In the keynote talk during last week’s midyear commercial real estate review at Boston’s Back Bay Westin, AEW Capital Management principal Douglas Poutasse occasionally wavered in his message, delivering seemingly contradictory information about future prospects for the industry. Given his subject material – the economy – such hedging would seem understandable, however.
Even amid “extraordinary productivity growth” among U.S. workers and a steady business climate, Poutasse fretted over excess spending – “we are borrowing like crazy,” he warned – and giant trade deficits that could derail future growth, especially when combined with soaring energy prices and the prospect of inflation. Two interest-rate hikes anticipated this summer send a clear message that “the Fed is going to fight inflation,” advised Poutasse. AEW’s chief investment strategist also opined that the global tide of capital could soon be interrupted, listing Japan as one lucrative source of funds that may be losing its nerve. On the other hand, foreign investment in U.S. real estate remains brisk, he said.
Co-sponsored by the National Association of Industrial and Office Properties and the Society of Industrial and Office Realtors, Tuesday’s breakfast program featured other industry experts as well, including Richards Barry Joyce & Partners principal Michael J. Joyce, multifamily specialist Jonathan Close and investment sales veteran Edward C. Maher Jr. of Cushman & Wakefield. Meredith & Grew principal James L. Elcock spoke on suburban market conditions and Debra J. Gould of Spaulding & Slye offered insight on the Cambridge office and laboratory scene.
Poutasse’s self-described struggle between optimist and pessimist was a bit softened from the stance he took at last year’s NAIOP/SIOR midyear overview. Despite noting that the roster of local companies on the Fortune 500 has dwindled from 16 in 1996 to nine at present following several large-scale mergers, Poutasse predicted good times ahead for Massachusetts thanks to its strengths in new-millennium industries such as life sciences.
Battered by the recession and slowed by tepid employment gains, the office market is on the mend in lock step with the economy, said Poutasse. “Recovery is coming to Boston,” he proclaimed. “We are coming around.” Condominium fervor has cooled, and residential investment is approaching dangerous highs, said Poutasse, but he credited the multifamily industry for retaining solid occupancy levels even as new supply arrives.
Close, a senior vice president at Apartment Realty Advisors of Burlington, seconded Poutasse’s outlook, maintaining that an estimated 5,000 new units being delivered this year and next will not be enough to disrupt multifamily fundamentals.
“Investors are overestimating the effect that the new construction will have on occupancies or rental rates,” said Close. The supply “is going to be absorbed, they are going to get their rental rate, and it is not going to be a problem.” Indeed, Close said the economy could quickly change the inventory equation. “Once jobs are created in Massachusetts, apartments will become 100 percent occupied overnight,” he said.
Investors should also be mollified by a dearth of new apartments in the pipeline, said Close, citing higher materials costs and insufficient land, plus a phenomenon where many communities have met the 10 percent affordability threshold for their housing stock that allows blockage of future apartment construction. State legislation known as Chapter 40B that has produced thousands of units soon will be rendered powerless in such popular markets as Peabody, Danvers and Burlington, Close explained. The latter community is projecting a 3 percent hike in apartment rents this year, added Close.
After leading the charge and driving up pricing for multifamily properties in recent years, condominium converters have backed off in the past quarter, said Close, opening the door for institutional funds and other capital sources to acquire product. The capitalization rate for apartments remains low, running mostly between 5 percent and 5.5 percent, said Close, with investors particularly drawn to assets along Route 128. Farther out of town, the value of an apartment complex varies greatly, said Close, although upper-crust developments are in vogue for most investors.
A Booming Arena
The entire investment arena is booming, Maher said. “As it stands right now, this is the hottest market we’ve ever been in,” he noted. One deal – the $514 million disposition of Boston’s One Federal St. – has already eclipsed the half-billion dollar mark, while Liberty Mutual paid $481 million for 10 St. James Ave. and 75 Arlington St. to start the year.
The NAIOP/SIOR program was also abuzz with the news of another landmark transaction in the works, that being the potential for a $600 million sale of Technology Square in Cambridge. Being brokered by Cushman & Wakefield’s Capital Markets Group, the seven-building office/laboratory complex was being acquired by Alexandria Real Estate Equities, as Banker & Tradesman initially reported in last week’s issue.
Alluding to the Russian bond crisis in 1998 that quashed the investment sales market overnight, Maher said it would take another global crisis to impede sales, with 2006 still inundated with capital from sources both domestic and overseas.
One reason for such optimism has been the rebounding office market, and speakers at Tuesday’s program reported generally favorable trends there. An expert on Boston, Joyce said the vacancy rate has stabilized and rents are on the rise, especially for prime tower locations. A belief that rents are heading upward is prompting some tenants with lease expirations out to 2010 to explore options, added Joyce, a trend which could lead to office construction in select instances.
Rental rates would have to exceed $60 before new construction would make sense, cautioned Joyce, and that mark remains elusive except for special circumstances. Joyce said he is encouraged by a rebound in the Seaport District, maintaining that vacancy rates there will drop to 5-6 percent by year’s end. The Fan Pier complex owned by developer Joseph Fallon stands a chance of getting under way soon, said Joyce, whereas the adjacent McCourt land now owned by Fox Corp. is yet to be permitted and will take several years for work to commence. Smaller undertakings could have an advantage, according to Joyce, noting a Druker Co. property in the Back Bay as one possible development option.
In Cambridge, the laboratory market is enjoying a solid 2006, said Gould, estimating that rental rates have risen from $46 to $54 in the past year and the availability rate has fallen to 12 percent. “Things are quite lively in the market right now,” said Gould, while office space has also responded positively. The availability rate for office space in Cambridge is down to 15 percent, Gould reported, while rents have jumped 10 percent this year. Office activity had been on the wane in 2005, but Gould said she is encouraged by the sudden spurt of leasing, including a pending agreement for 25,000 square feet.
There has been some seepage of Cambridge companies moving to the suburbs to escape higher rental rates and enjoy amenities such as parking, but Gould said there will be enough firms that want to be in the city to keep office and laboratory rents increasing over time.
The entire suburban market has attracted its share of life sciences and health care activity, Elcock said in his overview. Consumer goods, insurance and financial services companies have also been taking space, said Elcock, so much so that popular locations such as Waltham could see new construction over the near term. Among the likely candidates to break ground first, said Elcock, are Boston Properties and Equity Office Properties in the central Route 128 region and Westwood Station in the south suburban market.
“Tenants like new product,” Elcock said of the motivation for new space at a time when certain areas such as Interstate 495 remain flush with office and flex product.
Pricing-wise, developers would require rents in the mid-$30 per-square-foot range to move ahead, and Elcock said that level is already being reached in certain communities such as Waltham, which is approaching $40 per square foot in some deals. The fringe submarkets are far off that pace, however, and Elcock said it will be some time before those areas turn around. The Interstate 495 North submarket has a 27 percent vacancy rate, said Elcock, while the I-495 West is 25 percent and the south stretch is at 24 percent.
