WILLIAM McCALL
Landlords ‘aggressive’
In a market awash in escalating vacancy rates and declining rents, landlords are aggressively chasing the few large companies searching for chunks of office space in the Greater Boston market. Fierce competition threatens to accelerate the trend toward falling rental rates seen throughout much of 2003, while deep incentive packages offered by landlords such as free rent for a portion of a lease and tenant fit-out improvements leave some brokers wondering how long property owners can stay afloat.
“It’s very hard to generalize, but in general, landlords are being very careful not to lose the tenants they have because the cost to replace them is very excessive,” said William McCall, president of Boston’s McCall & Almy. “Landlords are very aggressive at keeping their existing tenants.”
McCall & Almy pegs the city’s downtown and Back Bay combined vacancy rate at 17.5 percent as the New Year begins. In the suburbs, the vacancy rate stands at 28 percent. All that, coupled with an increase in lease expirations scheduled between 2004 and 2005, has landlords scrambling to fill empty spaces, some of which have now been vacant for years.
The prolonged market downturn, which left the balance of lease negotiating power in the hands of the tenants, has exaggerated the typical flight to quality. Many tenants have traded in less desirable, lower floors for the views of Boston’s Class A tower space at comparable costs. A bifurcated market resulted with vacancy rates below 6 percent on floors 20 and higher at office towers and at more than 20 percent for lower floors, according to Claude Hoopes, principal of Boston’s CRESA Partners.
Those first 15 floors are in serious trouble, according to McCall. Fidelity, at 53 State St., has been trying to sublease its space on floors numbered in the mid-teens for two years, he said.
With vacancy rates at their highest in at least 10 years, landlords are left with few options, particularly when other property owners are offering free rent and tenant improvement as persuasion for a new location.
There are a handful of large tenants floating around the suburbs, some of which are expected to land within the next few months. The German company Straumann, which occupies 25,000 square feet at 1601 Trapelo Road in Waltham, is closing in on a 100,000-square-foot deal in Andover. Straumann is an international scientific research company. GE Panametrics, designer and manufacturer of products such as hygrometers for moisture and oxygen measurements, is searching for as much as 140,000 square feet along Route 3, the publishing house Pearson is looking for 140,000 square feet in the Route 128 area and Centra Software, a company that helps organizations shift group-oriented business to the Internet, needs 60,000 square feet in the same neighborhood.
‘Hanging On’
Kronos, a single-source provider of human resources, also is rumored to be looking at opportunities in the 150,000- to 200,000-square-foot range in Lowell or Chelmsford. Kronos’ broker, Trammell Crow principal John Boyle, wouldn’t comment on the search, except to say that the company is reviewing all opportunities in the marketplace.
One industry watcher, who asked to remain anonymous, said that supply and demand has fostered competition among landlords, a situation that has many property owners or managers biting down on rent prices.
“Landlord A doesn’t want to lose against Landlord B or C – a competitive nature takes over,” he said.
Rents along Route 128 have dropped dramatically. Three years ago, the average rate ranged from $50 per square foot to $60 per square foot. Now, it’s typically between $19 per square foot and $26 per square foot. The industry watcher attributed the huge drop, absent along Interstate 495, to the sparse number of tenants searching for space in the Route 128 neighborhood.
“How long can a landowner that isn’t a large pension fund last?” he said.
Foreclosures and bankruptcies were commonplace in Boston during the early 1990s, when the last commercial real estate slump ran its course. Today, there are few such examples.
“The real estate fundamentals appear to be worse than 1991, yet there’s not the rash of foreclosures and bankruptcies,” said Brian Kavoogian, principal of The Davis Cos. and president of the Greater Boston Real Estate Board. “This time, real estate is far better capitalized than the past.”
Low interest rates also have played a part in helping landlords weather the storm.
In the 1980s, developers could finance a project for 100 percent of cost and 80 percent to 90 percent of value – leaving a small safety margin if the market turned. Today, properties are far better capitalized, Kavoogian said. Most developers are required to contribute 30 percent to 40 percent equity and those that used to go it alone are forced to bring in partners.
“Equity interests are getting hurt but for those people it’s more of a matter of inclination, not ability, to continue,” he said. “If a property’s leased, it’s selling for yields and values we’ve never seen in the market. So they’re thinking ‘if I can just hold on a little longer, I can sell for crazy numbers. If the building’s worth X and I’m able to lease it, I could sell it for one-and-a-half times X.’ So they’re going to wait.”
Despite the slumping commercial real estate market, building sales still commanded hefty prices in 2003. In the largest deal of the year, the John Hancock properties, including the signature Hancock tower in Boston’s Back Bay, sold for $910 million. In August, 99 Summer St. in the Hub sold for $69 million, and in the suburbs, the Norwood Polaroid campus sold for $17.3 million.
As real estate investment trusts continue to outperform the Standard & Poor’s 500, an increasing number of investors are pouring money into real estate investment trusts. The U.S. Securities and Exchange Commission lists about 180 REITs with total assets of more than $300 billion. More than two-thirds are traded on the New York Stock Exchange, the American Stock Exchange and the Nasdaq.
For the properties that aren’t REIT-owned, things still aren’t so bad.
“With the short-term debt and the lowest interest rates in history, the cost of hanging on is very low,” Kavoogian said. “The frustration is for prospective investors who are all trying to make new investments while owners are reluctant to sell.”
