Market Watch finds oversupply of Missoula apartments, risk in “big box” retail investment

Based on population trends and cap rates, this year’s report suggested that Missoula was approaching an oversupply of multi-family housing. The current vacancy rate ticked up 1.3 percent from last year to 4.2 percent. (Missoula Current file photo)

Those looking to invest in commercial real estate in Missoula would be wise to stay away from big-box retail stores, multi-family properties and building spec homes valued at more than $300,000, a panel of real estate experts said this week.

Instead, when it comes to Missoula, opportunities lie in redeveloping failing retail properties, providing flexible turn-key space for office or warehouse use, and finding triple-net lease properties that can be filled with a viable tenant and resold for a profit.

“Interest rates are low, capital is available and people are optimistic,” said Matt Mellott with Sterling CRE Advisors of Missoula. “It’s a good time to invest defensively. We’ve been in an up market for a long time, and at some point, the business cycle will catch up and there will be a correction to commercial real estate, and that will affect Missoula.”

Sterling CRE unveiled its second annual Missoula Market Watch at Stockman Bank on Wednesday night, where it provided investors the latest data on commercial real estate trends in Missoula.

The research looks to help investors make informed decisions based upon actual market data, not anecdotal evidence. While such data is often available through third-party services in major metros, it was lacking in Missoula until now.

“I would argue that’s where bubbles come from, because it’s often inaccurate and incomplete data, so it leads to an overbuild of different asset classes,” said Mellott. “If you actually collect the data and do the trend analysis on that information, you can head off a lot of those bubbles, and you can find opportunity and risk.”

In its second annual report, Sterling CRE tracked 84 unique projects in Missoula, each valued at more than $500,000. Together, those projects total $900 million in local investment. Sixty percent of those projects were planned or taking place inside an urban renewal district.

“Most of the public money is going into government buildings and schools, and the vast majority of the private money is going into mixed-use projects – the Old Sawmill District, the Riverfront Triangle as it’s currently proposed, and the Roam student housing project. Mixed use is a very big source of investment right now.”

Based on population trends and cap rates, this year’s report suggested that Missoula was approaching an oversupply of multi-family housing. The current vacancy rate ticked up 1.3 percent from last year to 4.2 percent.

Still, an estimated 997 additional units are expected to come online in the next 24 months, a figure that outpaces local population growth. At the current rate, the study found, the multi-family vacancy rate will approach 8.4 percent by 2020.

In comparison, the vacancy rate for office space across Missoula held at 9.8 percent, though in the downtown district it stands at 18 percent. That later figure is driven in part by the vacant federal building.

“It’s a huge chunk of space and it has a number of restrictions on it, so it’s not easy to rent,” Mellott said. “When you remove the federal building, the downtown vacancy rate is about 8 percent in the office market.”

Mellott said roughly 155,000 square feet of office space was delivered in 2017, while an additional 200,000 square feet is slated to come online in the next 18 months. In the next five to seven years, an additional 175,000 square feet is planned or proposed.

All told, that amounts to 375,000 square feet of space within the next seven years, and while it sounds like a large number, Mellott said, it could hit the mark. To fill that space, Missoula will need to absorb 54,000 square feet of office space each year.

“You can equate that to jobs because, generally, you think of absorption of space by employee, and each employee takes 225 square feet on average,” Mellott said. “If we need to absorb 54,000 square feet per year, that means we need 240 new office jobs per year.”

ClassPass is now looking to hire another 120 employees in Missoula for its downtown office over the next two years, and Advanced Technology Group has plans to grow its own staff as well, as do several other local firms.

“Some of the other companies in town are growing pretty aggressively, so that number seems within reason,” Mellott said. “Those are just a handful of companies. There’s a number of smaller companies that are hiring as well.”

The vacancy rate for industrial space stands 5.2 percent, down 3 percent over last year. Mellott attributed the decline in vacancy to changes at the former Smurfit-Stone Container Corp. pulp and paper mill, which is no longer viable for a number of reasons.

Last year, roughly 52,000 square feet of warehouse space was absorbed in the Missoula market. That’s expected to increase in the coming years. It’s unknown if Costco will be one of those projects, though the company has stated its intent to build a new store in Missoula.

“There’s 325,000 square feet of space that’s slated to come online in 2018 and 2019,” Mellott said. “That’s a huge jump in industrial space that’s being built. Of that, only 3 percent is spec building. Said another way, 97 percent is build-to-suit, so there’s a tenant lined up for that user.”

Figures in the retail sector offered a mixed bag, though the outlook isn’t good, Mellott said. A number of national chains with a local presence, including Shopko, GNC, Rent-a-Center and PetSmart, are expected to file for bankruptcy this year.

City-wide, the retail vacancy rate stands at 3.5 percent, a .5 decrease over last year.

“Cap rates are going up pretty dramatically, and investors at the high level are seeing there are problems in the retail world, and they’re adjusting accordingly,” Mellott said. “If you’re Southgate Mall Associates and you see these trends, what do you do? You sell, and that’s evidently what they’re doing.”