Office rents have come crashing down across greater Boston. Where they’ll come to rest – and when – remains uncertain, but it is a matter of crucial importance to landlords who are already feeling pinched by the current commercial downturn.
The longer, and deeper, rents slide, the closer landlords creep to blowing their margins – and, potentially, losing their buildings.
Over the past year, from second quarter 2008 to second quarter 2009, asking rates in greater Boston Class A properties have fallen 20 percent, according to data from Jones Lang LaSalle. In Boston’s Financial District, published rents have dropped 23 percent. In the Back Bay, they’re down 36 percent. Across all asset classes in the region, year-over-year asking rates are down 18 percent. Concessions such as free rent are pushing published rates down another 10 percent, according to tenant brokers CresaPartners. And rents still haven’t hit bottom.
Office Building Bets Busted
Crashing rents sow distress in their wake. The first wave of that distress hit Boston earlier this year, when New York investors Broadway Partners lost the Back Bay’s John Hancock Tower and Waltham’s Bay Colony Corporate Center in quick succession. The two peak-market acquisitions totaled 2.7 million square feet, and cost Broadway upwards of $1.6 billion. In each case, Broadway had made a big bet that it could drive rents skyward, and paid dearly when that bet soured.
Gale International suffered a similar fate this month. The development firm, along with its joint venture partners Mack-Cali Realty and JP Morgan, yielded the keys on a seven-building office portfolio along Route 3 and I-495. A mortgage maturity triggered the property surrender, although Gale and Mack-Cali didn’t have to struggle mightily with the decision. They bought the portfolio for $53.6 million in 2006, betting they could drive occupancy and rents higher. However, in the 36 months the partnership controlled the office portfolio, it posted a net loss of $13.8 million – a figure that’s more than 25 percent the portfolio’s original purchase price. Last year, the portfolio lost $5.1 million.
And there’s more pain coming. Property & Portfolio Research (PPR) is predicting that, from the third quarter of 2008 to the downturn’s eventual bottom, rents across metro Boston will fall 30 percent.
“We still have half of it left,” said Mark Hickey, an analyst at PPR. “The fall will be pretty harsh.” PPR includes Worcester, southern New Hampshire and Rhode Island in its Boston metro region.
Joe Sciolla, managing principal at CresaPartners in Boston, believes rents in some submarkets, such as 495-North, can’t go any lower, because landlords there are already close to doing underwater deals. He predicts rents in Boston, Cambridge and 128-West will fall another 5 percent, and that “at least 50 percent of the market will be at, or close to, break-even. That’s pretty substantial.”
Sciolla added that after rents stop falling, they’ll stay flat until 2011. That, he said, will inevitably leave landlords “just on the doorstep of foreclosure.”
‘A Bad Formula’
Mike Smith, a managing director in Jones Lang LaSalle’s capital markets group, cautioned it’s tough to draw broad conclusions about property owners falling into distress because “everyone’s basis is different. Basis has nothing to do with market rent.”
Smith added, “Particularly with anything acquired in the 2006 or 2007 timeframe with heavy debt, in all likelihood there’s some form of stress on the properties. Vacancies are up, rents have turned or flattened, there’s been an expansion in yield requirements for investors – that’s a bad formula.”
At a recent Real Estate Finance Association conference, Brian Kavoogian, president of Charles River Realty Investors, said his firm did a lot of sitting on its hands during the boom because “it was pretty clear … prices were way outside the [historical] range.”
Asset prices, Kavoogian said, “were reaching levels we had not seen before. You had to believe in a level of rent growth that, for most of us, was hard to imagine. It was hard to imagine tenants paying $85 per square foot for view space on a regular, consistent basis.”
But David Begelfer, CEO of NAIOP Massachusetts, drew a sharp comparison between the current commercial downturn and the one that followed the banking crisis of the early 1990s.
During that recession, Begelfer recalled, “We started with high vacancy. You lowered your rent and nobody would bite, because there was no demand. Zero. Right now, the talk is that the recession has bottomed, we’re going to see slow growth – there will be job stabilization by the end of the year. That means not going to see a freefall of rents. I don’t think you’ll see a [further] dramatic drop in rents because there’s been some stabilization on the demand side. Other parts of the country – Florida, Phoenix – they’re having all the problems we had in 1990.”
Begelfer added that while properties that traded in the past few years may fall into distress, “a lot of owners have owned for more than five years, and have a lot of equity in their property. And all rents not coming due this year and next.”
