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Honolulu - Manhattan of the Pacific

Details: Created on Monday, 23 January 2012 11:18

HONOLULU—MANHATTAN OF THE PACIFIC

Island economy, limited space pose a challenge to investors

By Matthew Bittick (PB) CCIM SIOR

November 2011

Some think of Honolulu as paradise in the Pacific. But for real estate investors, it’s more like Manhattan on a compact scale. Honolulu is a classic island economy, with inefficiencies that savvy investors have exploited for decades.

Honolulu is currently experiencing an increase in its vacancy rate, due chiefly to a few large tenants “rightsizing” and larger owner-users putting new space on the market after relocating employees to more efficiently designed space in other owned properties.

Today’s environment is generally viewed as a tenant’s market for the smaller user. But for larger users (over 10,000 square feet) options are limited. The largest block available currently is a 45,000 square-foot space in Kapolei at the Hale O Kapolei. The second largest is 25,600 at downtown’s First Hawaiian Center. Needless to say, larger tenants are at a distinct disadvantage having to negotiate at a time when there are virtually no viable relocation options.

Rent for space, particularly in Honolulu’s central business district, becomes inelastic as vacancy drops below 11 percent. At the end of September 2011, the vacancy rate was 13.77 percent. As a result, weighted average monthly base rents for Class A and B office buildings have swooned to $1.59 to $1.77 per square foot per month.

Premium effective rents are expected to materialize as the market continues to tighten. The return of a landlord’s market is anticipated over the next 24 months. Many landlords, anticipating rents for larger tenants to significantly increase, have shifted their leasing position from short-term tactical goals to long-term strategic goals.

Overall, Honolulu is a long-term growth market with a high barrier to entry for development of new office buildings. The city has a reputation for offering a high quality-of-life and a history of long-term job formation. But it is also one of the most supply-constrained markets in the world. The most recent new office building in downtown Honolulu was completed in 1996, and there is no plan for additional development anytime soon. Based on current Class A market conditions, rates would need to increase by more than 10 percent compounded annually for the next 11 years before market rents would justify new construction—conservatively estimated today at $550 per square foot. Think Manhattan and San Francisco prices.

Six major islands constitute the state of Hawaii, but most of the activity is on Oahu in Honolulu, which is home to 70 percent of the state’s population. While the office market there is slow today, it is poised for a rapid recovery. With no new buildings planned, high barriers to entry, and considerable distance between the islands and the West Coast and countries of the Pacific Rim, the Honolulu market is unlike any other. During the last recovery, triple net rents peaked at $1.75 per square foot, nearly an 80 percent increase from their preceding economic low. Honolulu is set for a similar increase, but this time starting from a more elevated low.

Matthew Bittick is president and senior managing director of Bishop Street Commercial, a commercial real estate firm in Honolulu, Hawaii. Visit www.bishopsc.com.