Office space continues to build up as demand teeters

Near the corner of Monticello Avenue and Charlotte Street in downtown Norfolk, construction workers lay reinforcing bar and pour concrete as the 22-story Wachovia Center office building rises floor by floor.

About 12 miles away in Virginia Beach, another new multi story office building will open to tenants next month.

The two are among nine office buildings under construction in Hampton Roads that will add 860,000 square feet to the market, yet only 27 percent of that space is already leased.

A couple of years ago, office space in the region was tight and prime locations were hard to come by. Those days are over.

In the past year, the office vacancy rate in Hampton Roads climbed to 10.7 percent from 10.1 percent, and it is up from 8.4 percent in 2006, according to a report by real estate firm CB Richard Ellis.

Donald Crigger, senior director of office properties for another firm, GVA Advantis, said he expects the rate to rise to 12.5 percent by the end of March.

A rate between 15 and 18 percent is considered to be oversupply. The national office market has a vacancy rate of about 14 percent.

At the same time, office rental rates have almost flattened. During the past year, the average rent for office space in the region climbed just 20 cents to $18.60 per square foot in the third quarter, according to CB Richard Ellis.

"Rental rates are going to start rolling backwards. There's no question," said Craig Cope, a local vice president of commercial developer Liberty Property Trust. "It's going to hit all the submarkets eventually."

Downtown Norfolk, one of the region's largest office submarkets, currently has the lowest vacancy rate at 6.2 percent - about where it's been for the past two years. Wachovia Center will add 250,000 square feet of office space when it is completed in summer 2010. While the project is 70 percent leased, it will create vacancies in other buildings downtown, most notably the World Trade Center, where Wachovia Bank has office space now.

As a result, downtown's vacancy rate may climb above 10 percent - its highest point in a decade.

Part of the problem is the tight credit market and a shaky economy that are preventing businesses locally and outside the region from expanding to absorb new space.

As a result, development firms in the region said they will retrench next year, focusing on leasing already-built space and retaining existing tenants in their buildings.

"Companies aren't actively looking for space like they were," Cope said. "A lot of companies are going to stay put. We haven't seen those sort of conditions for four years."

Perry Frazer, senior vice president at CB Richard Ellis, said more companies have been renewing their leases as opposed to expanding or moving into higher-end space.

"Businesses are in the same boat as the landlords," he said. "They don't want to spend money on moving."

Liberty, which recently completed a 73,500-square-foot office building in Chesapeake's Independence Place office park, has 130,000 square feet of available space in its 21 office buildings in the region. Cope said the firm isn't planning any more for now.

"I don't think anybody is going to start any new projects without significant pre-leasing or unless it's for a specific user," Cope said.

Lou Haddad, president and chief executive officer of Armada Hoffler, the developer behind the Town Center of Virginia Beach, agreed.

"Whenever there's a good amount of pessimism in the country, it manifests itself in leasing space as well," Haddad said. "No one wants to feel very adventurous in a time like this."

Despite that, Armada Hoffler has proposed a $214.8 million fourth phase at Town Center, which includes a 22-story tower for Gateway Financial Holdings Inc. Gateway recently agreed to merge with Hampton Roads Bankshares Inc. Armada Hoffler wants to start on the project in the middle of next year with a completion date well into 2011.

"Obviously we're hoping there will be better economic signs before we start," Haddad said.

The economic slowdown is making it harder for leasing agents to lure tenants into newly constructed office buildings, such as the 100,000-square-foot Two Columbus Center at Town Center.

Vivian Turok, senior vice president of office leasing for Divaris Real Estate, which handles the leasing for Town Center, said just 18,000 square feet has been leased at Two Columbus Center so far.

"There's going to be a lot of subleases on the market because people are trying to consolidate or find smaller space," Turok said.

Economic development officials in the area said now is the time to pitch Hampton Roads to companies located in more expensive office markets.

Warren Harris, Virginia Beach's economic development director, said the available space allows his agency to continue pursuing companies throughout the Northeast.

"We're still marketing the cost benefits of being here," he said. "Although that pool has gotten smaller, there are companies who are wanting to expand."

The same is true for downtown Norfolk.

"For the first time in recent history, Norfolk will have full-floor opportunities in several downtown buildings to offer to corporate decision-makers, whether local to Hampton Roads, or from outside our region," said Chuck Rigney, an assistant director in Norfolk's development department.

Falling rental rates could entice some smaller businesses to seek higher-quality space in newly vacant office buildings, said Deborah Stearns, managing director of real estate brokerage and leasing firm GVA Advantis.

"There are older buildings in the market that are challenged to provide enough cable space for companies to really take advantage of technology to help run their business," she said.

Recent acquisitions by Harbor Group International seem to suggest the Norfolk company expects the office market will remain strong in the coming years. In September, the firm purchased the World Trade Center in downtown Norfolk for $54 million, and in July, Harbor acquired the 11-story Town Point Center office building for $12.75 million.

Josh Brown, (757) 446-2318, josh.brown@pilotonline.com