It is increasingly difficult to be an optimist in commercial real estate, but the National Association of Industrial and Office Properties put its best spin on the downturn last week via a panel discussion analyzing two sectors that have fared better than most – retail and apartments.
“Both of those markets, despite some underlying softness, remain very strong,” real estate attorney Brian C. Levey told the audience at Rowe’s Wharf in Boston last Wednesday. Levey, whose Bowditch & Dewey law firm sponsored the program, was seconded by moderator Paul Ayoub, with the Peabody & Arnold principal acknowledging that the retail and residential sectors have been the most resilient in the current downturn.
Ayoub demonstrated how quickly conditions evaporated through skillful execution of the milk-in-a-cone trick, filling a cylinder while detailing the amount of development and economic resources poured into commercial real estate until the market cratered at the end of 2000. “We woke up in 2001 and there was nothing there,” Ayoub said, opening the cone with no liquid evident, a feat which earned the attorney generous applause.
In providing the retail overview, Finard & Co. partner William Beckeman said the fragmented nature of the industry makes it difficult to make sweeping generalizations. Some product types or retailers are faring better than others, he said, and certain submarkets continue to foster growth while others may ultimately need less space.
“Quality [retail] information is hard to come by,” said Beckeman, disputing one national measure that claims Massachusetts has less retail than the rest of the country. The figure gives the area 18.3 square feet per person, compared to just over 20 square feet nationally. But Beckeman said the statistic only counts properties of more than 100,000 square feet and those sporting three or more tenants. That leaves a lot of retail unaccounted for, with Finard & Co.’s extensive database of all retail properties in Eastern Massachusetts indicating the per-person ratio is actually closer to 35 square feet.
Finard & Co.’s numbers give Eastern Massachusetts 164 million square feet of retail in 20,699 separate properties. Of the 46,283 retail establishments, Beckeman said one-third occupy less than 10,000 square feet, making smaller stores a critical component of the shopping sector.
Based on population estimates, Finard & Co. anticipates about 750,000 square feet of virgin retail development will be built in the Bay State annually for the next 10 years, although Beckeman warned such growth could be tempered by factors such as a lack of land, communities resistant to commercial construction and global economic woes that typically slow consumer demand. There is 2.9 million square feet of retail space under construction in the Bay State at present, Beckeman said.
Demographics will play a key role in future retail activity, said Beckeman, with Boston and Worcester expected to see a decline of residents while Cape Cod, Southeastern Massachusetts and markets along Interstate 495 could enjoy population growth by as much as 25 percent in the next decade. “Look for those areas to lead the demand for new retail space,” Beckeman said.
Store formats will be less important than location, said Beckeman, predicting that the bulk of new retail will come from those behemoths who have dominated the news lately. Led by the ongoing Wal-Mart invasion, Beckeman said others likely to be aggressive include Home Depot, Kohl’s, Lowes and Stop & Shop. That could be bad news for local developers, architects and construction companies, Beckeman said, because such firms tend to limit their use of real estate providers.
“If you don’t have a relationship with one of these retailers, it will be difficult to do business with them,” said Beckeman, although he added that a property owner with a prime site could benefit from the arrival of such firms.
Retail is also evolving due to shifts in an aging population, Beckeman said, but not always in a set pattern. With an additional 8 million people slated to reach their 60s by the end of the decade in the United States, some retailers will respond to that sector even as others rush to meet the so-called “echo boomers” ballooning the ranks of the teenage population, Beckeman said. With parents in their peak earning years focusing resources on their children, Beckeman said many stores are cropping up to serve that demand.
On the flip side, e-commerce could have a detrimental impact on traditional retail activity, Beckeman said. “What happens when the echo boomers who grew up on the Web get their own credit cards?” he asked. Those shifts are already making retail properties turn to service uses vs. goods, as witnessed by the advent of medical, legal and educational professions migrating to such properties.
Shopping for Financing
On the residential front, Avalon Bay Communities Vice President William McLaughlin said the multifamily market has been hit harder than expected by the recession, with rental rates dropping back to 1999 levels after several years of solid rent growth. Vacancies for upscale apartment communities have skyrocketed of late, he said, estimating that Avalon’s properties are experiencing vacancy rates in the 8 percent to 10 percent range vs. averages closer to 1 percent or 2 percent before the market peaked in mid-2001. Avalon had its slowest Labor Day in years, McLaughlin said, followed by a brutal third and fourth quarter.
“The [multifamily] market is not nearly as solid as it might appear on the outside,” said McLaughlin. “The economics aren’t what they were a year ago.”
Downtown Boston has seen some slippage, but McLaughlin said the weakest demand can be found along Route 128 and in the MetroWest market. Not coincidentally, those areas have been hardest hit with company layoffs. “We are a lagging indicator,” McLaughlin said. “Until you start to fill office buildings with new jobs, we will not see a landlord’s market in the residential [sector].”
One wild card previously not a concern in Massachusetts has been a sudden flood of new multifamily supply. McLaughlin said there are as many as 20,000 apartment units on the drawing boards within the I-495 beltway. Many will probably never get beyond that point, but McLaughlin said those that do break ground could have a long-term impact on the market. One of Avalon’s strongest markets, the Bay State’s North Shore, is seeing considerable competition among new multifamily players, he said.
Although competition among apartment communities is heating up, McLaughlin said Avalon Bay has lost the bulk of its tenants to homeownership, with many taking advantage of low interest rates and acceptable pricing to buy into a residence vs. continuing to rent. “People are leaving our communities in droves to buy homes,” said McLaughlin. But while that may be hitting the bottom line, he also maintained it is a good sign that the current recession is not as harsh as its predecessors.
The worst thing about the recession, according to McLaughlin, was the suddenness with which it appeared. While not as solid as Long Island, N.Y., or Los Angeles, two pockets where rents are actually appreciating, Massachusetts has fared better than some regions, said McLaughlin, and there are signs that conditions stabilized in the first quarter. “We are sort of bumping along … and I think we will continue to bump along through the rest of the year,” followed by a rebound, McLaughlin said.
The financial markets also continue long-term belief in the Bay State, panelist Kevin C. Phelan told the NAIOP audience. Phelan, who heads up the Finance and Capital Markets Group for Meredith & Grew, said lenders are still eyeing opportunities locally with an outlook that the region has relatively solid fundamentals.
“This area, unlike the redlining we saw in the late 1980s and early 1990s, is still very strong,” Phelan said. “No one has panicked.”
In order to win business, Phelan said lenders are lowering their loan-to-value ratios and competing hard to secure deals. Mezzanine debt is plentiful, he said, adding that both multifamily and retail are popular product types as opposed to office assets.
Lenders like apartments, Phelan said, because of the perceived barriers to entry, plus the limited likelihood of a foreclosure. Apartments, he said, “are easier to understand and are still the preferred product of choice,” despite the recent rise in vacancies and rent slippage.
As for retail, Phelan said grocery-anchored centers are particularly in vogue. One growing concept is to supplement a large supermarket with a handful of smaller anchors or retail offerings. “That’s the way to go,” Phelan said. “They are very creditworthy and they are going to get financed.”
