While multifamily carries the highest distress rate among all property types, the local Seattle market has remained one of the strongest and most stable in the country. The strength of the market has helped shield it from the greater levels of distress infecting other multifamily markets. Twenty-nine assets are reported as troubled, less than 1% of the total multifamily properties in the Seattle MSA. Although assets with loans that were securitized have typically carried a higher distressed rate than conventional financing, only three such loans in Seattle were listed as delinquent, equating to less than 1% of securitized loans backed by multifamily. Although present, concern over loan maturities is minimal, and the bulk of CMBS debt is set to mature in four to six years.

Retail Demand Strengthens

Seattle-Tacoma retail property owners will begin to reduce leasing incentives this year as job growth and minimal completions drive modest occupancy gains. The sharp reduction in consumer spending that led to store closures and elevated incentives has since run its course, and operators, emboldened by a turnaround in leasing last year, will cut concessions as 2011 progresses. Strong fundamentals have kept the level of retail distress down, with just 5.5% of nearly 240 CMBS retail loans labeled as distressed. With another 10 to 15 conventional loans in distress, Seattle has a total $280 million in distressed retail. Comparatively, the sector has performed extremely well, and the level of stress both on a percentage and dollar basis is considerably lower than other, smaller West Coast markets such as the East Bay, Sacramento and San Diego.

One point of concern, however, is the nature of distressed retail in Seattle, and many of those properties are already 90 days delinquent or greater. With workouts and modifications typically accomplished earlier in the delinquent life, it appears that several retail assets will be headed toward foreclosure and REO in the coming months. While still a trickle, these assets will play a role in pricing guidance for stabilized assets throughout the year.

Office Market Faces Challenges

Space demand in core office districts of Puget Sound will strengthen this year as major employers lease discounted sites, particularly along densely populated corridors. This trend rose to prominence last year in Downtown Seattle, with Russell Investments relocating to more than 200,000 square feet in the former WaMu Center and Amazon.com Inc. committing to nearly 70,000 feet at Columbia Center.

As major office districts experience leasing demand, suburban assets will struggle until core space is filled. Large blocks of contiguous space left vacant in these areas, including the former Russell Investments site in Tacoma, will face extended marketing times early in the recovery cycle as companies opt for preferred business addresses in King County.

Investment activity will strengthen this year as institutions and private equity firms step up to acquire newer, distressed assets in prime locations. Risk-averse investors with a long-term hold strategy will target upper-tier assets, particularly those leased to large employers poised for extended growth in the Bellevue/Issaquah and Central Seattle submarkets. Improving operations and increased investor demand have already compressed cap rates for performing properties in these areas to the low-7% range, 100 basis points below the 2009 peak.

By the numbers, the Seattle office market is the most troubled of the four major property types with 40 properties currently labeled as distressed. Weak fundamentals in the sector as well as aggressive underwriting in several office assets that went through securitization during the boom have contributed to the elevated levels of distress.

Put in perspective though, less than 2% of all metro office buildings are distressed and much of that has been focused on the Beacon Cos.' Seattle portfolio as well as other high-profile assets traded between 2005 and 2007. As such, the delinquency rate among loans securitized through CMBS is much higher, with 5.75% labeled as distressed. These loans carry a balance of nearly $215 million, equal to more than 10% of the outstanding CMBS office balance. While this trails the national average, it bears watching since vacancies remain elevated and any rental rebound appears several months away.

Industrial Outlook Improves

The vacancy rate among flex properties in the Seattle-Tacoma metro reached 12.4% in the fourth quarter, up 90 basis points year over year. Flex operations will begin to firm in the second half, resulting in just a 10-bp improvement to 12.3% before posting steeper declines in 2012. Warehouse operations fared better in 2010, rising just 30 bps to 7.5%. By year-end 2011, warehouse vacancy is anticipated to fall 50 bps to 7%, driven by improved leasing and below-trend deliveries. Industrial trade volume has gained considerable momentum. Looking at investment sales, during 2010, transactions involving industrial properties increased 17%, after decelerating 53% one year earlier.

The increase in container traffic in 2010 has helped stabilize the Seattle industrial market and lower the number of assets falling into distress. Only 18 properties were labeled as distressed in the metro, the lowest number of any of the four major property types. While only two CMBS industrial loans were listed as delinquent, this was out of a total of just 68 industrial loans that were securitized, and this, too, was the smallest total.

The market may also be challenged in the near-term by the disruption in trade with Japan as a result of the devastating earthquake and tsunami. The lack of goods flow may push smaller owner/operators into 30- to 60-day delinquencies as they realign their distribution channels and deal with the disruption in payments and shipments. It is too early to predict any long-term impacts on trade, but the performance of the industrial market, especially one so dependent on its port, will provide any early signs of distress in the coming months. Even though the Seattle economy will experience some short-term setbacks, the market is poised to perform well over the long term.

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