Honolulu's Outlook Heats Up
As Capital Gets a Face Lift

Despite an earthquake that dinged a normally idyllic image, Honolulu's commercial real estate enjoyed another blockbuster year in 2006.

The state's hotel-room revenue rose 6.5% to $3.2 billion last year. Hawaii recorded the second-highest hotel occupancy rate at 79.8% and the second-highest average daily hotel room rate at $184.81 out of the top 25 U.S. hotel markets, according to Honolulu-based Hospitality Advisors LLC and Tennessee-based Smith Travel Research Inc. New York City was the top market in both categories.

The state capital of Honolulu anchors a metropolitan area with a population of about 905,300 residents on the island of Oahu. The area has started to attract luxury-level residential and hotel properties that in recent years have tended to favor other Hawaiian islands such as Maui.

Waikiki Beach, a densely developed strip that saw its reputation slip in recent decades as many properties became outdated, is undergoing a major face-lift. Changes include a $535 million plan by Outrigger Enterprises Group, a Honolulu-based hotel management and development company that is updating hotel rooms and adding retail. Trump International Hotel & Tower Waikiki Beach Walk, a 38-story hotel condominium, is also under construction.

At the same time, downtown Honolulu is going more upscale. Dallas-based Hughes Development LP plans to begin construction late this year on Pacific Quay, a high-end residential and retail project overlooking Honolulu Harbor.

Meanwhile, the city's tight commercial real-estate market, already boasting the lowest office-vacancy rate of the major U.S. markets, shows few signs of easing. Soaring land prices, rugged island terrain and a tough regulatory environment have helped to restrain new commercial construction.

Just how much better can the market get for landlords? The answer for some sectors such as hotels, which has seen substantial redevelopments of existing properties, may be not much. "We have to be careful," says Mel Kaneshige, Outrigger's executive vice president of real estate and development. "We can't keep raising our rates and expect people to keep coming."

There are some warning signs. Some experts expect a cooling in the national economy to damp travel, the region's top economic driver. Existing home sales fell in the state last year and residential construction is expected to decline this year, according to a report by Paul Brewbaker, chief economist at the Bank of Hawaii. Still, the rapid rise in home prices in recent years has left Hawaii struggling to address issues of homelessness and housing affordability.

Most of the area's challenges are byproducts of its success. Among them: metropolitan Honolulu had the lowest unemployment rate of any metro area in the U.S. at 1.6% in December, well below the U.S. rate of 4.3%, according to the Bureau of Labor Statistics. That has made it hard to find qualified employees.

Development in the retail and warehouse sectors is finally beginning to ramp up in response to the strong demand. After six years of little new supply, about 400,000 square feet of new warehouse space is expected to be delivered this year, according to Property & Portfolio Research Inc., a Boston-based real-estate research firm. By contrast, only one moderately sized suburban office building is expected to be completed this year, says Matt Birchby, a real-estate economist with PPR. Honolulu's fourth-quarter office-vacancy rate of 8.9% was the lowest of the 54 major U.S. markets surveyed by PPR.

Office rents will need to rise from their current mid-$20 per-square-foot range to the $30 range to justify new office construction, says Ken Hughes, president of Hughes Development, who opted several years ago not to include an office component in Pacific Quay.

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