The third-quarter report on the local commercial real estate market, from Cushman & Wakefield|Commercial Kentucky, does not paint the pretty picture Louisville was hoping for.

The overall vacancy rate for office space ended the quarter at 13.6 percent, up nearly a point from a year ago, the highest it’s been since late 2014. The overall net absorption rate – the rate at which available space is filled during a given time period – was negative for the first time since 2013.

Office Q3 2017 | Cushman & Wakefield Commercial Kentucky

Downtown is actually headed up

In the Central Business District, the downtown market that so many regard as vital to the health of any city, the overall vacancy rate ended the quarter at 15.3 percent, the highest since 2014. And the vacancy rate in Class A buildings was 14.6 percent; and here, too, net absorption was negative.

Since there has been no new Class A construction since the Aegon Tower (now called 400 West Market) went up in 1992, the only conclusion is that tenants are fleeing the downtown office buildings. For the suburbs? For Southern Indiana? For a different city altogether? Or maybe they’re downsizing as their current leases come up for renewal. Or perhaps going out of business.

Hold on, says Jeff Dreher, senior director at the real estate firm, it’s not nearly as bad as it may look. Some of the factors for the bad numbers, he says, may be temporary.

For example, Humana vacated almost 40,000 square feet at 400 West Market. But Dreher says some of Humana’s action was predicated on the planned merger with Aetna.

Now, he says, with the merger halted by a federal court’s antitrust ruling, Humana is rethinking all of its office space. The report says Humana is also expected to vacate over 50,000 square feet at Waterfront Plaza in early 2018.

But really, says Dreher, nobody knows what the company plans next. The only predictable aspect of Humana’s decisions is it generally creates major shifts in the local market.

“The way it looks to me,” Dreher says, “Humana will continue to occupy space in both the CBD and the suburban markets, as they traditionally have.”

Some of the factors have nothing to do with the strength of the market, only with companies’ new approaches to office space.

“Many companies are trying to put more people in less space,” Dreher says. “For example, law firms, who used to have some of the larger ratios of space per person, are now consolidating. You just don’t see those larger offices in law firms anymore. The old 150-plus-square-foot spaces are now shrinking, to 100 square feet or less. And the firms’ large law libraries are essentially disappearing. Everything’s online now.”

Also, Dreher points out, more companies are experimenting with work-from-home arrangements. “The jury’s still out on whether that’s a long-term trend or not,” he says. “We’ve heard mixed messages. It makes it hard to have a company culture when people are working remotely and don’t have a chance to interact. There are some benefits to the arrangement, but also some costs.”

And some of the factors are addition by subtraction. For example, Kindred Healthcare will be vacating 45,720 square feet in the Kaufman Straus Building, 427 S. Fourth St. But it’s relocating those operations to the building it recently completed at 680 S. Fourth, where, Dreher says, “they’re creating a sort of campus.”

“It looks like a negative, but it’s part of the company’s growth.” And, he says, “it creates a new opportunity for someone else to backfill.”

“Opportunity” seems to be the watchword in Cushman & Wakefield’s assessment of Louisville’s downtown market. And opportunity, Dreher feels, is created by vacancy. “You need to have vacancies for a healthy market. Without space for people to move into, things can’t change – as long as the demand is there.”

And apparently it is, at least in C&W’s Louisville office. “It’s hard to measure the demand statistically,” says Dreher, “but there’s interest, there’s foot traffic through the available spaces, and we’ve received many calls and inquiries.”

He says Louisville is definitely on the radar of companies that are looking at new cities or multiple cities. “Those are highly competitive situations, but we are getting a look. We haven’t won as many of those as we’d like to, but as the downtown amenities continue to improve, we’ll hopefully be more successful moving forward.”

Louisville has had some wins with call center operations, he says, “but obviously, we’d like to get some more headquarters-type operations, too.”

He feels downtown is only building toward a crescendo, with the bridge project having been completed, the new Omni Hotel about to open, the convention center renovation winding up and a new soccer stadium in the works.

“It’s all a formula for positive things to come, as long as that demand remains – and at this point, it is. And as long as the general economy continues to chug along as it has been, I think downtown Louisville is poised for some growth, despite what the statistics in this report show.”

Suburbs solid

In the suburban market, it’s been steady-as-you-go for some time. The Class A vacancy rate of 9.8 percent in the third quarter was slightly above a year ago, but it has been in single digits for at least the last five years.

And the prime suburban markets are all relatively healthy: The Hurstbourne/Eastpoint submarket had an overall vacancy rate of 8 percent; the Northeast submarket, 5.1 percent; and St. Matthews, 7.8 percent.

There has been new construction in the suburbs, too. Woodlawn Center Office Park on Hubbards Lane in St. Matthews recently completed Phase II.

Shelbyhurst, on the corner of Shelbyville Avenue and Hurstbourne Lane, is getting ready to start Building #4. (ResCare Human Resources has been announced as the anchor tenant of the new building.)

And there is new product at Old Henry Crossing. Payment Alliance International signed a lease to take 29,000 square feet of new space at 2101 High Wickham Place, in the Old Henry Crossings Business Park, Building #5, for its Louisville operations. Its prior lease, at 6060 Dutchmans Lane, ended in June.

A shift in preferences

What’s interesting, says Dreher, is, “when I first got in the business, we had suburban users and downtown users, two entirely different tenant bases. Today, we see many people evaluating both options.”

He says he just completed a transaction with a long-time suburban tenant – Job News, the advertising agency — that decided it wanted to move downtown from the Hurstbourne area.

“A lot more companies are drawn to the vitality of the city, all the options, the restaurants for lunch, the after-hours opportunities, the ability to walk or bike to work.

“The new tech startups are mostly choosing to be downtown. They tend to hire millennial-age employees, and that’s where the millennials want to work, live and play. It’s the future.”

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