Miami’s roller-coaster commercial real estate ride since start of century continues

Since the start of the 21st century, Miami has had a real estate boom, a real estate bust and now another real estate boom. New construction seems to be going up all over town, land prices are soaring and everyone is building.

The smiles are back indeed if you are selling an office building anywhere in Miami. Ever-increasing prices are almost reaching the top of 2008 of $600 per square foot being driven by the very low cost of money (real estate is a capital-intensive industry), rising rents and the worldwide fascination feast with Miami. Everyone wants a piece of Miami.

Normally, these factors would lead to a surge of new office building construction, since Miami developers believe it is their God-given right to overbuild any market segment that is looking strong, such as condos. However, in the core Brickell/downtown market, there are only two office buildings under construction. Both are located at Brickell City Centre, totaling +/- 260,000 square feet and slated for delivery this year or next.

The reasons for this lag in new buildings are threefold: a large amount of existing vacant space (over three million square feet); a slow recovery in employment in office space occupiers; and no new net growth in the public sector. In addition, the attractive incentives of the past six years for tenants — including free rent, generous tenant improvement allowances, extra parking and minimal annual increases — are perks of the past. Free rent and tenant improvements are less than half of what they were two years ago and almost all leases contain a 3 percent annual increase in the base rent.

During the recession, many employers and industries adopted different standards for office design, emphasizing open space planning and collaborative spaces. Flexible work spaces hours and locations have reduced the amount of space used per employee, so all the banks and law firms will now lease less office space in the future unless they add employees. These trends continue to impact the workplace.

Furthermore, new buyers of existing office buildings are aggressively increasing their quoted rents by more than 10 percent. That trend, the cost and availability of parking, and the traffic congestion in the urban core are causing some tenants to seek out alternative markets, such as Coral Way, Coconut Grove or Miami Beach. Those areas have vacancy rates of 4 percent, 7 percent and 8 percent, respectively, compared to 15 percent for downtown.

Things might change. Brickell City Centre, Miami World Center and All Aboard Florida have major office components in their master plans totaling over two million square feet needed in the next five years, so there will be plenty of competition for new and existing tenants for some time to come.

Is this the right time to start a new office project, given the improving rental market and low interest rates? The costs of producing a major building — primarily land, construction and soft costs — are all increasing. The surge in residential construction has driven up both land and construction costs (up 1 to 11/2 percent per month), and the Federal Reserve Bank should start increasing interest rates by the end of this year.

The enthusiasm generated by the eMerge conference and the funding by the Knight Foundation for entrepreneurial enterprises is creating a new group of office space users, many of whom are very flexible with the type of space and location they occupy. This trend has created new demand but one the market is just adjusting to. This is a new area of opportunity for office developers.

Another effect of the recession has been the preference of tenants for flexibility, with shorter lease terms or the ability to terminate a lease with some notice. Many firms have elected to occupy executive suits such as Regus rather than commit to a landlord directly. These trends have again limited the guaranteed rent stream that developers rely on to make critical go/no-go decisions on a project, and secure equity and debt funding.

Current asking rents for Class A buildings are in the high $40s per square foot; total taxes and operating expenses run around $15 for a net of $25 to the landlord. If the total project cost is over $500 per square foot, the return on such a project fully leased would be 5 percent, which is not a robust return. Under these circumstances, any developer would want to have a significant portion of the new space leased in advance of completion. That was the case with Two Brickell City Centre, when Akerman Senterfitt leased 80 percent of the building prior to completion this year.

Miami’s motto always is “build it and they will come,” but now we are overbuilding condos and offices are next. Conclusion: If you own a well-leased office building, sell now.

▪ The figures mentioned in this column exclude government and medical office space.

This story was originally published July 26, 2015 at 3:00 PM with the headline "Miami’s roller-coaster commercial real estate ride since start of century continues."