After what has been an exciting and eventful 2014 and 2015 for commercial real estate investment in Greater Boston, it’s hard not to wonder what’s in store for 2016. We seem to have kicked off the year on just the right note, with GE announcing its move to Boston. Looking back at 2015, when sales volume matched 2007’s record total, a number of events and trends influenced the wave of transactions – including record figures for multifamily assets, significant foreign investment from established and new industry players, and continued reinforcement of Cambridge as a destination for core real estate investors.
It’s equity, not debt, that is fueling the commercial real estate market.
When we look back to the run-up in values going into 2006, we remember cap rates being close to where they are today, with one key difference – interest rates were higher. So investors were using lots of high-leverage debt, driven by the CMBS market, and projecting big rental rate increases to make deals work. Today, things are remarkably different; the 10-year treasury is at 2 percent (versus 4.4 percent in 2006), and overall leverage is much lower (closer to 60 percent, versus 75 percent to 80 percent in 2006). The takeaway here is that debt is being used to engineer returns in a very different way than it was 10 years ago.
Why is the pool of equity capital so deep, and where is it coming from? To be sure, China is always in the discussion and understandably so. It has exhibited the highest percentage growth of capital deployment into U.S. commercial real estate, but it’s not the largest foreign investor. Canada carries that distinction, and in a big way. Canadian investments can be seen in Boston (see Oxford, PSP), but there are many others, including Sweden (Skanska), Germany (Union), Singapore (GIC) and Japan (Mitsubishi).
What’s really interesting is that the recent volatility in commodity and equity markets, while creating some pause for these investors in other global gateways, is placing a spotlight on Boston. Many of these groups feel underexposed to our market, and see it as highly resilient to the volatility we are seeing elsewhere. We have observed that the impact of our strengthening currency is increasing the velocity of capital going into hard assets in the U.S. in the near term, rather than the opposite. Recent legislation around tax relief for foreign investors in real estate will also have a material impact on new investment in the U.S. and gateway markets such as Boston.
Right now, so much of the talk around Boston’s real estate community is about GE. Companies all over the world will follow GE to Boston; the phone is ringing off the hook as a result of this announcement. Remember, GE is a technology and infrastructure company now, so this stamp of approval has positive reverberations for real estate in the city and across the region.
The Road Ahead
All of the chatter about the oil rout, lower global growth rates, a choppy corporate bond market and selloff in equities is hard to ignore, but real estate fundamentals are exactly where they need to be. Just observe some of the indicators: low unemployment, low interest rates, low federal deficit, rent growth in the residential sector, positive net absorption in the office sector, moderate leverage, strong consumption and new supply that many think is still falling short of demand. In Boston’s suburban office market, rents are increasing at an impressive rate and developers are responding to growing companies’ desire for more unique, collaborative office space in an urban environment with extensive amenities.
To be sure, the regulatory environment around real estate lending is making things a little tricky of late. The net impact is higher interest rate spreads and, in some instances, lower proceeds. Still, while spreads are higher than many would like, the underlying indices are very low and, more importantly, there is plenty of nontraditional capital to step in where banks cannot be competitive on loan proceeds or funding structure. The pool of capital for debt is very, very deep.
In summary, 2016 brings some compelling opportunities to our market. Overall demand should continue to fuel new development and adaptive re-use of existing buildings. We should keep a close eye on growth in the tech sector and new venture capital investment in the region, as these are major factors driving today’s office market. 2015 gave us record pricing in the sale of 222 Berkeley/500 Boylston, which sold for more than $1,000 per square foot. It’s hard to argue that values are going down given the depth of capital, but global volatility is likely to maintain current valuations or result in moderate increases for the most special investment opportunities. One could make a strong argument that given where Treasury rates are today, that cap rates on average should be 50 to 100 basis points lower. Greater Boston continues to be a highly strategic and desirable market for global capital, with no signs of abating any time soon.
Carlos Febres-Mazzei is a director at Eastdil Secured.
