Data Firm: Northwest Arkansas Must Slow Office Construction

(Tom Reed is a partner in Streetsmart Data Services.)

Streetsmart Data Services researches various sectors of the commercial real estate market in Northwest Arkansas. In this article we would like to discuss the professional office sector of the commercial real estate market.

Currently, Streetsmart examines between 5 million and 6 million SF of professional office space in Benton and Washington counties.

This represents both Class A and Class B space. Class A space pertains to those properties that are considered the best in the marketplace, and are typically multi-story buildings leased under full-service lease arrangements (tenant pays base rent plus janitorial expense and the landlord pays all remaining expenses).

Class B space is typically single-story office properties leased under gross lease arrangements (tenant pays base rent plus janitorial and, typically, utilities and interior maintenance, with the landlord paying the remaining expenses). The properties examined by Streetsmart are competitive, non-owner occupied investment properties.

The trend in overall vacancy rates in Class A and B office space for 2007 in Northwest Arkansas was upward. Vacancy rates increased from near 19 percent in the first quarter of 2007 to more than 25 percent in the fourth quarter of 2007. This was primarily the result of the introduction of new product to the market, with little pre-leasing. The vacancy rate actually dipped to near 17.5 percent in the second quarter but quickly jumped to more than 23 percent in the third quarter as the result of the addition of a 400,000-SF office building to the Bentonville market.

Bentonville, Rogers, Fayetteville and Springdale contain the bulk of the office space examined by Streetsmart, with Bentonville and Rogers containing the majority of the Class A space. The health of each of these office markets varies. Bentonville and Fayetteville are currently experiencing the highest professional office vacancy rates, with Rogers not far behind.

Each of these three markets reflected a vacancy rate in excess of 20 percent in the fourth quarter of 2007, with Bentonville and Fayetteville each closer to 30 percent. Springdale, which has only Class B space, experienced a more healthy rate, near 10 percent, in the fourth quarter.

Over the past few years, Bentonville has typically reflected the highest professional office vacancy in the Northwest Arkansas market. This began with the introduction of the Bentonville Plaza Building (near 260,000 SF of rentable space) in 2004. This property had little pre-leasing when it was delivered to the market.

The office vacancy gradually improved in Bentonville with the absorption of space in Bentonville Plaza, and actually dropped to near 16.5 percent in the second quarter of 2007. However, with the introduction of the Superior Building (near 400,000 SF) in the third quarter of 2007, the Bentonville professional office vacancy jumped significantly.

However, in 2007 with the introduction of new product to the Fayetteville market, and with minimal pre-leasing of this product, the vacancy rate ballooned to an unhealthy level.

As with most sectors of the commercial real estate market, when vacancy rates are low, developers begin construction of new product. Typically, the situation is over addressed and more space is added than needed. Then vacancy rates jump, and it takes time to absorb the new space. As space is absorbed and vacancy rates fall, the process begins again.

A slowdown in the delivery of new professional office space to the Northwest Arkansas market needs to occur. New office deliveries in the fourth quarter of 2007 were in Rogers and Springdale, with a total of near 75,000 SF added. Office space under construction in the fourth quarter totaled near 35,000 SF.

Given the supply of available professional office space in the Northwest Arkansas area, the expectation would be that rental rates would decline. However, in reality, the average annual per-SF rate increased near 5 percent for Class A space and near 1 percent for Class B space between the first and fourth quarters. This trend is not expected to continue. As lessors attempt to fill vacant space, given the supply and competition, rent concessions are likely.

(Tom Reed is a partner in Streetsmart Data Services. Streetsmart Data Services provides quarterly reports pertaining to the single-family residential, multifamily residential and the commercial real estate market in Benton and Washington counties. The offices of Streetsmart Data Services can be reached at 479-575-9100.)