The Baltimore Metropolitan Area Class B Office, Light Industrial & Retail Markets
by Jessie Newburn www.jessienewburn.com May 2006
Introduction The following document provides interested parties with an overview perspective of the Baltimore Metropolitan Area real estate market and several demographic and economic trends that appear to be influencing it. The document is provided as a “white paper” and “thought piece,” and readers are encouraged to seek other sources of data and information in order to draw their own conclusions.
Forward-looking Statements This document includes “forward-looking statements” that are the sole opinion of the writer and not that of MCB or any of its employees, directors, officers, agents or affiliates. All statements other than statements of historical fact included or incorporated by reference herein, for example, regarding the prospects for the real estate industry and market may constitute forward-looking statements. Forward-looking statements may include words such as “believe,” “anticipate,” “expect,” “plan,” “will,” “may,” “could,” “estimate,” “intend” or words of similar meaning, and may address future events and conditions concerning the real estate industry and markets. Readers are encouraged not to rely solely on this data and to seek additional information if they so choose.
Why the Baltimore Metropolitan Market … and Why Now
In the Baltimore Metropolitan market, there are a number of factors that may have a positive impact on the Class B office, retail and light industrial markets. They are – 1. The intentional and dynamic strategic planning and investment by local business, government and nonprofit organizations in developing downtown Baltimore as a vibrant, desirable place to work and live; and the possible transformation of Baltimore into a 24-hour city. 2. The shift in demographics with more Thirteeners (often called Gen Xers) and “empty nest” Baby Boomers moving into the city, creating greater demand for retail, services and office space and an influx of potential entrepreneurs and new business growth. 3. The conversion of “once undesirable” Class B and Class C buildings into high-end, amenity-rich residential apartments and condominiums, creating a new, lucrative opportunity for Class B properties while concurrently shrinking inventory of such properties. 4. The existence of a thriving “aeropolitan” economy surrounding the BaltimoreWashington International Airport, Baltimore’s status as a port city, and a robust regional infrastructure of interstate highways and major roads, rail and other transportation services, providing yet another reason why local, national and international corporations benefit from moving their business interests here. 5. The high-population growth of the region, including Baltimore, Washington, D.C., Suburban Maryland, and Northern Virginia, and the specific and combined strengths of the office markets in each region. 6. The remarkably high ranking in terms of demographic concentrations, household income and other positive economic indicators that Baltimore displays when viewed as a “Major Metropolitan Market,” rather than just as a “city.”
The Intentional, Intelligent Re-Design of a City
How Baltimore is Transforming from a “Has Been” to a “Hot Scene” and the Potential Impact on Class B Office, Retail and Light Industrial Investments It was not too long ago that Baltimore City was a compilation of sad statistics. Its “spirit” and vitality (and tax base of residents and businesses) was ebbing … fleeing … to the suburbs. This trajectory could have continued unabated until Baltimore became a “has-been” city with a high inventory of vacant buildings. In the late ‘90s, the devastating loss of the Alex. Brown headquarters, the city’s oldest and most prestigious financial house spurred the Downtown Partnership to explore a novel enterprise: the “emerging industry” of attracting new residents. The Downtown Partnership then formed the Downtown Housing Council and commissioned a feasibility study to examine the reclamation of empty office buildings (Class B and C) for market-rate housing. “In a city known for its horizontal row houses and mid-rise buildings, the idea of vertical high-rise living in a struggling downtown with little job growth seemed more than risky: it seemed almost laughable. The feasibility study concluded that such development would need major city subsidies and suggested that, even with incentives, downtown could only hope for low-income rentals” (The Next American City, 2004). However, Baltimore – an almost forgotten city next to its rich and famous neighbor, Washington, D.C., and a city once largely ignored by its intensely affluent suburban neighbors – demonstrated its core values of pride, community and determination. The first office buildings converted to residential units leased in one-third of the expected time and at rents fifteen percent higher than projected. Baltimore continues to run a sharp and polished campaign to lure young urban professionals living in D.C. and nearby suburban Maryland. The “Live Baltimore” campaigns are hip, directly aimed at DC’s jugular (astronomical housing prices) and the plain truth of the suburbs (they offer few social amenities and are quite often boring for younger professionals). Just this year, Baltimore launched a regional campaign to brand and reposition the city, including radio, TV, print and web advertising mostly aimed at the leisure travel market in Washington, D.C. and Philadelphia. “Get in on it” is the theme, and it addresses what most residents and visitors already know about Baltimore: it’s one of the best kept secrets around.
The Baltimore Area Convention and Visitors Center, the engine behind this project, hired consulting firms involved in branding FedEx, BP and the cities of Madrid and Hong Kong to develop this first-class campaign designed to bring both more tourists and more residents (and, logically, businesses) to Baltimore.
These campaigns have paid off in numerous ways.
Downtown Baltimore, Now
Data and Perspective Over 40% of Downtown Baltimore’s employees live in Baltimore City, earning $1.9 billion annually which they take back to their neighborhoods, providing an increase in money flow and demand for local goods and services, retail development and office space. A larger tax base, particularly from residents without school-age children, allows greater municipal investment in infrastructure, public transportation (both inner- and intra-city), and streetscaping – all of which are clearly identified goals of the city’s leadership. These large-scale improvements and amenities have the potential to attract more businesses to locate in Baltimore, creating more upward pressure on rents and demand for office space. Downtown Baltimore is home to more than 2,500 businesses that provide approximately 88,600 jobs. The five largest employment sectors in Baltimore are – 1. City, State and Federal governments, 2. Healthcare and medical research, 3. Finance, insurance and real estate, 4. Professional services (legal, accounting, advertising, architecture, etc.), and 5. Education.
All five of the largest employment sectors are essentially white-collar professional industries with high salaries for employees and less environmental impact on the community. By the close of 2005, over 10,000 people were calling Downtown Baltimore home: an increase of over 50% since 1999. Sixty-five percent of these new residents located from outside of Baltimore City. “Empty nest” Baby Boomers and Thirteeners (those born between 1961 and 1981 and, by far, the largest influx of new residents) are able to rent or purchase luxury housing at rates impossible to find in Washington, D.C., and they are bringing their desire for a social, 24hour, city scene to Baltimore’s businesses. With everything from New York-style loft apartments in converted old Class B buildings to brand-new, luxurious, high-rise condos with waterfront views to architecturally rich brownstones to elegantly rehabbed apartments with all the modern amenities a 30-something could want, the housing stock in Downtown Baltimore is attracting people (and their dollars) who are tired of suburbia. The average income per new resident is nearly twice that of the salaries of longer term residents. Though some of the new residential units are from new-construction projects, many of the new housing units are conversion projects, transforming once-undesirable and difficult-torent Class B and Class C office space (18 buildings as of 2004) into high-end, amenity-rich apartments and condos. Residential conversion projects can provide two positive impacts on Class B Office and Light Industrial investments: they concurrently – 1. bring more high income residents (and most likely a more educated and professional population base) who typically work in office environments, and 2. diminish the existing stock of Class B space, increasing pressure on rents and the value of existing buildings. Nationally, Central Business Districts (CBDs) located in 24-hour cities are projected to outperform other markets (rather logically) in the coming years. Baltimore is ranked as one of the strongest CBDs. The upward surge of Downtown’s population and its residents’ desire for social activities and a vibrant street life supports Baltimore’s transformation into a “24hour city.”
Several large, high-profile corporate tenants renewed their leases (and are expanding their presence) in Downtown Baltimore, citing, among other reasons, the preference of many employees for a downtown office location with the social and cultural amenities the City offers. Particularly noted was that their best and brightest talent recruits coming out of college prefer downtown living. One example of such a decision is T. Rowe Price, which recommitted to a long-term lease at 100 E. Pratt Street, keeping more than 1,100 jobs Downtown.
Approximately $2.8 billion in public and private investment is in the pipeline to develop Downtown Baltimore, representing 110 projects in various stages of completion. An additional $2.6 billion is being invested in the neighborhoods surrounding the core of Downtown, for a total investment of $5.4 billion to Downtown Baltimore and its adjacent neighborhoods.
The Baltimore Metropolitan Market currently offers the single largest concentration of professional and business opportunities in the region, and economic and residential development is on the rise. Many national retailers and entertainment establishments, long-absent from Baltimore, are now moving into the city. Included in the list of new national chain stores are Staples, Best Buy, Barnes & Noble and Hard Rock Café, to name a few. In addition, planning is underway for the “Superblock,” a five-block section of the Westside, which will significantly increase the housing, retail, mixed-use and parking in that area. Overall, through 2008, the Downtown core will see the development of approximately -!"2 million square feet of institutional space, !"1,500 hotel rooms (including a Ritz Carlton and a Four Seasons Hotel), !"1 million square feet of office space, !"700,000 square feet of retail space and !"5,000 housing units. There will also be substantial gains in the number of parking spaces and investment in Downtown’s public spaces and infrastructure.
Baltimore is being noticed – and noted – nationally. The Brookings Institute recently released a report called Who Lives Downtown, providing a look at the health of 44 cities across the country. Based on a number of factors such as population growth and household demographics, it ranked Baltimore’s Downtown just below top-tier cities like New York and Boston, and one step above Washington, D.C. The report also stated that Baltimore was “on the brink of becoming a full-fledged urban powerhouse.” Kiplinger’s Personal Finance, a national publication, recently heralded Downtown Baltimore as a “great place to retire,” particularly for its proximity to cultural attractions and the waterfront. The numerous world-class attractions in Baltimore – including the National Aquarium, Camden Yards, the new Reginald F. Lewis Museum of African-American History and Culture, and the American Visionary Arts Museum (ranked one of the best museums in the U.S. by a national travel magazine) – have catapulted Baltimore to “one of the top ten upand-coming travel destinations in the world,” in 2005, according to Frommer’s Travel Guides, a publisher of international travel guides. Additionally, Baltimore is home to two sports teams: the Orioles and the Ravens, and has two new state-of-the-art sports arenas: Oriole Park at Camden Yards and M&T Ravens Stadium.
Office Markets in the Region
The Baltimore-Washington Corridor: It Just Keeps Growing A new term has been circulating among urban planners. So new that even a Google search will barely produce any hits. The term is “Aeropolitan,” and it refers to the “city” that develops around an airport. The Baltimore-Washington Airport, recently renamed the Baltimore-Washington International Thurgood Marshall Airport (BWI), is a stellar example of this niche economic explosion. What was once a small regional airport sprinkled with limited industrial and warehouse space nearby has expanded into one of the fastest-growing airports in the U.S., replete with a thriving economic community, thus strengthening the economic corridor connecting Baltimore and Washington, D.C. In addition to its observable growth, BWI was awarded by the Airports Council International numerous first place awards in recent years for its international marketing campaigns. While the local economy is growing around the airport, business leaders throughout the world are hearing more and more about the benefits of traveling through BWI and about locating their business interests near BWI. High caliber air travel, good ingress and egress, and a solid structure of logistics lure local, national and international businesses to locate nearby. The implications, of course, are greater demand for office space, particularly Class B office, flex space and light industrial space. The City of Baltimore is served by Amtrak, the MARC trains, Light Rail and Greyhound. It is easily accessible by I-95, 295, 695, I-70 and I-81. There is another term coming into use among urban planners and commercial real estate investors: “Edgeless Cities.” When two large cities are located in relative proximity to one another and share many of the same logistical advantages between them, an “edgeless” quality develops between the two, and the recognizable geographic boundaries become less clear. Another quality of “edgeless cities” is the volume of office and light industrial space found in suburban areas. The demographic base of mostly high-income, highly educated, white-collar professionals and the amenity-rich nature of the area continue to attract more residents and more office-space-using businesses.
In looking at the expanding edgeless city between Washington, D.C., and Baltimore – combined with the rapid “aeropolitization” of the BWI Airport, it is easy to see an office market with all the ingredients for continued economic expansion, rent increases for cashflow investments and accelerated demand for value-add Class B office investments. Suburban Maryland: Solid, Steady and Stable “The Maryland market has become a destination for investors seeking stability,” according to the Marcus & Millichap 2005 Annual Report. Particularly with the “life sciences rich Maryland submarkets” and the “expanding military contractors that are gradually filling space left behind from defunct technology firms,” the Maryland market is, simply put, stable. No troughs. No meteoric rise. Just stable. And in the same report was stated, “Office-using sectors are forecast to expand at a stronger pace than overall employment, particularly in high growth markets,” such as Maryland and its expanding suburbs and exurbs. And Some More Data from Regional Commercial Real Estate Reports “Due to the stable nature of its tenant base, Suburban Maryland’s long-term prospects appear strong; values and rents should rise steadily along with job growth.” “By 2007, rents should be rising at or above the long-term average of 5% per annum.” “Values have risen 5% per annum since 2001 in Suburban Maryland, due to the stable nature of its office market.” Washington, D.C. : The Treasured Market of the Nation To knowledgeable investors, it’s probably not news to hear that the Association of Foreign Investors (AFIRE) has named Washington, D.C., as “the best urban real estate market in the world,” besting even London and Tokyo. Nor would it be surprising to read the Wall Street Journal tout Washington, D.C., as “leading all markets with a vacancy rate of 7.2%” (January 6, 2006). Or to learn that the D.C. office space sale price at $405 per-sq-ft. is the highest in the nation, even higher than Manhattan, which comes in second at $398. Washington, D.C.’s vigorous economy and its fundamentally sound office market make it a top choice for investors from all over the world. “Total returns for office properties in the Washington, D.C., market were 14 percent during a recent 12-month period, higher than
any other domestic market,” according to a 2005 OfficeResearch Report from Marcus Millichap. Given the relatively stable market created by the Federal government’s extensive presence and by the attraction of foreign investors and strong returns, the D.C. office market provides a healthy pulse for the entire region. As well, strong competition has prompted many developers to undertake revitalization projects in the outlying areas.
Class B – Office & Light Industrial
A Hands-on Approach “Properties with current or potential vacancy issues are becoming increasingly attractive to investors with turnaround or conversion strategies. The office sector offers higher yields over other investment real estate property types, with the average cap rate 100 to 150 basis points more than cap rates for core retail and apartment properties. For investors willing to take a more hands-on approach, returns can be even more rewarding, especially as we enter into another economic growth cycle.” This comes from Marcus & Millichap’s recent annual report. A bargain is only a bargain if more money comes out of the deal at the end of the day. Using either a value-add approach or an intelligent, niche-industry, hands-on approach can produce the greatest cash flow from currently undervalued properties. In addition, having numerous industry and regional relationships to yield proprietary deal flow; knowing how to recognize “under the radar” opportunities and having the expertise to thoroughly analyze a deal are other key factors in successful real estate investments. Perspectives from the Industry: How Many Regional Firms View the Market “Capital flows to the office sector are forecast to rise this year as investors begin to take profits out of other core property types in favor of the higher cap rates available in the office sector. In addition, the weak dollar will continue to encourage foreign investment.” “The rebuilding efforts following hurricanes Katrina and Rita, in addition to a high demand from new home construction and overseas demand for raw materials will lead to significant increases in material costs and shortages. New construction will be hindered, and a greater demand will be placed on the Class B inventory, thus increasing real rents and property values.” “Office employment continues to expand at a faster rate than overall nonfarm employment. In 2005, we expect close to 700,000 new office-using jobs, a gain of 2.5 percent. A slightly greater rate of growth is anticipated in 2006.”
“Equities … remain somewhat uncertain in their direction, and in some cases are providing a negative return to investors. Even with a healthy stock market, the abundance of capital coming into the real estate market will support prices. Rising demand from institutions, foreign investors, REITs and private investors, a group that will expand as the Baby Boomers close in on retirement, will all lend support to the market.” “We expect capital flows to the office sector to rise. Investors perceive that the market has passed its cyclical bottom, and the economic recovery will pay dividends in terms of occupancy and rent growth starting in 2006.” “There is a growing trend toward portfolio diversification with more and more investors turning toward the office sector. “Capital flows to the office sector will rise as investors dispose of other core property types to take advantage of higher yields.”
Underserved Baltimore Metropolitan Retail Sectors
A Retail Assessment Summary for Baltimore City The Baltimore Development Corporation, Downtown Partnership of Baltimore, Inc., Baltimore City Department of Planning, and the Charles Street Development Corporation recently formed a Strategy Team to develop a comprehensive retail strategy and marketing program for the City of Baltimore, focusing primarily on downtown and certain neighborhood retail districts. The selected information that follows in this section is directly from the 2005 Retail Assessment Reports produced by the Strategy Team. Much of the information is demographic in nature and supports the position that the Baltimore Metropolitan market is quietly positioning itself to become even a stronger economic force than most investors are noting. While retailers consider a wide variety of factors in making location decisions, actual decisions are driven primarily by demographics: population, employment and income. If the demographic data and trends in a location do not meet predetermined requirements, a retailer is not as likely to move their business to that location. What Top Cities Have in Common 1. Large metro area populations, 2. High center city population densities, 3. High center city daytime employment, 4. High center city average incomes, 5. At least one large mall or shopping district (400,000 to 1.5 million square feet) in the center city, 6. Good public transportation, and 7. Good public safety either real or perceived The problem in comparing cities’ demographics and economic indicators is that cities are political jurisdictions that are very different in size (land area), and the information obtained does not provide for apples-to-apples comparisons. For example, Phoenix has a city population of 1.39 million, and Baltimore City has a population of 643,000. So it is commonly assumed that Phoenix (6th largest U.S. city) is over twice as big as Baltimore City (18th largest). However, Phoenix City has a land area of about 475 square miles, whereas
Baltimore City has only 81 square miles. Baltimore City actually has a population density three times greater than Phoenix. (Even downtowns are difficult to compare.) Therefore, instead of using the top 25 cities for comparison, the Strategy Team decided to start by identifying the 25 largest metro areas, which represent true markets. Using this data, Baltimore actually ranks 8th among the top 25 U.S. metros for population within a 1-mile radius of the city center, while Phoenix ranks 17th. The Baltimore City Market and Retail Potential Baltimore arguably has one of the nation’s top center cities. The mix of residents, employers, tourists and amenities in the core of the city supports Baltimore’s emergence as a top tier downtown. Among the top 25 U.S. metro areas, Baltimore ranks -• • • • 8th for number of households earning $75,000+, 10th for number of retail establishments, 16th for total employment with 102,812 employed in the center city, and 10th for per capita income with $35,556.
While the presence of high-end national chains is somewhat limited in Baltimore’s city center, the City does have a large number of small, street-level, local retailers. Baltimore has a number of reasons to be optimistic about its position to attract and support a strong retail base. The City: 1. is arguably one of the nation’s top downtowns given its dense clustering of residents, businesses, visitors, institutions, sports facilities and events, 2. meets many factors that are driving national retail chain locations in top tier cities, 3. has a high population density, 4. has a large number of high income earners in the city center, 5. is realizing a booming demand for high-end residential units, 6. has a high hotel occupancy rate with many new hotels in the pipeline, and 7. has the authenticity (architecture, culture, distinct neighborhoods, diverse populations) that is driving urban renewal in many major markets. As a Central Business District, Baltimore has – • • • • 200,000 employees 700,000 conventioneers and growing 15,000,000 tourists annually an increasing number of household incomes of $60,000+
In Baltimore’s case, while population in certain neighborhoods has declined, the number of households in those areas actually increased. Incomes are also rising in many city neighborhoods. In neighborhoods in and around downtown and the Inner Harbor, homes that previously housed lower-income families of five, are now middle- to upper-class households of one or two people. The City is also realizing significant infill development. So, population may decline, but number of households, median household incomes, property values, and tax revenues in many neighborhoods are going up. Currently, Baltimore lags in terms of high-end national retail. However, based on demographics, Baltimore’s center city is poised to attract high-end retail and take its place among the top U.S. center cities.
Why Baltimore; Why Now
As more Class B office buildings in Baltimore are converted into residential units, logically, fewer of the older Class B office buildings will be available for rent by local businesses, or for purchase by investors. This market change has the potential to create an upward pressure on demand for office space, real office rents and the value of office buildings in the local market. Add to this condition, the intentional demographic change by Baltimore’s municipal, business and nonprofit leaders of luring affluent, educated young professionals into Baltimore – many of whom freelance or own small businesses. And not just any kind of business. High-tech jobs. Professional services businesses. New-economy corporations with low environmental impact and high cash inflows. Add to this demographic change, professionally experienced, often wealthy, “empty nest” Baby Boomers choosing city life in Baltimore over the ‘burbs and you have an even greater dynamic of combined demand for residential, retail and office space. Add to these factors the internationally acclaimed, fervently sought market in Washington, D.C.; the forecasted stability of the surrounding markets in Northern Virginia and suburban Maryland, the “aeropolitization” of the BWI Airport and the economic expansion in the corridor between Baltimore and Washington, D.C.; the accessibility and transportation infrastructure in and around the City, and the intense affluence and high desirability of the region in and around Baltimore and Washington – for office, retail and residential space; the “edgeless city” phenomenon affecting the entire region; and Baltimore’s strength as a Central Business District and its rapid transformation into a vibrant 24-hour city and you have, I believe, the ingredients for a very strong market.
Sources www.areyouinonit.com WB&A Market Research The Wall Street Journal Kiplinger’s Personal Finance The Brookings Institute “Who Lives Downtown” report Marcus & Millichap National Office Report, 2005 Downtown Partnership’s Down Development Report, 2004-2005 Downtown Partnership’s 2004 State of Downtown Baltimore Report “The Race for Residents: D.C. and Baltimore Go Head To Head” by Elizabeth A. Evitts, The Next American City, February 2004. Real Capital Analytics 2005 Annual Trends Report Baltimore Development Corporation’s 2005 Retail Assessment Summary