Companies seeking larger blocks of office space are staying on the sidelines for the most part so far this year because of diminishing inventory in the area’s hottest submarkets of East Memphis, the Tenn. 385 corridor and Downtown.
The health of the local office market for the remainder of 2012 is expected to hinge on activity involving smaller businesses, and they should have plenty of choices since of the 600 suites in the city that are vacant, 80 percent measure less than 6,000 square feet.
“We are seeing a slow, steady increase in the expansion of smaller mom-and-pop business owners so far this year. We expect to finish the first quarter with positive absorption,” said John Mercer, director of leasing for Raleigh, N.C.-based Highwoods Properties Inc. and 2012 president of the Memphis Area Association of Realtors Commercial Council. “We have several local companies that are current customers that we are talking to right now about expansion, and we even have a few new companies to the market that are smaller users.”
Mercer said he believes, however, that the uncertainty that sometimes comes during an election year could temper the expansion of small business somewhat as the year progresses.
He is also seeing encouraging signs and interest from the business service, financial service and health care sectors so far this year.
“We are all keeping a close eye on the fallout that may or may not happen from the Raymond James-Morgan Keegan merger,” he said.
Many of the remaining larger blocks of space in the East Memphis and 385 corridor submarkets were gobbled up last year. EdR (formerly Education Realty Trust Inc.) signed the largest lease of the fourth quarter of 2011 with a deal for 26,981 square feet at Boyle Investment Co.’s 999 Shady Grove building.
“There’s not going to be a lot to choose from for the large users going forward,” Mercer said. “I think one could argue that a new building is needed, but the constraints on pre-leasing and/or the amount of equity needed could be too onerous to a developer right now to start construction.”
The most recent construction of new office space in Memphis happened in 2008, when Boyle built the aforementioned 999 Shady Grove building and Highwoods developed Triad Centre III.
Concessions like free rent and tenant improvement costs were in play more heavily last year, but Mercer expects to see that trend decreasing this year thanks to less downward pressure on rental rates.
Don Drinkard, CBRE senior associate specializing in the Downtown office submarket, said he is seeing steady activity in 2012 from smaller businesses.
“The larger users really are not out and about yet so far this year, probably as a result of the fact that many are still trying to backfill shadow space (leased but unused square footage) that they probably still have available from when the recession was in effect,” he said. “But overall we are seeing positive signs that the Downtown Memphis office market is on the rebound.”
Overall the Memphis office market posted a positive net absorption of 135,535 square feet for 2011, driven primarily by Pinnacle Airlines move from the Airport submarket to Downtown’s One Commerce Square building, which is one of only a handful of building in the area that experienced positive absorption last year.
Pinnacle’s move and expansion by roughly 100,000 square feet of space helped lower the overall Downtown vacancy rate by 6 percent and decrease the Memphis MSA vacancy rate by 1 percent to 17.9 percent, according to CBRE’s fourth quarter MarketView report.
The 385 corridor boasts the area’s lowest vacancy rate at only 11 percent.
Overall, asking lease rates have not changed much in the past 12 to 18 months, and Drinkard expects that to continue through 2012. The overall asking lease rate for the Memphis MSA registered $17.66 per square foot at the end of last year. However, rates could begin to rise in 2013.
“Going into next year, if vacancy rates have decreased then landlords are likely to start increasing their rental rates,” Drinkard said.
Leasing and sales volume so far this year remains quite light, according to Henry Stratton, vice president of brokerage services at Colliers International. He also points out that there is still a substantial amount of shadow space that needs to be refilled.
“We continue to experience a lack of confidence by office space users that we will see any substantial improvement in general economic conditions,” Stratton said. “Additionally, there is a large amount of sublease space on the market, which should keep some pressure on rental rates.”
He said he believes market activity in 2011 was buoyed by an uptick in employment rates in the professional and business services sector. With no new development under way, he expects vacancy rates to improve slightly throughout the balance of 2012.
“The vast majority of the office deals that we are working on currently definitely involve smaller users,” Stratton said.