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Special Report: 'Armageddon impact' of expiring leases boosts Louisville's downtown office vacancy rate

by Steve Kaufman

Downtown Louisville’s office vacancies boil down to: Too much space, not enough people.

It’s only getting worse.

If you’re one who believes the measure of a big city is the hustle and bustle of its downtown office buildings, I recommend that you avert your eyes.

The Class A vacancy rate in Louisville’s Central Business District, according to figures supplied to Insider Louisville every quarter by Commercial Kentucky Inc. (and its parent, Cushman & Wakefield), is at 16.2 percent.

“That may be the highest since we started tracking the market in 1987,” says Commercial Kentucky president E. Phillip Scherer III.

And it’s not getting better anytime soon.

In the next quarter, the Nucleus Innovation Center – Market Street healthcare-related project scheduled to be completed next month, will become part of Commercial Kentucky’s statistics.

It appears to Phil Scherer that there will likely be some non-healthcare-related tenants. And that will make it commercial office space.

Also by next quarter, Humana will have vacated more than 100,000 square feet at 515 W. Market St., moving most of its government business operations to the Forum Office Park on North Hurstbourne Parkway.

Humana will also be relocating workers from three other downtown properties.

It seems hard to believe that just a year ago, the downtown vacancy rate was just 5.8 percent and, in a city that seems to need a jolt of self-confidence on a regular basis, casual observers were crowing that Louisville was on the come!

“We had been one of the leading cities in the country,” recalls Scherer. “In terms of low downtown vacancy rates, we were in the Top Five.”

But, notes Scherer, the clouds were already on the horizon. Those stats, he says, didn’t reflect the “Armageddon impact” of leases about to expire.

“We knew Aegon was going to downsize, but its lease still ran through the end of 2012. Also, Mercer was going to be leaving Meidinger Tower for Aegon and also downsizing, but that wasn’t going to be recognized statistically until its lease expired and the physical relocations actually took place.”

Amid all that happy talk, says Scherer, that was the elephant in the room – until the elephant vacated the room, presumably for the suburbs.

“Companies were downsizing, trying to do more with less, just to survive,” he says. “This wasn’t just because companies have fled downtown for the suburbs or relocated to other cities.”

He says Louisville is still paying a tremendous price for the real estate recession, and the recovery has not yet happened.

“By mid-year, we’ll have 500,000 square feet of vacant office space downtown in either Class A or Class B+ buildings. That roughly translates to 2,000-to-2,500 fewer people working downtown than four or five years ago.”

What recovery we’ve seen has been in manufacturing and health care services, plus a modest residential real estate recovery. “And we’ll see a nice bump, beginning July 1, in construction employment because of the bridges project. We’ll see significant growth in disposable income and consumer spending.

“But none of that translates to traditional office space.”

The good news is that we didn’t use those artificially low numbers as an excuse to do a whole bunch of downtown construction, which would have left us with a lot of white elephants. Elephants need to be fed – especially the ones in the room. The Aegon Tower, built in 1993, is still the last bit of major downtown construction.

Jerome Kern and Buddy DeSylva (thanks, Wikipedia) told us to “look for the silver lining,” and Louisville has a few, as the Commercial Kentucky report makes clear:

Wage and personal income growth in the Metro area have outpaced that of the U.S. economy, thanks to employment gains in the educational, healthcare and construction sectors, which have complemented gains in manufacturing employment at both Ford Motor Co. and General Electric’s Appliance Park.

The unemployment rate declined to 7.8 percent during the fourth quarter of 2012 with further improvement, albeit modest, forecast for 2013 and beyond. The nation’s official unemployment rate currently stands at 7.6 percent.

There was strong suburban leasing activity during the quarter of 235,572 square feet, leaving a vacancy rate of about 14 percent. But even that doesn’t tell the whole story. In the all-important Hurstbourne/Eastpoint sector, the vacancy rate dropped to 10.3 percent. There was new leasing of more than 164,000 square feet, or 62 percent of all the leasing activity in the Louisville market.

By comparison, there were only about 28,000 square feet leased in the CBD.

Two of the biggest lease transactions during the quarter occurred in Hurstbourne/Eastpoint:

Enterprise Rent-a-Car took 15,741 square feet at Eastpoint Business Center – just inside the Gene Snyder Freeway at the LaGrange Road exit – and an undisclosed tenant took 30,000 square feet at Paragon Place, 9100 Shelbyville Rd.

The only deterrent to growth, noted the report, is “the lack of large blocks of available space [which] may somewhat stifle suburban leasing activity until additional inventory becomes available.”

We also had what Scherer calls “a modest recovery” in the residential market.

But the market that’s booming here is the industrial market, which has seen national companies such as Amazon taking warehouse and distribution space in a burgeoning industrial park resurgence – in Southern Indiana and down the Interstate-65 corridor – to be near the UPS WorldPort air-freight hub.

The hope, says Scherer, is some of those companies seeing the virtues of living and working in Louisville – the low costs of living and doing business, the local amenities, the nice lifestyle, the accessibility of everything – and moving some of their executive operations here.

“What we have, for better as well as for worse, is a significant block of available space,” he says. “And we have aggressive landlords who won’t have to say ‘no’ to relocating companies looking for an urban environment – regardless of their square footage demands.”

He says we’ll have five buildings in the Central Business District by mid-year with 100,000 square feet or more for a single tenant:

It would bring some higher-paying professional level jobs to Louisville. We need those higher-paying jobs here if we’re going to remain competitive with our peer cities. There’s a significant difference between what an Aegon employee was earning when they were fully staffed here and what a distribution worker at Amazon is earning.

Scherer said he went to a Louisville Downtown Development Corp. breakfast recently, in which the group was told that the Class A downtown office market was “holding its own.”

“Well, I don’t know what it was holding,” he says, “but that suggested to me that our public officials aren’t sure what they can do about the situation.”

He says the LDDC, Metro Mayor Greg Fischer and Greater Louisville Inc. need to be out there aggressively marketing the community. But, he said, we’re not going to get that infusion of big company interest until we get more direct flights out of Louisville into the cities where these companies do business.

“Big national companies depend on direct flights,” Scherer said. “We can’t afford to keep being seen as a city that’s a connection away from every other city. The Louisville Regional Airport Authority is always trying to convince airlines to give us more direct flights, I think. Otherwise, you’re just not going to get that New York company, or San Francisco company or Chicago company.”

But, he said, there are more companies that don’t necessarily depend on direct flights than those that do, “and those are the companies we need to be out there in front of, telling our story. We need to take that message to the user. We can’t wait for the user to come to us.

“It’s not like we’re going to have an open house in all our downtown office buildings, and corporate America will stop by.”

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