Some sectors of the Spokane-area office market experienced strong demand in 2008, but the number of lease transactions is expected to slow this year and possibly next year, industry observers here say.

Also, rents for such space could hold their own during the current recession, but landlords might have to sweeten tenant-improvement allowances when negotiating new leases, they add.

A fall 2008 vacancy survey of competitive office space showed the vacancy rate for Class A office space downtown was 7.3 percent, down from 13.8 percent a year earlier. The survey was conducted by Auble, Jolicoeur & Gentry, a Spokane real estate appraisal firm.

The overall downtown office vacancy rate, which includes mid-priced Class B space and lower-rent Class C space, was 13.5 percent, up modestly from 13.1 percent a year earlier. The 2008 vacancy rate was still the second-lowest in five years, the survey shows.

Mike Livingston, an associate broker with Kiemle & Hagood Co., of Spokane, says he's concerned that the real estate market here for office space will soften before economic conditions turn around.

The office market tends to lag the economy, and the Spokane economy tends to follow the Puget Sound economy, sometimes by a year or more, Livingston says. Going by those past trends, if the economy stabilizes in Western Washington sometime next year, the office market here still might soften through 2010, he says.

If the economy turns around in the second half of this year, however, the Spokane office market might escape without much of a decline, Livingston says.

In the fall survey, the downtown periphery and North Spokane sectors showed declines in vacancy rates, while the Valley continued to show higher vacancy rates.

Karen Meek, a partner in Auble, Jolicoeur & Gentry, says she's optimistic that low office vacancy rates downtown will hold up through the recession.

"Downtown isn't overbuilt," she says. "Vacancy rates have stabilized, and there's not a lot of layoffs, compared to what we're seeing in other parts of the country."

The average annual rent for new leases and lease renewals for Class A office space downtown last fall was $24.56 a square foot, up 21 percent from $20.28 a year earlier, the survey shows. Overall Class A office rents downtown, however, remained steady at $18.67 per square foot in 2008, compared with $18.62 a year earlier.

Meek says the increase in recent rents reflected in the survey might have been a short-term blip, and she's hearing that recent rental rates have stabilized at around $21 a square foot.

Tenants aren't demanding short-term leases as might be expected given the current economic recession, she says. She adds, though, that landlords might have to be generous with tenant-improvement allowances when negotiating new leases.

Typically, Class A tenants are signing five-year contracts for new leases and three- to five-year contracts for renewals, Meek says.

Landlords who are leasing out large amounts of space or who are providing significant tenant-improvement allowances can expect tenants to sign 10-year leases, she says.

Livingston says new landlords who have entered the market in the last few years have improved the quality of their office buildings with the expectation of pushing up rents. That has encouraged other landlords to spend money on upgrades and raise their rents, he says.

Office properties that were built or significantly improved in recent years include the Bank of Whitman Building, at 618 W. Riverside; the Grant Building, at 806 W. Riverside; and the Bank of America Financial Center, at 601 W. Riverside.

"If a tenant wants nice space, some of it gets pushed into the rent," Livingston says. "Spokane is still very affordable."

He says the tighter Class A office vacancy rate in the fall survey came at the expense of Class B space. The survey shows the vacancy rate in Class B office space was 19 percent in the fall of 2008, up from 13 percent a year earlier. Class B rents though, remained steady at $15.74 a square foot, compared with $15.73 a year earlier, the fall survey shows.

The vacancy rate for Class C office space downtown tightened to 4.4 percent in the fall survey, down from 8.86 percent a year earlier. Average Class C rent, though, dropped to $11.72 a square foot, down from $13.11 a year earlier.

The downtown periphery has had consistently low vacancy rates, although rents haven't budged much in the last three years. The vacancy rate in 2008 was 7.6 percent, compared with 7.8 percent in 2007 and 8.5 percent in 2006. Meantime, the average rental rate in the downtown periphery was $15.82 a square foot in 2008, $15.81 in 2007, and $15.88 in 2006.

North Spokane continued to show improvement, with a 9 percent vacancy rate in the fall survey, down from 10.7 percent in 2007 and 16 percent in 2006. The average rent remained nearly level at $16.09 a square foot, compared with $16.34 in 2007 and $16.01 in 2006.

Spokane Valley has had chronically high vacancy rates that are only expected to rise in the near term.

The fall survey shows the vacancy rate for office space there was 13.3 percent, up from 12.49 percent a year earlier. The survey doesn't include the River View Corporate Center, a recently completed 250,000-square-foot office building that Worthy Enterprises LLC, of Spokane Valley, developed and is marketing. The building was completed late last year, after the survey was conducted, and it remains largely vacant.

Jack Marr, director of leasing for Worthy Enterprises, says, he's got prospects for space ranging from 2,000 to 100,000 square feet, although River View Corporate Center has to compete with other vacant space in Spokane Valley and Liberty Lake for those prospective tenants.

"It's tough all over," Marr says of the leasing climate.

Worthy Enterprises is seeking premium lease rates for the new office space. The average annual rent at the River View Corporate Center ranges from $21 to $24 a square foot. For the rest of Spokane Valley, the average annual rent was $14.30 a square foot, the fall survey says.

Worthy Enterprises is offering some tenant improvements to prospective tenants at cost, Marr says.

The developer's original goal was to reach full occupancy within two to three years of completing the building, he says.

"We're taking it week by week. We knew it wasn't going to fill up overnight," Marr says. "Hopefully, the second year will be better than the first."

Livingston says the Valley office sector is smaller in terms of total office space than the downtown and periphery sectors, but more of the Valley space is suitable for larger tenants that would need 10,000 square feet of space or more.

Such tenants likely would be looking for facilities that provide free parking and lend themselves to "back office" uses, such as call centers, information technology departments, and manufacturing facilities, he says.

With a higher vacancy rate than other sectors of the Spokane office market, the Valley probably won't see rising rents soon, he says, adding, "People who come into the market will expect a deal."

Overall, though, Livingston says there's some room for optimism when comparing the Spokane office market with larger markets around the country.

"In other markets, when the economy is going well, merchant developers build products to take advantage of it," he says. "Frequently, a lot of new space comes onto the market just as it turns."

Spikes in vacancy rates in those markets aren't primarily due to businesses leaving, but because the market has become overdeveloped, he says.

"Spokane is not that kind of a market," he says. "Not that many people are developing buildings without tenants. Spokane tends not to spike too high."