to move into the former Port of Portland building at 121 N.W. Everett St. in Old Town. Last year, SAIF Corp. traded 21,000 square feet of space at Kruse Way for space in the Crown Plaza Building in downtown Portland.

Downtown Portland has become an appealing option for businesses that need less than 10,000 square feet because of low rates being offered for Class A space.

“There has been some flight from the suburbs to downtown,” said Bob Stutte, president of Norris & Stevens Inc. “In the past, we’ve seen the reverse.”

The city of Lake Oswego cited in a recent economic development strategy report that Kruse Way’s increasing office vacancy rates are a problem.

“The vacancies on Kruse Way have affected the city in terms of employment and spending in our retail areas,” said Jane Blackstone, economic development manager for the city of Lake Oswego. “We’re doing whatever we can by way of marketing and working with prospective tenants to fill that space.”

No new office construction has occurred along Kruse Way since developer Shorenstein Properties opened Kruse Oaks III in spring 2009. Mike Salsgiver, executive director of the Oregon-Columbia chapter of Associated General Contractors, said the amount of vacant space in areas like Kruse Way is a sign that the situation may worsen.

“We have another real-estate bubble coming because of the continued vacancies we’re seeing in new office space,” Salsgiver said. “Oregon may have overbuilt.”

Brian Owendoff, managing director at CB Richard Ellis, disagreed. The vacancies at Kruse Way and other office clusters are not because of excessive supply, he said, but rather inadequate demand because of high unemployment rates.

“The greater Portland area has lost 37,200 jobs,” Owendoff said. “Even though Kruse Way has historically high vacancies today, banks aren’t lending. That means no new construction. Eventually, the space will be absorbed.”

According to Gordon King, vice president at Colliers International, two waves of vacancy have already hit Kruse Way. The first came in 2006, when the mortgage meltdown led to the vacancy rate rising from 3.7 percent in the second quarter to 10 percent by the end of the year. Then, the overall economic collapse contributed to the vacancy rate rising from 15 percent to 23 percent in the fourth quarter of 2008. Now, King said, companies’ relocations to downtown Portland will likely trigger a third wave.

“Suddenly, businesses are looking at just the cost of a space,” King said. “Businesses today don’t consider location as highly and are willing to trade that for lower-priced space. These buildings are well designed and maintained, but price sensitivity is driving things.”

King said the area has recovered before. During the mid-1980s, the collapse of the lumber industry contributed to Kruse Way vacancy rates reaching 22 percent. Eventually, financial firms moved in.

“It took seven years after the decline in the ’80s to get back into a landlord-oriented market,” King said. “It might be four to seven years until Kruse Way is back at a 10-percent vacancy rate. Commercial real-estate cycles are very long.”

If Multnomah County, which charges a 1.45-percent business income tax, increases the tax to make up for major budget shortfalls, Owendoff said we could see companies in downtown Portland relocating to places like Kruse Way. Clackamas County, where Kruse Way is located, does not have a business tax.

“The window of opportunity to get Class A office space downtown at a Class B price is closing,” Owendoff said. “I’m hearing from businesses downtown that if taxes in Portland go up, they will leave. From where I sit, that vacancy rate will get whittled down to below 10 percent in five years.”

But until taxes increase, or the job market improves, Kruse Way landlords will continue to offer lower rental rates, tenant-improvement allowances and other perks, Raicht said. That may explain why real-estate professionals still believe Kruse Way can bounce back.

“If you have faith in Portland, you have to have faith in Kruse Way,” Stutte said.

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