CHAPEL HILL — The Triangle commercial real estate market performed extremely well in the third quarter, marked by all-around increases in rent and decreases in vacancy rates.

As do analysts in the residential market, commercial analysts feel bullish about the prospects of the market, specifically in retail and office markets. This is a result of a strong economy, with low unemployment and steady job growth.

With an unemployment rate of 3.5 percent, the top concern for tenants in the Triangle office market is talent attraction. An increase of jobs comes with the need for more office space, and more retail facilities to accommodate a growing workforce is vital. This extends into the residential market, as workers must be housed.

Essentially, a thriving economy is what marks success in the Triangle commercial market. The Urban Land Institute considers Raleigh-Durham its third pick for overall real estate prospects in 2019, affirmation that this  rings true.

Retail rents are rising and vacancies are falling

New residents drive expansions of necessity retailers, and with the presence of strong economic drivers, the Triangle has seen its fair share of growth.

According to the Marcus & Millichap report for the second half of this year, the influx of new residents and rising incomes is supporting retail spending above the national average, allowing necessity retailers to expand their presence to meet the needs of new consumers.

“On a macro level, from a commercial real estate perspective, investors have viewed the Triangle as an excellent place to be in for the long haul because of the strong population growth and stable economy,” said Andrew Margulies, first vice president of investments at Markus & Millichap. “There are strong economic drivers with Raleigh being the state capital, so the state government, lots of universities, biosciences as well as tech.”

“Those different economic drivers bring a lot of jobs, and when you have a lot of jobs it increases demand for retail space. Those are factors that influence decisions in an investment standpoint—that’s why you see a tremendous amount of development going on and redevelopment going on around the Triangle.”

The effects of such growth can be seen as the vacancy rate in Raleigh has noticeably tightened, holding at an average rate near or below 4 percent in June. According to Marcus & Millichap, Raleigh has the lowest vacancy rate among the three North Carolina metros and is over 100 basis points lower than the national average.

As vacancies drop, rents have been growing. The average asking rent has increased 3.4 percent year-over-year, reaching $17.63 per square foot. Rents in the North Raleigh and Glenwood/Creedmoor submarkets have increased in each area over 6 percent to $17.41 and $19.46 per square foot, respectively.

“Higher rent and lower vacancy means that landlords are seeing higher revenue streams coming in for their properties,” said Margulies. “So, the implications are higher valuations for the landlords. Valuations are certainty going to be coming in higher if they having leases signed at higher rents and if they are filling up vacant spaces. This is surely what we are seeing in the market right now”

As a result, Margulies believes that specific to the Raleigh-Durham area, there will be continued pressure on pricing.

“Even as interest rates continue to rise, the supply demand factors in the market will continue to impact pricing positively for landlords for valuations,” he said. “Whatever the market valuations are for a certain kind of property, the value of the asset in the Raleigh-Durham market, depending on where it is, typically yields better-than-average pricing and a lower-than-average capitalization rate compared to other markets that we sell in the Carolinas because of the supply and demand factors.”

“So, the prediction is that valuations will still continue to be strong in the next several years, with the exception for assets where you may that you have a grocery store that decides they’re not going to make it in those locations and decides to pull out. Those are the type of assets that are going to have negative impact.”

Grocery retail is in hot water

While the retail market as a whole looks promising, there is concern among investors about the grocery-anchored retail asset class.

“Raleigh is ground-zero for the grocery wars that are going on right now” said Margulies. “Basically, every grocer in the country that has a presence is trying to plant a flag or multiple flags in the Raleigh-Durham market, and over the next five to seven years, that is going to have an impact on some aspects of real estate valuation because there is not enough growth from a population growth standpoint.”

This has caused investors to have to proceed with caution. Margulies says he started hearing concerns from the investment community about grocery competition in the Raleigh-Durham market last year, and for the entire year, has continued to hear such concern.

“Don’t get me wrong, it’s still a preferred asset class, grocery-anchored retail, but investors are being much more discerning about the locations, the sales volumes of the stores, the sizes of their boxes,” he said. “Every asset is being scrutinized intensely whether it is a private investor, institutional investor.”

An example of this added caution can be seen with the entry of Wegmans into the Triangle market. The New York-based grocer has recently announced its plans for four new stores in the Triangle.

“What I’m hearing is that the other grocery stores who have had flags in the market for a long time, like Harris Teeter and Whole Foods, are certainly looking at them as another formidable competitor coming in, this is something that is on a lot of retailer’s minds and investors too, especially if they have an asset that is near a Wegmans or a grocer that competes with Wegmans,” Margulies said. “It gives them concern about the long-term trajectory of their stores and their locations. But, at the same time, the grocery wars are having an impact even on a company like Wegmans.”

Wegmans, which typically only opens three stores per year, will be opening North Carolina’s first store in 2019. This store, located on Wake Forest Road in Raleigh, will total 100,000 square feet.

Two more are being planned in Cary. However, both stores have been scaled back. The Twin Lakes Center installment faced a delay when the developers decided to decrease the project by 27,000 square feet, a decision it considered to be in line with general grocery store trends.

“The fact that they are already starting, as a new grocer coming to the market, to shrink their component on newer stores tells you that they are also thinking about it as a very competitive airspace,” said Margulies.

Office market trends remain consistent

According to the CBRE third-quarter office market report, the quarter was marked by robust leasing activity and tight vacancy as the market continues to see positive net absorption. Vacancy remains steady at a low 9.8 percent for the Triangle overall market.

Brad Corsmeier, an executive vice president at CBRE, says the office market trends have remained consistent for the past 12 quarters.

“We continue to see positive growth, absorption and tenants are still taking up office space,” he said. “Rents continue to grow, especially in the Class A market. The market remains tight in regards to vacancy. That continues to allow new development to occur.”

The consistency is a good thing for the Triangle market. Having a reliable market is important to investors, said Corsmeier.

“If you are investor and you are coming in for a five-year hold and looking at a cycle and you see consistent numbers, it makes your decision easier to invest. It takes out a lot of potential risk or concern about risk so that’s huge for someone to see the constancy.”

Still, there was definitely notable activity. The third quarter of 2018 was marked by large major leases as the Class A office market continues to tighten, according to the CBRE report.

Some of the notable leases include insurance firm Arch Capital signing a lease for 104,000 square feet at The Dillon in and international law firm McGuire Woods signing a lease for 42,000 square feet at FNB Tower. Both locations are in Downtown Raleigh.

In fact, investment management company JLL considers the third quarter to be record breaking.

In terms of sales, this year had a record-setting pace of sales in according to the JLL third-quarter observations report. This was marked by 7.1 million square foot year to date sold, already exceeding last year’s 6.1 million square feet sold in the Raleigh-Durham market.

Average sale prices for office properties increased to $251.95 per square foot per quarter, a 70 percent increase from last year.

The JLL report contributes the reason for this increase to Trinity Capital’s sale of six Perimeter Park buildings to Ascendas-Singbridge and the sale of the Wells Fargo Capital Center in downtown Raleigh. These sales recorded average sales prices per square foot of $270 and $318, respectively.

In addition, rising asking rents make the Triangle a less affordable pick for office space.

“Raleigh is relatively more affordable compared to New York and Los Angeles, but we are no longer the cheapest market out there,” said Ashley Rogers, a senior research analyst at JLL.

According to the CBRE report, Class A vacancy dropped to 7.91 percent with downtown Raleigh seeing the most activity. Class A rents hit a high and are continuing to climb. Downtown Raleigh has the highest average Class A asking rates, $30.87 per square foot. The new construction asking average, in comparison, is $35.33 per square foot. However, an increase of sales price has affected both Class A and Class B rent.

“We are seeing an increase in asking rents in both Class A and Class B property,” said Rogers. “We are seeing a disappearance of larger tenants, so they are turning to new construction. At the same time, this leads us to a large quantity of new construction as that’s what is getting snatched up so fast, just because there isn’t a ton out there for new users.”

“What this mean for us, looking forward, is that tenants who are looking for space, even as small as a 5,000-foot block, are going to need to give themselves more time. Typically, a client gives 12 months historically, but now since we are more dependent on new construction and that can take longer to deliver, new offices can take 24 months to deliver. You need to search for new space further out.”

Construction is rife. There is currently over 2.6 million square feet under construction, with the majority in Central Durham. About 900,000 square feet is said to deliver in the next quarter.

“When we have such a high number of products deliver, what we see is that depending on how occupied they are or how many leases they have,” said Rogers. “If they are very well leased, 75 percent or above, what we see is a huge jump in positive absorption and vacancy rate remains constant or falls typically. iI these buildings are not pre-leased highly, maybe less than 50 percent, what we see is a negative impact on absorption”

According to Rogers, this what happened when the Dillion delivered in downtown Raleigh, but it has since rebounded.

“This is a market that leases up pretty quickly,” said Rogers.

Recent office construction

In West Raleigh and downtown Raleigh, the vacancy rates are hovering around 8 percent, and in downtown Durham vacancy rates are at 2.4 percent, according to the JLL report.

With such low vacancy rates, builders are finding their projects are leasing well. In fact, some development companies are even building based on speculation. The News & Observer reported on several of these developments.

Raleigh-based Dominion Realty Partners kicked off its latest project, Wade V in Wade Office Park development, making this is the third straight building the company has built on speculation in Raleigh. Dominion focuses on Raleigh, Charlotte and Richmond, Virginia, markets, yet Raleigh is the only market the company applies a speculative building strategy, making this a testament to the high demand for space in the Triangle.

Wade V will be a six-story, 209,000-square-foot building, the biggest of the five buildings in the Raleigh office park, which have all been built by Dominion. Wade III and IV were also both built on speculation and have been successful in terms of leasing — every building there is over 93 percent leased.

Though not on speculation, the company is also currently building FNB Tower in downtown Raleigh right now, a project that is already over 62 percent pre-leased.

In October, Heritage Properties announced that Capital Bank would be relocating its Raleigh operations to seven and eight floors, or 53,553 square feet of total space, of the new One Glenwood tower. The building is over 80 percent leased and still has several months until it opens to tenants.

The company has already submitted plans for another 10-story building adjacent to One Glenwood, which it hopes to open by the third quarter of 2020.

The Dillon, the biggest project of John Kane to date, is almost fully leased. The Dillon, which takes up an entire city block, is a mixed-use development that includes an office tower with retail space as well as apartment buildings.

Following this success, Kane’s company submitted plans for building up to 20 stories on Cabarrus Street. These plans come after six months after it revealed it had over six acres of land under contract in downtown Raleigh.

With more than 2.6 million square feet of office space is now under construction in the Triangle, according to JLL, and the Triangle’s total vacancy rate has risen to 1.4 percentage points, from 12.1 from 10.7 percent. Buildings are being leased quickly, but rising vacancy rates indicate this might not always be the case.

This may be a good thing, however, as the commercial real estate market is extremely tight. Less vacancy equates to more availability, a good thing for buyers who are struggling to find open property that fit their standards.

“When you look at the numbers, the vacancy of 2.8 million square feet sounds like a is a lot of vacancy, but it’s scattered in all these little corners,” said Amanda Hoyle, regional director at Metrostudy’s Raleigh Office. “There is not a lot of vacancy out there, which is the reason we have more construction underway. If a big company were to move here, they don’t have a lot of options of where to go in terms of buildings that already exist. They would likely have to talk to builders.”

Big developments

And a big company moving to the Triangle is a very plausible option. There would lead to an increase of office buildings being built as well as a need for new residential space.

Apple has been a favorite when it comes to speculation of a big company moving in. For much of the past year, the company has been seeking to find a spot for a large new corporate campus, with the Triangle emerging as a leading candidate.

During the summer, there was talk that an announcement naming the Triangle the new site was imminent. There has yet to be any announcement on such facility.

“We heard a lot of chatter, but nothing has come of that,” said Hoyle. “We also haven’t seen them announce that they are going somewhere else. So, if Apple is internally talking about what their expansion entails, it’s something completely their timeline.”

According to Hoyle, if Apple were to come to the Triangle, it would be an absolute game changer for the area as it would create enormous opportunities for both commercial and residential construction to meet the needs of a growing workforce.

“If there are 3,000 or more new jobs, that’s a lot of new housing we are going to need,” she said. “Right now, residential and commercial markets are tight. We don’t have a lot of vacant inventory right now on office side. If they are to come here, it’s going to create a boom in the construction industry—it would be absolutely game-changing.”

This is something that excites builders, especially residential builders, as with more jobs comes more need for housing.

“The builders are all asking all the time if I’ve heard anything new about it because they want the ability to ramp up and start construction quicker to capture those buyers,” said Hoyle. “It would be huge for every real estate aspect if Apple came here.”

Apple is not the only major company to have its eye on the Triangle. While the Raleigh was not ultimately picked for Amazon’s second headquarters location, it was named one of the HQ2 finalists, a decision that generated a significant amount of media buzz. Crystal City in Northern Virginia and Long Island City in Queens were ultimately chosen as the sites.

Still, Amazon is bringing jobs to North Carolina, with as officials announced in August a distribution center will be located in Garner. This is Amazon’s first location in Wake County, and the project is said to bring 1,500 new jobs to the area along with a $45 million payroll. The distribution center will be located on “Project Axis,” a 680,000-square foot building and 2.6 million square feet of development on nearly 88 acres once occupied by a ConAgra plant in which a deadly explosion occurred in 2009.

This will be a great opportunity for the residential real estate market in both Wake County and the neighboring Johnston County as workers in this new center will need to find places to live.

There are also smaller companies that can have a significant impact.

“I’m even bullish about companies like Arch Capital that are bringing 360 people to the downtown Raleigh to the Dillon building,” said Hoyle. “Those are jobs that are going to pay on average over $100,000 each. Well, those are the types of buyers or executives that can afford to buy a home.”

But, while those with well-paying jobs can afford a home, a significant influx of jobs will make homes less affordable for those who earn average or below average wages in the region. Home prices across the Triangle are surging, and that means fewer and fewer people can afford to buy them.

This story is from the North Carolina Business News Wire, a service of the UNC-Chapel Hill School of Media and Journalism