The change in the economy, reflected in the uncertainty of the stock market, has clearly impacted the Boston real estate market. At the halfway point of 2001, the market is experiencing increased vacancy, negative absorption, slower demand and lower rental rates.

Boston
As the largest submarket, the Financial District sets the tone with a total vacancy of 5.9 percent and negative absorption of 1.2 million square feet, largely due to the abundance of sublease space in the market. The Back Bay is the second largest submarket at 10 million square feet and has a 6.4 percent vacancy rate and modest absorption of 75,086 square feet. The combined total size of the six other submarkets is 10.5 million square feet. Together, these six markets have a vacancy rate of 11 percent and negative absorption of 245,692 square feet.

Rental rates slipped this quarter but did not fall dramatically. Asking rents reached $100 per square foot last year with selective transactions in the $70s and $80s per square foot. Asking rates for the same space today are $60-$75 per square foot. Landlords will negotiate with strong credit tenants. The ask and the take for Class A space in the market will continue to tighten in the $55-$65 range depending on views, location, term and condition of premises.

The big change from 2000 to 2001 is the sublease market. At the end of the first quarter, there were 826,000 square feet of sublease space in the Boston market, a spike from a year-end 2000 availability of 157,000 square feet. That number has increased to 1.1 million square feet and has leveled off as the quarter comes to a close. The wild card will be Verizon’s pending sublease at 125 High Street ranging in size from 150,000 to 250,000 square feet and now being shown to selective large users.

The sublease market continues to be the area of opportunity for tenants looking for space in Boston. Class A space is priced in the $50-$55 per square foot range and, in many cases, a direct lease with improvements can be negotiated with the landlord. Class B space throughout the city is available in the $35-$45 square foot range. The sublease market total of 1.1 million square feet is four times the historical average for the last 10 years and one and one-half times the previous high of 740,000 square feet in 1994.#

Cambridge
The office vacancy dynamics in Cambridge continued to weaken during the second quarter. By June 30, 2001, the overall vacancy rate had increased to 11.8 percent, up significantly from a first quarter vacancy of 9.3 percent. The higher vacancies resulted from the continued retreat in the technology sector.

Demand remains very slow, especially for office space. The lack of new demand, coupled with the technology company cutbacks, explains the negative net absorption of 653,000 square feet through the second quarter.

The low demand, high vacancies, and increasingly aggressive sublease offerings have driven office rents downward. Recent proposals for Class A office space in Kendall Square and East Cambridge have been in the $40-$50 per square foot gross range, as compared to the $60-$75 range in November 2000. Quoted Class A rates in Alewife have dropped to the $35-$45 per square foot gross range.

Interestingly, quoted rental rates for existing laboratory space and shell space in “biotech ready” buildings have not fallen and, to date, have remained firm in the $50-$60 per square foot NNN range (rate variation depends on a specific space’s condition or on the level of tenant improvement allowance funded by a landlord). The steady biotech rates result from the continued current low biotech vacancy rate in the 2 percent to 4 percent range. These dynamics are likely to change over the next 12 to 24 months, as 1.5 million square feet of new biotech projects will be delivered to the market.

There is currently modest demand (275,000 square feet of active requirements in the market) in the biotech sector, and there have been no space givebacks like those experienced by the Internet and e-commerce sectors.

Suburban Markets
The Suburban market’s vacancy rate is 10.1 percent, up from a vacancy rate of 6.4 percent at the end of the first quarter of 2001. The suburban market shows a negative absorption of approximately 5 million square feet. Other than the tight Route 495 South market, all other suburban markets have a vacancy rate close to double digits and all are experiencing negative absorption.

The weighted average asking rent is $26.56 per square foot. In the suburban market there are 42 buildings currently under construction, which will add a total of 5.7 million square feet to our inventory. Of the 5.7 million square feet, approximately 50 percent is pre-committed. The major story for the second quarter 2001 is the abundance of sublease space totaling 3.5 million square feet that has become available in the suburban office/R&D market.

There were interesting trends that developed during the second quarter. A major difference from the first quarter 2001 was the increase in showing activity, although actual commitments were still lower than last year’s record high levels. Both tenants and landlords are uncertain about the current market conditions, but both are reacting quite differently. Tenants, reevaluating not only their own businesses but also the rental rate trends, are slow to close transactions. Landlords continue to be very aggressive in attracting the attention of prospective tenants (particularly those with excellent credit) and their brokers by offering incentives such as additional tenant improvement allowances.

The decline in rental rates is due in large part to the amount of sublease space now available in the market, especially since lower rental rates are the primary leasing tool for the sublandlord. However, many tenants still prefer to negotiate with landlords who have the ability to complete transactions based upon term, rental rate, and tenant improvements. In addition, the viability of the sublandlord continues to be a concern for many prospective tenants.

Investment Market
Sales volume in the first half of 2001 actually eclipsed 2000’s mid-year level, checking in at over $1.8 billion despite the slowdown in leasing activity. The number of sales offerings has recently declined and marketing periods and due diligence periods has extended, particularly in markets most acutely affected by the technology downturn. However, the sales of Boston’s One Federal Street, the Watertown Arsenal and Waltham’s Polaroid campus demonstrate that buyers are actively seeking well located, core real estate. Boston’s CBD and Suburban markets have maintained their ranking among the top five national destinations for investment capital.

Pricing and yields for favored product types, namely CBD Boston, multifamily, and industrial, have not shifted materially since the beginning of the year, stabilizing at 50-100 basis points above levels at the end of 2000. There is significant movement in the suburban office sector due to credit and technology exposure issues and opportunities exist to buy assets in fringe locations with excess vacancy. Cash strapped owner/users like 3Com, Lucent, and Polaroid have also marketed their buildings at discounted price levels. Fewer assets are on the market as owners are averse to risking devaluation in a slower leasing market, as interest rates are favorable.

Foreign investors have led the way downtown. While few trophy class buildings are on the market, there are opportunities to enter the Boston market through assets located in emerging neighborhoods including Lafayette Corporate Center and 1&2 Lincoln Plaza.

At the mid-year mark, the pace of office and R&D offerings in the suburban market has slowed, mainly due to rising vacancy rates.

The multifamily market continues to be one of the tightest in the country, with vacancy of just 1 percent, and an annual rent growth of 5-10 percent. Yields for stabilized product are about 8 percent, or 7 percent for superior product, and there are few sites and high barriers to entry for new development.