Strength of class A office market depends on point of view

The class A office market in the Milwaukee area has shown gradual improvement recently and the downtown east area is arguably the region’s strongest class A office submarket.

But just how strong is the downtown east class A office market? Could it support a new class A multi-tenant office building? Is there demand for a new class A office building in the suburbs?

Commercial real estate industry insiders have different answers to those questions and some view the market through a different statistical lens.

Click here to see the Downtown East submarket class A office buildings infobox

The downtown east class A office market had a 9.5 percent vacancy rate in the third quarter, according to commercial real estate data firm Xceligent. But Milwaukee-based commercial real estate brokerage NAI MLG Commercial pegs the downtown east class A office market vacancy rate at 3.3 percent.

The reason for the wide difference is that NAI MLG Commercial now only considers five office buildings to be in the downtown east class A submarket. Xceligent counts 10 buildings in that submarket.

“In this new report we adopted a revised standard for the definition of Class A office space. Buildings must be of institutional investment quality, with lease rates and locations that support that designation,” said NAI MLG Commercial principal Jack Jacobson, who wrote the firm’s third quarter metro Milwaukee office market report. “Part of what we want to do is stimulate the discussion and push owners to reach for Class A. I think that is what tenants want.”

The five downtown east buildings that NAI MLG considers class A are essentially the market’s top performers: the 1.1-million-square-foot U.S. Bank Center (2 percent vacancy), the 422,865-square-foot 100 East building (10.1 percent vacancy), the 370,000-square-foot Milwaukee Center (7.3 percent vacancy), the 225,000-square-foot 875 East building (0 percent vacancy) and the 220,000-square-foot Cathedral Place building (0 percent vacancy).

The Xceligent data includes the two poorest performing class A office buildings in the downtown east submarket: the 654,165-square-foot 411 East Wisconsin Center (22.2 percent vacancy) and the 283,450-square-foot 1000 North Water building (17.1 percent vacancy).

NAI MLG Commercial no longer counts the 411 East Wisconsin Center building as part of the class A office market because of its tenants in common (TIC) ownership structure, said Jacobson. The building is owned by dozens of investors and it can be very difficult to negotiate a deal that meets all of their approval, he said.

“It’s a question a broker has to ask: why would I take a tenant there to look at the building,” Jacobson said. “It shows great. But, you can’t do a deal.”

But not everyone sees the 411 building that way.

“It’s still by all standards a class A building,” said Dan Jessup, executive vice president of Jones Lang LaSalle. “I respectfully disagree with (NAI MLG Commercial) removing 411 from their class A statistics.”

“A building’s class doesn’t have anything to do with the ability to make a deal,” said Andrew Jensen, principal of The Boerke Company. “I think the 411 building will always be class A.”

The performance of the 411 East Wisconsin Center could be improved if it is sold to a different owner that is not hamstrung by the cumbersome TIC structure. Commercial real estate sources say a potential buyer for the building is conducting due diligence and a deal to sell the building could be completed soon. The TIC structure could make it difficult to complete a sale, but commercial real estate sources say that all of the owners of the building are supporting plans to sell the building under the pending deal.

Commercial real estate sources also say that the 411 building’s largest tenant, Quarles & Brady, which occupies about 185,000 square feet of space in the building, plans to renew its lease there once the sale of the building is complete.

As for the 1000 North Water building, which is owned by Anthony Palermo, NAI MLG Commercial does not consider that building in the downtown east class A office market because it is located too far north from the hub of the central business district, Jacobson said.

“It’s not really a class A location yet,” he said. “I think it will be (in the future).”

Why does it matter which downtown east buildings are considered class A, and which are not? It matters to developers, lenders and city officials trying to determine if the downtown office market has enough demand to support development and financing for a new office building.

With its tighter view of the downtown class A office market, NAI MLG Commercial believes there is a need for a new class A office building in the downtown east submarket, Jacobson said.

“For several years we have heard about the pressure to build a new downtown office tower. No question the time has come to build one,” he wrote in the firm’s quarterly office market report. “A tenant looking for 20,000 square feet of contiguous (class A office space downtown) may not have any choices in existing buildings.”

If a new class A multi-tennant office building is built in the downtown east area, it appears the most likely project is the 17-story, 358,000-square-foot building planned by Irgens at 833 E. Michigan St. The building would be anchored by the Godfrey & Kahn law firm.

“I believe there’s clearly a need for it and I believe Irgens will make it happen,” Jessup said.

But some commercial real estate brokers are skeptical that a multi-tenant class A office building will be built anytime soon downtown. “I think it’s going to stay on the drawing board for a while,” said one, who declined to be named.

One problem for developers of new buildings is that many tenants attracted to downtown are more interested in older buildings, such as the brick warehouses in the Third Ward that have been converted to office space or the adaptive reuse of Schlitz Park north of downtown or The Tannery complex in Walker’s Point, said Ned Purtell, a partner with RFP Commercial.

“People like downtown, but they’re looking for cool space, not necessarily class A space,” he said.

The desire for “cool space” is what has bolstered the office market downtown and in nearby areas such as the Third Ward and Walker’s Point, Purtell said. The office space vacancy rate for the Third Ward/Walker’s Point submarket has fallen from 23 percent to 19.5 percent during the last year, according to Xceligent.

Still, the Brookfield submarket could also support a new class A office building, Jacobson said.

Here again, NAI MLG Commercial has a narrower view of the class A office market. The firm only counts five buildings as class A in Brookfield: the former AT&T building at 17950 W. Corporate Dr., owned by Hammes Company and leased recently to FedEx SmartPost; and the Crossroads Corporate Center buildings at: 20700 Swenson Dr., 20800 Swenson Dr., 20935 Swenson Dr. and 20975 Swenson Dr.

By comparison, Xceligent counts 33 class A office buildings in the Brookfield submarket in its latest report.

Much like the downtown east submarket, Jacobson says the Brookfield submarket lacks large available class A office spaces and could support a new class A office building.

“The class A vacancy rate (in Brookfield) is 10 percent but large blocks of contiguous space are very difficult to come by,” he said in the NAI MLG Commercial report. “There are land sites in Brookfield Lakes and Bishops Woods that are shovel ready. The question landlords are asking themselves is, ‘Will there be tenants willing to pay $16 per square foot triple net and can they sign those tenants before the Ruby Farms development takes off?’ The answer is yes.”

Irgens is working on mixed-use development for the Ruby Farms site, located between I-94 and Bluemound Road west of Calhoun Road. The project could include office development, but the project is in the early stages of development.

However, some commercial real estate brokers expressed doubt that there are enough potential tenants available to get a new class A office building project going in Brookfield.

Sign up for BizTimes Daily Alerts

Stay up-to-date on the people, companies and issues that impact business in Milwaukee and Southeast Wisconsin

No posts to display