HCRE

The Honolulu office market continued its occupancy slide that started in mid-2008. The 2nd quarter saw 98,605 square feet of negative absorption which was slightly more than the 1st quarter and was spread amongst nearly all the ten sub-markets tracked by our survey bringing the island-wide vacancy rate to 13.6%. With the exception of federal government leasing in late 2009, the news has been gloomy for Honolulu landlords since the beginning of the 2008 recession.

Asking gross rents (base rent plus full service operating expenses) increased from the 1st quarter by a penny to $2.98/sf/mth, but remained unchanged from this time last year. Average operating expenses decreased by $0.01/sf/mth from the first quarter to $1.30/sf/mth. Operating expenses were $1.24/sf/mth this time in 2010.

Honolulu Office Gross Rents ($/sf/mth)

Base rents increased slightly for the quarter, but have declined $0.06/sf/mth from the 2nd quarter 2010.

Landlords continue to compete fiercely for tenants, and the uncertainty of Pacific Office Properties future makes it unlikely that we will see an office market recovery until 2012 or beyond. One of our competitors recently made a private prediction that recovery will be delayed to 2013.

Job growth turned positive in the 3rd quarter of 2010, and UHERO is forecasting a 1.6% increase in payroll jobs in 2011 followed by a 2.2% increase in 2012 and 2.3% increase in 2013.

While job growth generally fills office space, most businesses continue to put more people in fewer square feet, so new jobs are not necessarily translating into more office space leased. We believe the current job growth forecasts are not large enough to significantly change Honolulu’s current office occupancy paradigm.

We have not seen the visitor industry rebound translate into office occupancy. DFS gave back 35,000 sf to increase Waikiki vacancy another 1.5% to 23.1%.

Honolulu’s heavy rail project back filled a Smith Barney vacancy at Alii Place as the City leased a 2nd floor of prime office space for its consultants. Bank of Hawaii’s Hale O Kapolei is hoping to fill some of its nearly 60,000 square feet of vacancy with rail-related tenants.

Even though the medical services industry is under huge cost pressures, we have seen a small number of service providers expand or move to new facilities in Waterfront Plaza and Hale Pawaa. The turmoil at Hawaii Medical Center East and West could result in doctors moving to other facilities. Please note that dedicated medical office buildings such as Hale Pawaa and Queen’s POBs are not included in inventory surveys.

The downtown Class A office buildings comprise about 40% of Oahu’s office inventory, are home to Honolulu’s larger tenants, and are typically seen as an indicator of the entire market. They lost another 17,802 square feet of occupancy during the quarter which pushed their vacancy up another 0.1% to 13.6%, nearly the post 9-11 high of 14%.

There are several large blocks of space that will hit the market as tenants continue their downsizing. They include a floor at Alii Place as Queen’s moves administrative offices to the medical center; several downsizes at Waterfront Plaza including McCorriston Miller Mukai MacKinnon; and several unnamed tenants in major CBD Class A office buildings.

Fortunately there is no new office space under construction, and when the economic recovery ultimately starts creating a significant number of new jobs, we should see a reversal of negative absorption. However there is typically a lag time between economic growth and office occupancy growth. We expect more business downsizing and right-sizing to increase vacancy through the balance of 2011 before the market bottoms in 2012 and changes direction.

Hawaii Commercial Real Estate’s index of available spaces increased from 661 to 713 spaces across the island. Except for very large spaces (over 30,000sf), tenants generally have multiple options which can force landlords to compete for their tenancy.

The result has been significant landlord concessions for tenants willing to move, including lower base rent or free base rent, smaller annual rent increases, improvement allowances, and occasionally moving allowances and parking discounts. However, moving and tenant improvement expenses are still so high for some tenants that paying an existing landlord a higher rate can sometimes be cheaper than moving. And, for tenants willing to limit their improvement requirements some landlords are willing to cut better deals.

Many tenants are looking seriously at owning their own space even though the initial mortgage payments may be higher than comparable rents. The trick is arranging financing and negotiating a purchase price that will be at or below the appraisal value.