Commercial Supply Outpaces Demand

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Mark Wann, associate broker with Griffin Company Realtors, doesn’t want to see what he saw elsewhere in the mid-1980s happen in Northwest Arkansas.
“Let’s watch out for any more Class A office projects being delivered to the marketplace for a period of time,” Wann said. “Because if these things aren’t pre-leased, there is going to be some ‘see-through’ space: no people, no furniture and you can see from one side to the other.”
Observers of the Northwest Arkansas commercial real estate market have been warning of an oversupply of space for quite some time and the Skyline Report for the first quarter of 2007 backs that up.
Prepared for Arvest Bank Group Inc. by the University of Arkansas’ Center for Business and Economic Research, the Skyline Report showed negative net absorption across every submarket of commercial space from Class A office to retail to warehouse in Benton and Washington counties.
According to the Skyline Report, nearly 1.5 million SF of commercial space came online in the first quarter — nearly 900,000 SF of it in the warehouse submarket — bringing the total available in Northwest Arkansas to more than 3.7 million SF.
The leasing market was active with nearly 100,000 SF absorbed in the retail and Class A submarkets, but the huge supply of new product obscures those figures.
Kathy Deck, director of the CBER, said it is difficult to assess the inventory in the market because negative absorption rates don’t lend themselves to projections.
Craig Hull, principal broker and owner of Hull & Company in Rogers said Northwest Arkansas is experiencing a “normal pause cycle” that could take 24 to 36 months of reassessment before demand catches up with supply.
Jeff Collins, a partner with Streetsmart Data Services Inc. of Fayetteville, said his company’s report gave the market a “B minus” for its absorption but plenty of risk still exists with substantial projects on the horizon and job creation slowing.
Wann has seen markets go bust. Born and raised in Springdale, he worked in the Atlanta market for 22 years before returning to his hometown in 1996 on the eve of Northwest Arkansas’ breakout growth.
The mid-1980s were extremely painful for many dynamic markets like Atlanta and Dallas when federal tax laws on depreciation were revised, people lost their equity and the savings and loan industry went under.
Bill McClard of Lindsey & Associates worked through that tough period as well as the late 1970s bust when inflation, high interest rates and skyrocketing energy prices soured the investment market.
Neither obtrusive federal laws nor high inflation and interest rates are a factor in Northwest Arkansas, McClard said.
Gonzo growth models characterizing any boom market are, though.
“Our basic problem is everyone who thought they could build something has built it instead of seeing what the demand was,” McClard said. “They just jumped out there and built too much and it happens everywhere. Dallas is famous for getting an 85 to 90 percent occupancy rate and going out and building a couple million square feet.”
While no one should take the Skyline Report data lightly, neither should they overreact, Wann said.
“What we’re seeing is not any sort of a bust,” he said. “It’s a correction that needs to take place from time to time as it does in the stock market. Supply and demand have to be in some sort of correlation.”

Filling Demand
The national averages for vacancy rates are about 8 percent to 10 percent in retail, and 10 percent to 15 percent for office space, Deck said.
By that measure, only the retail and medical office submarkets are in line with current demand at 11.9 percent and 10.8 percent, respectively.
The office vacancy rate for the region is 15.7 percent with Bentonville (17.3 percent) and Rogers (16.8 percent) home to the most empty space.
Fayetteville has seen the greatest jump in vacant office space after possessing a healthy 8.6 percent to 10.9 percent range in the first three quarters of 2006 with positive net absorption in two of those periods.
The vacancy rate in Fayetteville has now jumped to 15.1 percent thanks to a negative net absorption of 130,322 SF in the first quarter of 2007.
For the market, office/retail, office/warehouse, retail/warehouse and warehouse vacancy rates were all between 17.4 percent and 20.3 percent vacant in the first quarter.
There was 73,617 SF of Class A absorbed in the first quarter with 117,961 added for a negative net of 44,344.
There was 23,889 SF of retail space absorbed in the first quarter, but 149,950 SF was added.
“We don’t need any more large retail complexes for the foreseeable future,” he said. “The retail segment is healthy. But nevertheless we have a lot of retail space out there. For small, well-located single-user retail buildings or strips in certain locations, they could be very profitable. You have to make sure you analyze it correctly so you can lease up in a somewhat predictable manner.”
McClard said there is an oversupply of everything on the market, including raw land.
An old axiom of real estate says buy land because God isn’t making any more, but McClard said the repeated speculative flipping and leveraging of it has gotten out of whack for the market.
“The demand for raw land is pretty weak right now because there are people who think [the price] hasn’t bottomed out yet,” McClard said. “If we’re not there, we’re close. I’m having more people become interested in doing projects. The last seven months were slow but it’s starting to pick up.”
McClard said owners of income-producing properties are “bulletproof” when it comes to a downturn in the market, but people who purchased raw land and leveraged it with the expectation prices would continue to jump are taking a major hit.
“When prices don’t continue to increase, their ability to stay in the market decreases,” he said.

Looking Ahead
From the looks of the building permit numbers compiled in the Skyline Report, developers are beginning to get the message.
There was a decline of 9.6 percent year-over-year to $96.5 million in commercial permits issued for the biggest cities in the two-county area from December 2006 to February 2007.
Hull said as long as people keep moving into Northwest Arkansas, the glut of commercial and residential real estate will take care of itself.
What should concern everyone is the job creation number. When that begins to drop off, Hull said, people should take note.
The monthly employment growth in Northwest Arkansas has dropped from around 650 per month to 550 per month from January 2006 to January 2007 according to the Skyline Report.
When the job creation flattens and goes downward, you’re just like the rest of Arkansas,” Hull said.
The rapid growth rates for Northwest Arkansas, while highly profitable in the short term, are not indicative of a healthy market. A stable market does not have the spikes and double-digit growth seen in Northwest Arkansas during the past decade. A stable market with slower growth can still be profitable while carrying far less risk than a boomtown mentality that goes too far.
McClard said it’s a glass half-empty, half-full debate and those who have known nothing but rapid growth are calling it half-empty.
Those who are focusing on the negative don’t know anything about the real hard times McClard has seen during 32 years in the business.
“I don’t see this market becoming where suddenly everything goes to the bank [in foreclosure],” he said. “I see some people with some problems, but there have been times [in other markets] if you needed a listing you had to go to the bank to get them. I don’t see this as being as severe as the ’70s or ’80s.
“For good brokers, there is work to be done and you can make a good living.”
The slowing market is also an opportunity for some.
Steve Jeffcoat, owner of Steve Jeffcoat and Associates in Fort Smith has built successful commercial real estate investment portfolios for himself in Austin, Texas, and in the Arkansas River Valley.
He said he stayed out of the Northwest Arkansas market during the past two or three years because he felt it was overvalued.
Now that things are cooling down, he thinks it could be a good time to get in.