Cleveland's Office Market
Revives with Health-Care Help

Bargain-hunting office buyers have snapped up Cleveland's trophy towers and suburban spaces at record levels this year, making the city a bright spot in northeast Ohio's commercial real-estate market.

The total volume of office-building transactions in the region valued at $5 million or more rose to $459 million through the third quarter this year, a 62% increase from all of 2006, according to Real Capital Analytics, a New York real-estate research firm.

The average price paid per square foot of office space for the period rose to $149, the second highest of the major Midwest markets after Chicago, where the average price fetched was $233, the research firm says.

The surge in interest came after the image of Cleveland's property market took a hit in late 2005. Indianapolis-based Duke Realty Corp., then one of the area's largest landlords, announced it would exit from Cleveland and sell off its properties because it no longer saw opportunities in the market. Some buildings that have helped boost sales levels this year were part of the Duke portfolio, including nine suburban office buildings and some land sold in March for about $145 million.

Some owners say they have been attracted by the prices and see potential where a restrained pace of new construction combined with some expansion by existing companies such as health-care firms have brought down the vacancy rate in upper-tier office buildings.

"Cleveland's going to become a stronger market," says Zack Egert, director of acquisitions for New York-based Sovereign Group. This year, Sovereign paid about $71 million for the 28-story Eaton Center, a trophy building largely occupied by Eaton Corp., a diversified manufacturer. Sovereign has another downtown office building under contract and is considering office properties in the suburbs.

The underlying weakness in the economy of the Cleveland area has taken its toll on the demand for all property types. As the region's manufacturing sector shrank, job levels fell 0.5% in the second quarter from a year earlier -- compared with 1.5% growth nationally -- and the Cleveland metropolitan area's population declined about 0.4% to an estimated 2.1 million, according to Moody's Economy.com.

The metropolitan area's overall second-quarter office, retail and warehouse vacancies were well above the average for 54 major U.S. markets, though rents rose in the second quarter from a year earlier, according to Property & Portfolio Research Inc., a Boston real-estate research firm. There are pockets of strength and weakness, brokers say, with occupancies in some older malls deteriorating while newer centers in wealthier suburbs are faring better. Likewise, the overall office vacancy rate in downtown Cleveland is expected to end the year at 21.5%, while in the healthier east submarket, which includes such suburbs as Mentor, it is expected to be 13.8%, PPR says.

Local government officials are working to capitalize on Cleveland's growing health-care industry, which includes the Cleveland Clinic. A county sales-tax increase went into effect Oct. 1 and is earmarked to fund convention-center space. That space will be part of a medical complex in Cleveland that would also include exhibit space for medical-equipment makers.

Mark Falanga, senior vice president of Merchandise Mart Properties, whose parent company Vornado Realty Trust owns the Chicago Merchandise Mart, is working with local officials to find and develop a site. Cleveland's affordable real estate and strong health-care industry make it an attractive location for the venture, he says.

It isn't just Cleveland's bargain prices that are attracting investors. Last year, for the first time in five years, downtown Cleveland saw the total amount of net office space leased in the top two levels of office buildings rise rather than fall, says David Browning, managing director of real-estate services firm CB Richard Ellis in Cleveland. That trend has continued this year and brought office vacancies in the city's top buildings down to about 11% in the third quarter from a high of 18% in 2004. That has even led some brokers to speculate that new downtown office buildings might be constructed in the near future.

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