Amazon Joins U.S. Office Building Revival

Technology companies help drive nascent rebound in office development.

Amazon.com Inc., which agreed to buy its Seattle headquarters for $1.16 billion, plans to start construction next year on the first of three new buildings that would add another 3 million square feet (278,700 square meters) as technology companies expand and invest in real estate.

Apple Inc.’s blueprint for a new 175-acre campus in Cupertino, California, features a futuristic ring-shaped main building of about 2.8 million square feet designed by British architect Norman Foster’s firm. Facebook Inc. will start on an expansion to its Menlo Park, California, headquarters that would add a single-story building designed by Frank Gehry with about 430,000 square feet, or enough for about 2,800 engineers.

Expansion by technology companies is helping drive a nascent rebound in U.S. office development from the lowest in more than five decades as default rates on construction mortgages decline from a 2010 peak. Tech companies are expanding workforces and many also want to centralize employees in custom offices with amenities existing buildings don’t always offer.

“There is a surprising amount of construction, given the amount of space available in the market,” said Jon Southard, managing director of CBRE Econometric Advisors, a Boston-based unit of commercial broker CBRE Group Inc. “Even the gradual improvement in demand we see going forward means construction is going to increase from here rather than decrease.”

Construction starts for U.S. offices are rising from 2010, when they totaled 57 million square feet, the lowest since at least 1960, according to McGraw-Hill Construction, which began keeping national data that year.

Office starts rose to 60 million square feet last year. They’ll probably dip to 59 million square feet this year as government stimulus programs wind down, and climb to 64 million square feet in 2013, said Robert Murray, vice president of economic affairs for the Bedford, Massachusetts-based construction-forecasting unit of McGraw-Hill Cos.

“The market is moving up from the bottom but it is moving up in a very hesitant, gradual manner,” Murray said. “If the economy and employment show sustained growth, then certainly the stage will be set for increasing office construction next year and several years after that.”

Construction loans for office buildings rose to an estimated $16.1 billion in the third quarter from $14 billion a year earlier, as the default rate decreased during the past two years, said Sam Chandan, founder and chief economist of Chandan Economics in New York.

 

Credit Freeze

The loans were among the worst-performing mortgages following the credit freeze in 2008. Default rates jumped from less than 1 percent of banks’ outstanding loan balances in 2007 when commercial property values peaked, to a high of 15.2 percent in 2010’s third quarter, according to Chandan Economics.

The rate has since fallen to 11.1 percent in the three months ended June 30, according to the New York-based real estate research firm. Second-quarter defaults were the lowest since the same period in 2009 when they reached 10.6 percent.

U.S. banks have $173.9 billion in construction and development loans, excluding single-family and small residential mortgages, according to the firm’s analysis of data from banks and the Federal Deposit Insurance Corp. That’s down from a peak of $438.6 billion in the third quarter of 2008.

“When lending dries up, construction loan balances will fall much faster than permanent commercial real estate loan balances because of their shorter terms and because lenders have written them off more aggressively,” Chandan said.

During the past three years, office construction came mainly from three sources: government buildings, data centers and private projects, including corporate headquarters, said Murray of McGraw-Hill Construction.

Tech construction has been cyclical, and just as the firms led the office market during the late 1990s, the bursting of the dot-com bubble contributed to a period of declining office development in 2001 to 2003. The companies are now helping lead office construction out of the doldrums.

Facebook, the operator of the world’s largest social network, needs the space after more than tripling its workforce since 2009 to 3,976 employees.

Google, the world’s biggest Internet search company, has been buying up land and renovating office buildings next to its main campus and furnishing them in anticipation of future hires.

The company, which has grown its staff to 53,546 as of Sept. 30 from 19,835 employees at the end of 2009, recently received permits from the city of Mountain View, California, where it’s based, to build a swimming pool for workers.

 

Expansion Costs

Google fell 8 percent Thursday after reporting third-quarter profit and sales that missed analysts’ estimates, signaling costs associated with new expansion are chipping away at profitability. The stock was down 2.7 percent at 1:04 p.m. Friday New York time. That trimmed this year’s gain to 4.7 percent.

Apple, the world’s most valuable company, filed revised plans in May for its so-called Campus 2, located mostly on the former Hewlett-Packard Co. head office in Cupertino. The plan involves demolishing about 2.65 million square feet of existing office and research and development buildings.

Companies in hiring mode are moving ahead with new office buildings even as national office vacancy rates remain relatively high. The U.S. office vacancy rate fell to 17.1 percent in the third quarter, from 17.4 percent a year earlier and 17.2 percent in the second quarter, according to Reis Inc.

Lack of new supply has helped curtail vacancies amid slow economic growth. Just 2.84 million square feet of new office space was added in the third quarter, “the equivalent of only a handful of medium-size office buildings,” Reis, a New York-based real estate research firm, said Oct. 2.

Employers may be reluctant to expand hiring amid the global economic slowdown and the so-called fiscal cliff, the $600 billion of tax increases and spending cuts that will take effect automatically at the end of 2012 unless Congress acts.

Office completions this year will rise to an estimated 9.92 million square feet from 9.23 million square feet in 2011, which was an 18-year low, according to CBRE Econometric Advisors. The firm measures finished space instead of starts. Last year saw the least amount of new office space being built since 7.86 million square feet in 1994, the year that Chief Executive Officer Jeff Bezos founded Amazon, now the biggest Web retailer. The subsequent Internet boom helped propel U.S. office completions to 100 million square feet in 1999.

Next year, office-property completions are projected to increase to almost 15 million square feet, according to CBRE Econometric Advisors. That’s about one-tenth of the record 171.7 million square feet of office space finished in 1986, according to the firm.

 

Minneapolis Headquarters

The Minneapolis-St. Paul area leads the U.S. for most office construction as a percentage of the existing market, followed by Houston and Boston, according to a Sept. 21 report by Michael Bilerman, an analyst at Citigroup Inc.

The metropolitan Minneapolis area has one of the greatest concentrations of Fortune 500 company headquarters of any area in the U.S., with about 20 such companies based in the area, according to the Minneapolis St. Paul Regional Economic Development Partnership, a nonprofit group that promotes job growth and investment in the 13-county region.

“We’re seeing the front end of a wave of new office and industrial here as the economy gets better,” said Michael Langley, president and CEO of the group, known as Greater MSP. “We felt the recession like every region did but we were never at the bottom. We’re not a one-sector region.”

The Minneapolis area has a broad base of employers in industries such as food, healthcare, energy and insurance, Langley said.

Minneapolis-based retailer Target Corp. is adding about 650,000 square feet to its so-called northern campus in Brooklyn Park, Minnesota, as part of a multi-year expansion that could add as much as 1.7 million square feet. The expansion was put on hold during the credit crisis in 2008.

Office construction starts in the U.S. peaked in 1985 at 350 million square feet, according to McGraw-Hill Construction.

Building of offices during the first half of the 1980s was boosted by the accelerated depreciation contained in 1981 tax legislation and the influx of women into the workforce during the 1970s, said Murray.

Although the accelerated depreciation provisions ended in 1986, “the overhang of office space that was created during the first half of the 1980s led to a very weak period for office construction that lasted from the late 1980s through the first half of the 1990s,” Murray said.

 

Seattle Growth

Seattle ranks seventh nationally for new office construction as a percentage of the existing market, according to the report from Bilerman, the Citigroup analyst.

Amazon is moving to complete its first land purchase by year’s end, plans that won’t be affected by its buying the 1.8-million-square-feet headquarters it now leases, said Al Clise, chairman of the development company that’s selling Amazon three contiguous blocks next to its Seattle campus. Amazon plans to build three towers with 3 million square feet, or about 7 percent of Seattle’s existing office market.

“Amazon is doing all their due diligence and all their work with the city and that is going full steam ahead,” said Clise.

Ty Rogers, an Amazon spokesman, declined to comment.

Vulcan Real Estate, the property arm of billionaire Paul Allen’s investment company that is selling Amazon’s 11-building campus, plans to recycle proceeds into new development, said Ada Healey, vice president at Vulcan.

“If you purely looked at the statistics, you really shouldn’t expect any construction in the market, yet there are examples like Amazon and you can dig into other markets too,” said Southard of CBRE.

 

Bloomberg

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