Commercial real estate's comeback: increased occupancy and rising rates are reviving Alaska's commercial real estate, despite a dearth of office building construction.

• Author: Collins, Gloria

Commercial Real Estate's Comeback

Increased occupancy and rising rates are reviving Alaska's commercial real estate, despite a dearth of office building construction.

If a small group of people who have been consulting in their spare time combined forces and went searching for office space in which to establish a firm, what are they likely to encounter?

Whether in Anchorage, Fairbanks or Juneau, they will find pretty slim pickings for the better, Class A office space. They will find more choices for less-select quality office space. They may even discover that converting retail space to office use in a shopping mall is an affordable option. But they are unlikely to find dirtcheap rental rates wrapped up in landlord concessions, which was a common situation when Alaska's economy bottomed out in the late '80s.

Alaska's commercial real estate market is healthy and getting healthier. Generally speaking, both office and retail space are tightening up, commercial buildings are being sold, rents are going up, and major Outside retailers are expanding their Alaska operations.

The big question is: When will new development -- especially of Class A office space -- occur? Industry experts don't have an answer yet. Market value of commercial buildings, while showing increases, is still well below replacement value. New construction currently would be unprofitable. And lenders are cautious.

Commercial construction will become viable when rental rates increase enough to provide income sufficient to justify owners' investments. For Class A office space in Anchorage, that figure is considered to be about $2.25 per square foot. As of April, the high end of Class A space rates was at $2.00 per square foot. Activity overall in Class A space appears to have slowed down this year compared to last year, when Anchorage saw tremendous increases, so no one is sure when the $2.25 figure might be reached.

Some real estate industry experts aren't convinced that higher rental rates, even in the presence of increased demand, would motivate lenders enough to take a chance on new commercial construction. "It's risky to finance new construction, regardless of where rents go," says Bruce Chambers, an associate with the Anchorage real estate firm of TRF/Brayton Inc.

He explains that, although increasing, sale prices on existing buildings are still running approximately 30 to 50 percent less than costs to replace the properties, given today's construction costs. With typical new construction financing, a lender would require a down payment of 25 percent cash to finance the other 75 percent. However, that 75 percent by itself could easily represent more than the current market value of the property -- and lenders balk at loaning more on a property than it's worth in the current sales market.

Also, if Alaska's present economic upswing were to last only a short time, such as three years, and then experience a similar-length decline, lenders who had financed new construction during the upturn could find themselves holding the bag -- again. In order to meet loan payments, the mortgagee of a newly constructed building likely would need to keep rental rates on the high side and therefore may not have the option of reducing rental rates to keep tenants if the economy plummeted again.

Chambers notes that the value dilemma could make bank financing...