After what was a banner year in many ways for Memphis commercial real estate in 2017, projections for this year were bullish. But at the halfway point of 2018, have expectations in the area risen with the temperatures or have they begun to dry out under the sweltering summer heat? 

“With the continuation of the economic expansion, commercial real estate continues its strong performance,” said Avison Young principal Shane Soefker. “Investors continue to see, in some cases, record asset pricing in office and industrial markets. But with the amount of investors looking for opportunities to deploy capital, it continues to be a challenging market in that regard.”

Here’s a look at how each commercial real estate sector is performing.

OFFICE 

After hitting a cyclical low of 17.9 percent in third quarter 2017, vacancy rates are on the rise, reaching 20.3 percent by the end of March 2018. Most of that is attributed to a combination of new supply hitting the market coupled with a national trend of companies downsizing their office footprint, according to Avison Young’s data. Leasing activity in the first half of 2018 totaled 460,000 square feet, which is the lowest midyear mark in the past five years. 

“Strong market fundamentals and economic growth over the years led to the construction of more than 800,000 square feet of speculative office space,” Soefker said. “That’s a significant amount of speculative space for the Memphis market, all of which has been delivered over the past nine months.” 

However, the addition of new inventory to the market is expected to taper off as the only large office building that remains under construction is 150 Schilling Blvd., 80 percent of which is already leased and will serve as the new office headquarters for Mueller Industries. 

The East Class A market continues to fetch the highest rental rates in the Memphis metropolitan statistical area, with figures that push or exceed $30 per square foot.

The biggest trend in the local office market, according to Soefker, is the continuing urbanization of Memphis. 

Employers such as ServiceMaster, which opened its corporate headquarters in the former Peabody Place mall last year, are fueling investor and developer demand Downtown. (Memphis News File/Houston Cofield)

“More recently demand for hospitality and multifamily has dominated the Downtown submarket driven by easy financing, improving occupancy rates and rapidly improving rental rates,” he said. “The office sector continues to improve as employers such as ServiceMaster, SouthernSun (Asset Management) and Wunderlich (Securities) are fueling investor and developer demand for opportunities.”

However, bringing new office product online Downtown can be challenging because of the existing office rental rates in the submarket versus the implied rents with new construction.

“Outside of the repurposing of the former Peabody Place Mall and the potential of the Gibson Guitar Factory, we believe the next large tenant in the Downtown market will have to consider new construction and we see the rental rate gap compressing into late 2018 and 2019,” Soefker said. 

As of right now, the only large-scale development opportunity in the area from an office perspective is the 250,000- to 400,000-square-foot Class A tower planned as part of the One Beale development.

Meanwhile, the city’s traditionally strongest office submarket, East Memphis, continues to thrive despite the fact many suburban markets across the country are feeling the brunt of the re-urbanization trend. 

“In many markets throughout the U.S., suburban office product has been written off by a large sector of the investment community as being largely obsolete and/or overbuilt in certain areas,” Soefker said. 

But according to Soefker, the East Memphis office submarket, along with other submarkets such as the Tenn. 385 corridor, continue to be a very viable asset class for investors. 

INDUSTRIAL 

Industrial vacancy rates in the Memphis MSA have increased from the cyclical low mark of 6.4 percent at the end of fourth quarter 2017 to 7.4 percent at the end of second quarter 2018, according to Avison Young’s market data. 

This is primarily due to the delivery of new speculative buildings in the area, with more than 3 million square feet of empty space added during that time. There was roughly 1.4 million square feet of absorption while leasing activity reached 4.6 million square feet. Though on the rise, asking rates in Memphis remain competitive, with rental rates of $2.83 per square foot – significantly lower than the national average of $7.56 per square foot. 

“Right now, you have a bunch of good product coming on the market and some good deals in the works,” said Andy Cates, Colliers International CEO and president of brokerage services. 

Within in the city limits alone, Cates noted Amazon’s new 615,000-square-foot facility at 3282 E. Holmes Road, Barrett Distribution’s 414,000-square-foot fulfillment center in the Chickasaw Distribution Center near Crumpler and Holmes roads and Dohmen Life Science Services taking 260,000 square feet in the Memphis Distribution Center at 5750 Challenge Drive.

“This is really making the Class A market in Memphis really tight, which is why you’re seeing the Class A market in DeSoto expand with this new construction,” he said. 

This includes an 869,000-square-foot building from IDI Logistics, 411,000 square feet from market newcomer H&M, two buildings from Hillwood Investment Properties totaling more than 1.2 million and two more from Core5 Industrial Partners totaling roughly 800,000 square feet. 

“Moving forward in 2018, I think these buildings will deliver and we’ll see a stream of tenants begin to lease them up,” Cates said. “The demand is strong and there is a lot of good things going on in the market as far as prospects go that, even if we’re only batting .500, we’re still going to do pretty well filling up space.”

RETAIL 

Meanwhile, the retail real estate sector has been in a sort of holding pattern for the first part of 2018, according to The Shopping Center Group partner Shawn Massey. 

With the majority of the large-scale projects – including The Lake District in Lakeland, Parkside at Shelby Farms and Southaven’s Silo Square – still a year or two off, smaller infill projects and inner city revitalization has been the name of the game in the early part of 2018.

“I think you’re going to see a lot more shopping centers reimagined,” Massey said. “As an industry and a city, there are a lot of things we need to do to reimagine retail.”

Massey said while areas like East Memphis and the suburbs are doing well, demand in the city is not just limited to those areas. 

“Frayser, Whitehaven and South Memphis – there is retail demand for space in those markets, but that space cannot be third- or fourth-generation space that is not fixed up to look good,” Massey said. “National tenants do not want to go into a property that looks 30 to 40 years old. They have a brand they have to maintain, so they either want to go into something new or recently renovated.”

For example, Massey said he helped one of his clients build a 12,000-square-foot shopping center last year at 4587 Elvis Presley Blvd. in Whitehaven that now is completely leased up and performing well. 

“Some people will say that Whitehaven is not supposed to do that, but Whitehaven can do that if landlords would just reinvest in their properties,” he said. “We have tenants that want to go into a fully renovated center, we just don’t have a lot of them in disenfranchised neighborhoods.”

The 1960s-era Eastgate Shopping Center, located on Park Avenue between White Station and Mt. Moriah roads, is undergoing a $30 million facelift to its storefronts and parking lots. (Memphis News/Houston Cofield)

Massey also noted that even areas like East Memphis aren’t exempt from this need. 

Eastgate Shopping Center, located on Park Avenue between White Station and Mount Moriah roads, is in the midst of an overhaul to modernize the look of the 1960s-era center.

“Eastgate is getting a $30 million makeover, and that is absolutely wonderful because somebody is doing that without an incentive,” he said. “They are giving it whole new façade and are making it look like a brand new center.”

This is important, Massey said, because until recently East Memphis’ retail stock looked tired despite being one of the best trade areas in the city.

However, with Seritage Growth Properties’ reimagining of the old Sears property at Poplar Avenue and Perkins Extended, along with nearby Laurelwood Shopping Center’s own makeover, the Poplar corridor as a whole seems to be getting an upgrade. 

“You’re going to see an influx of new tenants in the east submarket because this owner is substantially investing back into the property,” he added. 

MULTIFAMILY

In some regards, the multifamily sector is becoming more and more intertwined with the retail sector as many of the most significant residential projects all have either retail or office components included, such as the previously mentioned Parkside at Shelby Farms, Lake District and Silo Square. 

“We are seeing some of the same trends in Memphis that are seen in other areas,” said James Maclin, general partner with M&M Enterprises and 3D Realty. “Multifamily customers want to be in what I consider ‘pods of activity.’ For Memphis, this is areas like Downtown, Overton Square, Midtown, Broad Avenue, U of M, etc.”

But perhaps the biggest news in the multifamily market was an amendment to a state law that effectively allows the Economic Development Growth Engine for Memphis and Shelby County to offer payment-in-lieu-of-taxes, or PILOT, incentives to residential projects beyond the central business district, which is basically bound by the parkways.

It took the work of state Sen. Brian Kelsey of Germantown and state Rep. Kevin Vaughan of Collierville, at the behest of just about every economic development entity in the area, to make the Shelby County-specific amendment a reality in Nashville. 

“There are lots of great projects, but the one consistent thing in all of them are the needs for some type of government help,” Maclin said. “That leads me to say that I think the biggest deal for the city is the work our administrations are doing in Nashville.”

Maclin said this includes everything from the work to remove the Confederate statues of Nathan Bedford Forrest and Jefferson Davis from city parks, to changes in the governance for the University of Memphis to the aforementioned changes to the residential PILOT boundaries.