Thriving Economy Fuels Class A Office Development

Nashville is now an established growth leader regionally and nationally.

The city was a national trailblazer as the U.S. economy recovered from the Great Recession. That head start positioned Nashville to take advantage of broader growth trends and stay ahead of the pack as the remainder of the region and country started to grow again. Moody’s Analytics places Nashville firmly in an expansion phase, with fourth quarter employment growth 330 basis points ahead of the prior year, in-migration driving single-family housing permits up 13 percent last year and accelerating wage growth. Quoting Moody’s, “With the commercial real estate market tightening quickly, the pace of hiring will soon be contingent on how quickly new offices can be built or renovated. Yet there is still a good chance office-using employment could beat expectations, especially after 2016.”

Class A buildings continue to dominate growth.
Overall absorption for 2014 totaled 666,639 square feet, while Class A absorption was 689,009 square feet. Absorption exceeded construction by over 200,000 square feet, and Class A vacancy dropped from 5 percent at the beginning of the year to 3.5 percent at year-end. Vacancy that low inhibits movement, as is obvious in Brentwood with only 45,000 square feet vacant, a rate of 2.1 percent. Vacancy rates in larger submarkets included West End with 2.2 percent vacant, Cool Springs with 2.5 percent and CBD with 4.5 percent.

Construction, Rising Rents
Class A asking rates for new construction in CBD buildings are in the mid-$30 range, almost $10 per square foot above the year-end weighted average asking rate for existing space. Class A asking rates in West End and Cool Springs ended 2014 at $27.62 and $27.00 per square foot, respectively. Green Hills/Music Row had the highest asking rate at $30.58 per square foot. Class B asking rates were around $23.00 per square foot in Brentwood, Green Hills/Music Row and West End, and just over $21.00 per square foot in the CBD. Average asking rates decrease as the most desirable space is leased and removed from the market. Tenant preferences for amenities such as fitness facilities or mixed-use environments assure that higher-priced space is leased first.

With rising rates and white-hot demand, new Class A and mixed-use construction has already increased dramatically, and it’s not expected to abate. Last year, new construction added 812,774 square feet to the office inventory. Build-to-suit construction for LifePoint and Tractor Supply accounted for 537,720 square feet of the total, and One Franklin Park was the only large speculative construction. After breaking ground with no pre-leasing, One Franklin Park opened in the fourth quarter 81 percent occupied.

The combination of its success, extremely low Class A vacancy rates and the reality expressed in the Moody’s report together support the logic of the current construction picture. Nine speculative buildings currently under construction and scheduled for 2015/2016 completion will total more than 1.4 million square feet. Pre-leasing in these buildings is currently at 855,000 square feet. The largest of these is the 450,000-square-foot Hill Center Brentwood on Franklin Road, which is 18 percent pre-leased. Two buildings in the CBD totaling 477,000 square feet have pre-leasing for nearly half the space.

Bridgestone announced its decision to move its U.S. corporate headquarters to the CBD from the Airport area and signed a lease for 514,000 square feet. This move will double Bridgestone’s current footprint at Highland Ridge Tower, with completion scheduled for late 2017.

Class B Market
The Class B office sector offers more of a mixed bag, with pockets of high demand and low vacancy contrasted against a few submarkets experiencing high vacancy. Some of that vacancy can be attributed to inter-market moves, such as Tractor Supply’s relocation in Brentwood. The bulk of the Class B losses were recorded in Brentwood, which had nearly 150,000 square feet. Tractor Supply and Corizon Health vacated 98,000 and 58,000 square feet, respectively, in Brentwood Class B buildings, but the vacancies are quickly leasing up at record submarket rates in the mid $20s.

Airport North and Airport South were the other two submarkets recording negative Class B absorption. CBD Class B buildings, where two State of Tennessee divisions took a combined total of 138,188 square feet in the UBS Tower, gained occupancy of just over 150,000 square feet. Class B vacancy among the larger submarkets varied widely at year-end, from 24.2 percent in the CBD submarket and 10.8 percent in Brentwood, to 2.9 percent in Cool Springs and 3.2 percent in West End.

With Nashville’s robust, diverse economy, wage growth and low office vacancy, the starting gun has sounded for developers. The next development wave, which also includes a number of new CBD high-rise multifamily buildings, will continue to reshape and transform the Nashville skyline over the next two years and meet surging demand from those who want to live, work and play in one of the United States’ great cities.

— By Crews Johnston III, SIOR, Managing Director, DTZ. This article originally appeared in the February issue of Southeast Real Estate Business.