Here’s What It Will Take to Build New Office Towers in Downtown Sacramento

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By: Ben van der Meer, Staff Writer, Sacramento Business Journal
Greg LeviGreg Levi, Managing Director, JLL Sacramento

Office-tower rents are creeping up. Occupancy is rising. Companies are coming back downtown after decades in the suburbs. So when will we see cranes again over downtown Sacramento?

The answer is sobering: not soon. For all the good economic news, the next new high-rise is likely years away.

Many factors are at play, say brokers at several Sacramento commercial real estate firms. These include office-design trends, Sacramento’s status as a second-tier market, and the continuing allure of lower rents and free parking in the suburbs.

But make no mistake, said Dan Chamberlain, a broker with Newmark Cornish & Carey who specializes in downtown office leasing. The needle is pointing the right way.

“Overall, what we’re seeing is extremely exciting,” said Chamberlain. But compared to the last boom, he said, “the downtown market is a different market.”

Tenant needs are diverse

Downtown is the only place to be for certain companies and organizations. Lobbying firms, nonprofits, associations and government agencies want to be downtown because of the Capitol, for example. That benefits buildings such as Meridian Plaza and the recently sold Senator Hotel, both facing Capitol Park.

Other companies look for prestige buildings to signal their standing in the business community.

That boosts prospects for the two newest high-rises, the U.S. Bank Tower at 621 Capitol Mall and the Bank of the West Tower at 500 Capitol Mall.

Overall, office vacancy rates in Sacramento’s central business district have dropped four points from over 19 percent in 2013, according to brokerage JLL.

Rates vary widely among the downtown office towers that the firm tracks. The Senator, a historic building that recently traded hands, has among the highest vacancy rates even though it’s among the closest to the Capitol. New owners have said they plan to extensively upgrade both office space and first-floor retail to improve the overall appeal.

Similarly, Plaza Five Fifty Five — another building with a higher vacancy rate — also has new owners. They also have announced plans to get aggressive with space upgrades and new tenants.

Age isn’t always a predictor. The newest high-rise, Bank of the West Tower, is more than 20 percent vacant. Because it opened in 2009 in the middle of a severe recession, many of its spaces are still awaiting their first tenant, some brokers said.

Not all want high-rises

But some companies may not find what they want downtown. For example, Sacramento is seeing a modest influx of design and engineering firms hoping to be part of the expected boom in downtown development, most notably around the Golden 1 Center and in the railyard.

One problem: Those firms are not big fans of high-rise office space.

Hammel, Green & Abraham, an architectural design and engineering firm, saw high-rise space as lacking the visibility the firm wanted for a relocation from Roseville, said office director Brent Forslin.

“In downtown, we would probably be over multiple floors,” he said. “As a design firm, the desirability for that is less.”

Instead, the firm found a converted warehouse on R Street, where it will occupy 12,000 square feet in October. Forslin described the space as funky and unique — attributes not often ascribed to gleaming office towers.

Firms like Forslin’s are willing to pay. Chris Strain, who specializes in tenant representation for Cushman & Wakefield, said the best “creative space” downtown commands a per-square-foot monthly rent that is comparable to the best office tower space, about $4. Given the relative scarcity of those creative spaces, he said, it’s actually more affordable to look at a high-rise.

Offices are changing

Another trend in office design is dampening demand for office-tower space: smaller offices. Many brokers said office tenants these days are looking for efficient, “smart office” space that encourages collaboration and plug-and-play workstations. They don’t need acres of cubicles.

Thanks to technology, they don’t need long banks of filing cabinets. And the popularity of more egalitarian workplaces means fewer offices, often away from windows.

As Chamberlain put it: “We don’t see the J.R. Ewing office any more.” The fashion today is to put rank-and-file workers near windows and natural light. While that means significant tenant improvements, it also means a smaller footprint, even if the firm is growing.

High-rises don’t pencil

All those factors that blunt the demand for office-tower space undercut the argument for new high-rises. In short: Demand is not strong enough to raise rents to the level that justify a new tower .

Tony Whittaker of CBRE Sacramento said current vacancy downtown is 14.8 percent. By comparison, when 621 Capitol Mall broke ground in 2006, vacancy was 11.5 percent, he said.

A similar gap exists in rents. Whittaker said the best spaces can be found for $3.20 monthly a square foot, but an entire building would need to rent for $3.50 before new construction makes sense.

On top of construction costs, he and other brokers said getting financing would be all but impossible unless the new building is nearly a third pre-leased. And those pre-lease tenants better be a bank or some other stable institution that would sign a long-term lease;; a law firm won’t do it in the eyes of a lender, Strain said.

“There are a lot of impediments” to office-tower construction, he said.

What about Vanir Tower?

Despite all the pessimism, one developer has boldly announced plans for a downtown high-rise. Vanir Tower would be a 26-story office building at 601 J St. that would include the headquarters of the company that proposed it: Vanir Group of Cos.

Vanir officials have said the building also would be occupied by an unnamed bank, which would seem to put the building in good standing for preleasing. Company officials submitted for entitlements at the end of last year and suggested 2018 as an opening date. But they’ve also said they’re willing to wait until the project makes market sense.

JLL, which publishes a regularly “skyline” review of downtown high-rise trends, has the listing for Vanir Tower. Greg Levi, a managing director at JLL, said planning for the tower now makes sense, in a counterintuitive way. After all, both 621 and 500 Capitol Mall got proposed and built as the market fell drastically, meaning they opened with few prospects for tenants.

“It’s almost like you need to start planning when you think you would never build it,” he said. Before those Capitol Mall buildings, Esquire Tower at 1215 K St. got proposed during the slow mid-1990s and opened during a strong economy in 1999, he pointed out.

Levi said while absorption and vacancy still have a considerable way to go before Vanir Tower makes more sense, he echoes other brokers about the market. He notes engineering firm AECOM is looking for 100,000 square feet. State agencies such as the Office of State Hospital Planning and Development are looking for up to 250,000 square feet of space. Whittaker said he’s tracking 70,000 square feet of pending new absorption.

The belief is that a new player in Sacramento’s high-rise market is in the near future. What no one is ready to say, though, is how near that future is.

“It’s not a party time yet,” Chamberlain said. “It’s coming. But we’re not there yet.”

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