Lt. Gov. Kerry Healey delivered the keynote address at last week’s NAIOP/SIOR mid-year commercial real estate overview in Boston.
Foisting optimism into a mid-year overview last Wednesday, commercial real estate broker James L. Elcock pointed to improved weather, the stock market’s resurgence and even an inspiring Red Sox comeback mounted the previous evening.
By the time some 400 attendees left the breakfast program, rain had begun falling with a cold vengeance outside Boston’s Swissotel. Wall Street staggered a few hours later, posting a near-washout of the major indices. And the slugging Red Sox were silent Wednesday night in Chicago, losing 3-1.
In many respects, the effort to put a bright face on the commercial real estate sector proved equally elusive at the overview, which was co-sponsored by regional chapters of the National Association of Industrial and Office Properties and the Society of Industrial and Office Realtors. Led by a keynote address from Bay State Lt. Gov. Kerry Healey, speakers did their best to offer an upbeat forecast, but most also acknowledged daunting obstacles for the local economy and that real estate still faces a long road to recovery.
“Clearly, we are bumping along the bottom,” said Elcock, a director with Meredith & Grew who delivered a wide-ranging report on market conditions. While insisting that “the majority of the bad news is behind us,” Elcock predicted that office rents will erode further in 2003, and said the region’s suburban vacancy rate is at an all-time high. Landlords who have turned to laboratory users to fill their buildings have seen a sudden drop-off in demand, Elcock added, revealing that no significant life sciences leases have been signed in the past 90 days.
The dearth of activity has led to a climate heavily favoring tenants, seconded CB Richard Ellis/Whittier Partners principal Christopher P. Tosti, who focused on the suburban market. Explaining that companies have so many options that they are making deals “based on colorful carpet,” Tosti advised that physical improvements can help better position a building for lease, citing a recent capital investment at Stony Brook Office Park in Waltham as one example. “You have to spend money on that today,” Tosti said.
Elcock puts the mid-year suburban vacancy rate at 16.4 percent for direct space and an alarming 25.7 percent when sublease opportunities are included for the 117 million-square-foot market. Average asking rents have dropped from a peak of $23.99 per square foot in 2000 to $18.52 per square foot at present. The rate was $19.66 per square foot a year ago, Elcock said.
Tosti cited a few hotspots, including a surge of velocity at the former 3Com corporate campus in Marlborough, purchased several months ago by Berwind Property Group. The broker, Lincoln Property Co., has cemented such tenants as Exact Sciences and Wellington Funds, and is said to be nearing commitments with several other firms for the 540,000-square-foot office park.
“That [complex] not only seems to be doing well, it is (achieving rents) near the top of the market,” said Tosti, with leases there said to be running in the low $20-per-square-foot range. “It’s a great property.”
The so-called flight-to-quality syndrome seen during the real estate crash in the early 1990s does appear to be again in vogue, said both Tosti and speaker Robert M. DeLaney, a principal with Trammell Crow Co. and specialist on leasing in downtown Boston. Tenants who migrated to Cambridge and the suburbs in the past now see an opportunity to return to the Hub, said DeLaney, adding that the completion of the Big Dig and other capital investment in Boston is also becoming a draw.
Tenants “are returning to the center a little bit,” said DeLaney, although he also agreed that pricing remains a key driver for making decisions. “It is a hard time to get tenants to pay a premium for office space,” DeLaney said. Although free rent is more of an equation in the suburbs, DeLaney said there have been some isolated incidents of that plum being offered in Boston, while tenant improvement allowances and more generous parking options are also coming to the fore.
Landlords are accommodating prospects in other ways, said DeLaney, citing a willingness by Equity Office Properties to restructure deals and pursue buyouts as being a main reason the landlord was able to strike new leases with Cambridge Assoc. and the Nixon Peabody law firm at 100 Summer St. in Boston. Corporate-owned properties such as the John Hancock Tower (recently purchased by Beacon Capital Partners) and 100 Federal St. have aggressively pursued deals in the Hub, DeLaney said, showing a willingness to “meet the market” in order to increase occupancy.
Not all landlords are willing to buckle, however, and stricter underwriting over the past decade has led to healthier assets whose owners thus far are not panicking by lowering rents, said Elcock. “They are ready to run a marathon,” he said, leading to prolonged negotiations to complete a lease.
Owners preparing to sell their buildings might be advised to bite the bullet a bit, said Spaulding & Slye Colliers principal Jeffrey B. Swartz, who reviewed the investment market. “Fully leased, cash-flowing real estate will sell well, but if you don’t [boost occupancy], investors will want to see the prices drop,” said Swartz.
Mimicking the path of tenants, Swartz said there has been a flight to quality among real estate investors, who are demanding credit and term in a rental roster. Downtown, Class A buildings are fetching the greatest attention, said Swartz, with Class B and C properties mostly off the radar screen. “We’re back to location and quality again – that is what capital is chasing,” Swartz said.
Interestingly, Swartz and Elcock both said there is a plethora of money pursuing real estate opportunities at present, but the stability aspect is keeping the stock of suburban buildings relatively untouched. Grocery-anchored shopping centers are a popular target, said Swartz, as are apartments and industrial buildings. But while he opined that the multifamily arena is becoming overheated on pricing, Swartz said he is encouraging users to consider purchasing office, flex and industrial buildings, with the historically low interest rates often making such strategies advantageous for that group.
In her remarks on the industrial market, Cushman & Wakefield Senior Director Catherine Minnerly said she is taking a similar approach in doing investment sales. To date, the message appears to be getting across, with Minnerly estimating that 40 percent of the 2 million square feet of industrial properties that have traded in Eastern Massachusetts in 2003 have been purchased by users.
Investors are also chasing industrial opportunities, Minnerly said, with rents holding steady due to limited supply, particularly for modern properties with ceilings of 28 feet and higher. “The industrial market is one of the hottest out there right now,” said Minnerly, who estimates it to encompass 260 million square feet, including 69 million square feet on the South Shore. According to Elcock, the current industrial vacancy rate is 15.3 percent, but markets focusing on high-tech companies have been particularly hurt, sporting a 21.8 percent vacancy.
‘Encouraging’ study
Retailers, medical device firms and auto parts companies have driven the industrial market to date in 2003, said Minnerly, adding that activity has been so solid there is a potential for new speculative construction over the near term. Such a move is unlikely for suburban and downtown office buildings, said DeLaney and Tosti, with a build-to-suit option the most likely scenario for new construction. At present, Elcock said, there are just three new office buildings under construction in the region, compared to a usual average of about 16 starts per year.
In making her address, Healey cited the resiliency of the commercial real estate market in the Bay State, with values still solid despite the recent downturn in rental rates and increases in vacancies. The lieutenant governor also quoted a recent study that showed most Bay State employers are planning to add new jobs or remain the same size in the coming quarter, with only 10 percent anticipating further job cuts.
“This is very encouraging,” Healey said, adding, “We believe the recovery will be slow and gradual, but we do believe it is coming.”
There are challenges ahead, Healey admitted, including a $3.2 billion budget gap and increasing numbers of residents with no health insurance. Competitiveness is also an issue, she said, explaining that the state is now ranked first in cost of living nationally and is second only to Hawaii in housing costs. Alluding to the wet spring, Healey asked the group, “Where would you rather live, here or Hawaii?”
But Healey pledged that the Romney Administration is doing its best to improve Massachusetts as a business center, including a new plan entitled, “Tapping Our Potential.” The effort aims to make government “partners of the business community” rather than an adversary, Healey said, with a predictable tax structure and all-out effort to reduce the cost of living. Increasing affordable housing will be a main target, Healey said.
