While the mayor – citing results of a just-released study – and economists debate the city’s expected return on investment for Fourth Street Live, another brand new set of figures shows a discouraging trend for those hoping for the commercial revival of downtown Louisville.
The overall office vacancy rate in the Central Business District jumped to 12.3 percent at the end of the third quarter, in figures released exclusively to Insider Louisville by real estate brokerage Commercial Kentucky Inc. and its parent, Cushman & Wakefield. That was an increase from the 10.4 percent vacancy rate at the end of the previous quarter.
And in the ultra-desirable Class A office buildings, the downtown vacancy rate climbed to 10.8 percent from 6.2, “the first time in a long time we’ve been in double digits on our Class A downtown properties,” according to E. Phillip Scherer III, president of Commercial Kentucky Inc.
As with most numbers, though, there’s a back story here that might lift some of the pessimism. According to Scherer, the second quarter numbers were skewed by Mercer Inc., the Louisville-based subsidiary of Marsh & McLennan, that took space in the Aegon Center after Aegon moved out of its own building.
“At the end of the last quarter, Mercer had begun moving into Aegon but had not yet moved out of Meidinger, so that space was technically not vacant,” he told me. “That made the second quarter vacancy rate unrealistically better than it should have been. The effect of the move really hit in the third quarter, making the Q3 numbers worse than they should have been in comparison to Q2.”
Nonetheless, in whichever quarter you place Mercer vacating 146,000 square feet in the Meidinger Tower and moving to 80,000 square feet in the Aegon Center, the downtown trend is not moving in the right direction.
“That’s all negative absorption,” said Scherer, using the industry term for the rate at which empty commercial office space gets filled. “And I expect those vacancy rates will remain high for the balance of the year. Meidinger won’t fill that space in 2012, we’re already in October and transactions simply don’t unfold that quickly.”
Commercial Kentucky reports well over 1 million square feet of unoccupied office space downtown, and less than 242,000 of that has been leased this year, in the brokerage’s hot-off-the-presses third quarter results.
Even the reported downtown leasing activity seems part of a zero-sum game, at best.
“If you look at the history of Louisville, most new tenants come out of somebody else’s building,” Scherer told me. Aegon moves out of its own building, and Mercer shifts from one downtown property to another.
Similarly, this year, The Learning House moved out of the Speed Building on Fourth and Guthrie and into the Kaufman Straus Building, right in the middle of Fourth Street Live; and the accounting firm Harding Shymanski fled the old Louisville Cement Co. building on South Second Street for the renovated Madrid Building on Third and Guthrie streets.
Both companies expressed a desire to remain in the hub of excitement and energy that downtown offers, but they both left vacancies that have added to CBD’s negative numbers.
The most significant game of musical chairs is being played by Humana, which has been gobbling up available downtown space: 230,000 square feet in the National City Tower on Fifth Street, plus hundreds of square feet in Waterfront Plaza.
On the other hand, the vacancy rate in the “suburban market” – which in Louisville includes everything that’s not downtown – declined to 16.8 percent from 17.9 percent, and in Class A properties to 12 percent from 14.4. (The overall rate would have looked even better, said Scherer, if not for negative absorption in suburban Class B properties of almost 194,000 square feet.)
And even that positive trending was made to look worse by higher vacancy rates in Old Louisville (30.8 percent, though there are only about 400,000 square feet of office space in the neighborhood) and Plainview/Middletown (27.9 percent vacancy in the second-largest commercial neighborhood outside of downtown in Jefferson County).
In the largest commercial neighborhood, Hurstbourne/Eastpoint, the vacancy rate fell to 13.8 percent from 14.4 percent. The neighborhood has had more than 269,000 square feet leased this year, roughly half of all the activity in the Louisville area. And it has had the only construction completion this year, the 125,000-square-foot 700 North Building on the Shelby Campus of the University of Louisville, the acreage tucked in behind the corner of Shelbyville Road and Hurstbourne Parkway.
That building, constructed by NTS Development Co. when no other builders were willing to take a chance on the market, has already leased its space, at a listed $25 per square foot, to Churchill Downs, Semonin Real Estate and Stifel Nicolaus & Co. So successful has the project been, in fact, that NTS is planning a new sister building, to be called 600 North, on adjacent property.
Of course, some industry insiders have sniffed that in times of tight credit – especially in a stagnant marketplace – those properties would likely not have received the financing they needed either, without the involvement of the University of Louisville.
“Based on its success in 700 North, NTS is feeling pretty bullish about the suburban market, but nobody’s feeling bullish about building downtown because we still have vacant space yet to be filled,” said Scherer. In fact, there hasn’t been a single Class A construction project downtown since the Aegon Center was built 20 years ago. And now Aegon’s out of there, with Mercer taking only a fraction of the available space – and less space than they were occupying previously.
The downsizing that Mercer did is part of yet another trend that’s affecting the numbers and the marketplace.
Many companies are requiring less work space these days, the result of three concurrent trends: layoffs (a trend one hopes will soon play itself out); more people working from home or some other remote facility (a trend that seems to be only gaining legs); and the rise of modular work stations that pack more people into smaller spaces.
“There’s been a clear trend toward smaller spaces,” Phil Scherer told me. “Right now, the rough average is about 200 square feet per employee, but that’s reducing down to about 150 per employee. More and more companies have their people sitting in 6-foot-by-8-foot cubicles, and workers – even executives – coming out of private offices and into collaborative work station systems.”
The good news is that such efficiencies keep Louisville companies viable.
The bad news is that we’re losing the density – people on the sidewalks, in the stores, in the lunch places, in the coffee shops, in the restaurants and bars after work – that gives any downtown its throb. “We still have more than 65,000 people working downtown,” said Scherer, “but we’ve taken some hits, such as Aegon and Humana moving employees out to the suburbs.”
But here’s the hope: a market softness that will force landlords to lower rents and offer other concessions and bring in tenants who are on the fence about whether to come downtown.
“I wouldn’t be surprised if we begin to experience what we call a ‘flight to quality,’ ” Scherer said. “Smaller tenants coming out of the suburbs or downtown Class B buildings and into the Class A buildings they might not have been able to afford previously.”
He says it’s the old supply-and-demand equation. With most of the leasing activity in the last two years occurring in the suburban markets, that vacancy rate is coming down, keeping rents relatively high in the most desirable buildings. “If CBD landlords begin to adjust their rates, the suburban market will become more expensive by comparison and maybe the downtown buildings will begin to fill up again, bringing more working downtown than in the past, and that would support downtown services, restaurants, even retail.”
Scherer says he thinks the city could have done more to make all this happen – including being more serious about a mass rapid transit system.
“I think in the last 20 years, when we should have been doing something about a rail commute, we’ve lost the opportunity to mold the future development of our city around transit modes,” he said.
“Louisvillians like to say they can get anywhere in 20 minutes and our traffic isn’t as bad as in Indianapolis or Atlanta, but if you look at the time of travel into the central business district for a city our size, we don’t look so good.
“And with bridge construction coming up, it’s going to get worse.”