Ronald K. Perry – ‘Champagne toasts’ over

Just because it’s time to sober up does not mean the party is over.

In essence, that was the message delivered last week at Meredith & Grew’s 22nd annual Trends in the Real Estate Market presentation at the Sheraton Boston, with most of the speakers at the event insisting that the difficulties seen in the final quarter of 2000 will not transcend to widespread problems in the coming months.

With an estimated 700,000 square feet of sublease space suddenly available in Boston after difficulties multiplied among technology firms late last year, M&G Senior Vice President Ronald K. Perry acknowledged that there will be “no more champagne toasts” as the industry begins 2001.

Landlords, Perry said, should not anticipate a return the levels seen in to mid-2000, when the booming economy and a dearth of supply sent rental rates into the stratosphere and locked tenants into bidding wars for the few options available. Average rents grew 18 percent in the city to a $50 per-square-foot average. Top deals of $85 per square foot in Boston were achieved at both 125 High St. and International Place, while the city’s vacancy rate dropped to 2.2 percent overall and 1.5 percent in the Financial District.

Most of the records were posted prior to the fourth quarter, when the momentum abruptly reversed itself. Whereas a 25,000-square-foot office tenant had just seven options in mid-2000, Perry said there are up to 14 buildings with that much available space to choose from today. Among the larger subleases are 100,000 square feet at the Seaport Center East in South Boston and 50,000 square feet freed up by Sovereign Bank at 75 State St. Tenants who “needed Rolaids this past year” can find relief from a more stabilized environment, Perry said.

“The frenzy has slowed, and we are operating at a much more fundamental pace,” said Perry, adding that he thinks demand will be more disciplined and will largely be driven by traditional firms such as financial services, legal and accounting operations. Even with the focus on New Age technology companies in 2000, Perry said the old-line economy was a major driving force last year, representing 85 percent of the 1.5 million square feet of net absorption seen in the 50 million-square-foot Boston office market.

A similar pattern occurred across the river in Cambridge, M&G Senior Vice President Joseph P. Flaherty said in his address to the several hundred people attending last week’s seminar. After enjoying “record everything” in the first half of 2000, Cambridge’s office market cooled considerably in the latter stages, with a vacancy rate of well below 1 percent increasing to 3.4 percent by year’s end. While still among the tightest around, the market is now awash in sublease opportunities, said Flaherty, offering tenants a slight bargaining tool.

“It’s pretty clear that the dramatic run-up in office rents of the last two years is over,” said Flaherty. Rates grew between 35 percent and 65 percent in 2000, with the top deal a $75 per-square-foot pact at 8 Cambridge Center. Kendall Square rents now average $60 to $70 per square foot, while the Alewife district is in the $48 to $55 per-square-foot range.

Responding to the need for space, coupled with a rush to beat new zoning regulations, Cambridge currently has 15 office and research buildings under construction, with the 1.5 million square feet of space slated to be delivered during the next 16 months. But while that will take some pressure off the constrained supply, Flaherty warned it could be the last major boost for some time, with the zoning rules and real estate prices creating “real and formidable” barriers to entry.

“From an owner’s perspective, Cambridge remains a very strong market,” Flaherty said.

Suburban landlords also have little to lose sleep over, M&G Senior Vice President James L. Elcock said in assessing that market. Although he agreed activity will not be as boisterous as in 2000, he nonetheless said that “in this case, slow is a relative term.”

“The suburbs are well-positioned to make this a smooth transition,” said Elcock, who predicted vacancy rates will stay in the single digits, absorption will be positive and the economy will remain solid. After a record 8 million square feet of net absorption last year, Elcock said he anticipates between 3 million and 4 million of net absorption in 2001, or about the average seen in the suburbs during the past five years.

Speaking on the financing climate, Executive Vice President Kevin C. Phelan said the leading sources will include life insurance companies, commercial mortgage backed securities and banks. With demutualization continuing, insurers may soon have more capital available, Phelan said, while CMBS remains an option despite a backslide in activity last year from $47 billion to $41 billion in CMBS issuance. Borrowers have been turned off from CMBS by the prospect of having their loans retraded or having deals change mid-stream, but Phelan insisted that “they are still an excellent source” of capital.

One interesting change that has developed recently is the preoccupation with tenant quality in offering funding, said Phelan, who added that “buildings are being looked at from the inside out rather than the outside in” by lenders. Solid-credit tenants will help attract financing, he said. Banks, meanwhile, “are looking for real equity in deals,” said Phelan, who maintained that such institutions continue to display “paranoia of past sins” in their lending practices.

‘Extraordinary Situation’
“We are not overbuilt, and will not be overbuilt, because our regulatory process will not allow it,” Phelan said.

In assessing the investment market, M&G Senior Vice President James F. McCaffrey agreed that the dominant question for most as the year begins is “is it over?” For the most part, McCaffrey argued that conditions are not as bad as they have been portrayed, especially in the so-called Technocorridor, which dominates much of Eastern Massachusetts. Even with the stock market woes of recent months, plus layoffs at several companies, McCaffrey said there is still plenty of venture capital money pouring into the region, while such players as Nortel, Cisco and Sun Microsystems remain committed to the Bay State.

“Winners will emerge, and losers will die,” McCaffrey said of the competitive optical networking industry, one which accounted for much of the activity last year.

The keynote speaker for M&G’s program was Edward H. Linde, president and chief executive officer of Boston Properties. Linde, who opened with a tongue-in-cheek prediction that “things will either be very good or very bad,” tended to side with the former in his presentation, noting that “in our portfolio, there is no space available.”

“There is no cause for undue alarm,” Linde said. “As certain tenants pull back, there are other tenants waiting to fill their shoes.”

Another trend which should keep supply from getting out of whack is the austere approach being taken by lenders, said Linde. Not only has consolidation limited the number of available capital sources, those that remain are demanding high loan-to-value ratios, Linde said, and want to see solid pre-leasing prior to backing new construction.

“Real equity is required,” he said.

In his remarks, M&G President Thomas J. Hynes Jr. attempted to put a positive light on the recent upheaval, declaring himself “cautiously optimistic” about the coming year. Hynes said Boston and the surrounding region has a number of reasons to remain upbeat, including progress on the Big Dig, the area’s wealth of educational institutions and a deep financial services industry. The city is well-poised to take advantage of the technology revolution, he said, as witnessed by Wired magazine’s listing of the Hub as the second best place in the world to establish a high-tech firm.

“I always like to compare Boston to the rest of the United States, and I take comfort in that comparison today,” Hynes said. “We truly are in an extraordinary situation.”

Greater Boston Office Market Seen Slower but Strong in 2001

by Banker & Tradesman time to read: 5 min
0