According to CB Richard Ellis/Whittier Partners President Andrew W. Hoar, commercial real estate activity in Boston has begun to pick up, but the city’s office market is still struggling.

Summer may have finally descended upon the Bay State, but that apparently does not mean a warm-up is in store for the region’s commercial real estate sector, with most panelists at a mid-year overview last week forecasting a decidedly tepid recovery during the final half of 2002.

“You walked out of there thinking people were cautiously optimistic at best,” concurred broker Robert B. Richards, who spoke on the Cambridge office and biotech markets. “They seemed to be searching for good news … but I don’t think there was much [evidence] any is out there right now.”

Indeed, Richards’ revelation that the devastated Cambridge office market saw a miniscule dip in vacancy in the second quarter was one of the few positive signs offered at the event, although keynote speaker Sara Johnson did stress that the national economic recovery is under way and investment broker Michael G. Smith of Spaulding & Slye Colliers predicted a stronger second half for commercial property sales. The Thursday overview at Boston’s Seaport Hotel was sponsored by the National Association of Industrial and Office Properties and the Society of Industrial and Office Realtors.

Activity in Boston has begun to pick up, but speaker Andrew W. Hoar said the city’s office market is still struggling, with negative absorption of 400,000 square feet in the first six months of 2002. The vacancy rate has climbed to 8.2 percent, while availability levels are up to 14.9 percent. The latter number is a result of 3.01 million square feet of sublease space flooding into Boston during the past year, including just over 2 million square feet in Class A properties.

“The subleasing has continued to be a huge drag on the market,” acknowledged Hoar, president of CB Richard Ellis/Whittier Partners. As a result, average asking rents have fallen to $41.54 per square foot, and could drop another 5 percent to 8 percent by year’s end, said Hoar. CB/Whittier is forecasting total negative absorption of 700,000 square feet for 2002.

Hoar said CB/Whittier has identified 3.1 million square feet of requirements for Boston office space, up from 2.2 million square feet last October. But while there were 19 significant lease deals during the first half of 2002, accounting for 1.1 million square feet of volume, Hoar said the increase is primarily from companies with lease expirations in 2004 and 2005 that are beginning to explore the market as opposed to expansion needs.

“This is a lease-driven market and not a demand-driven market,” said Hoar, who predicted it will remain so in the coming months. CB/Whittier does anticipate conditions will stabilize next year, and some of the city’s better properties could see rent growth by 2004. The vacancy rate ultimately will peak in the 14.5 percent range, Hoar predicted. He did note that Boston continues to fare better than other markets, rating second nationally in both vacancy rate and average rents. Washington, D.C., has the lowest vacancy at mid-year with 5.5 percent, while New York City is first in asking rents at $44.74 per square foot.

‘Best News’

Across the river in Cambridge, a glut of office space added in recent years has been whittled away considerably by a trend of converting space to laboratory and research uses, said Richards, president of Richards Barry Joyce & Partners. That contributed to a drop in vacancies between the first and second quarter, with the mark falling from 15.8 percent to 15.6 percent.

While barely noticeable, it does indicate that the worst may be behind Cambridge, said Richards. A sudden spate of office deals late in the second quarter has helped bolster that possibility. RBJ&P brokers have completed more than 100,000 square feet of office leases in the past month, including 20,000 square feet by pharmaceutical giant Novartis, which is taking excess space left over by Forrester Research.

“It’s the best news we’ve had in this market in a long time,” said Richards. The activity will only be noteworthy if Cambridge is able to build off it, said Richards, but he maintained it is encouraging considering that market was one of the first to suffer the reversal of fortune from the boom period enjoyed through 2000.

“We are certainly going to be keeping a very close eye on Cambridge to see if the level of activity increases over the next six months,” said Richards.

The other Cambridge market – biotech and medical research – continued to improve in the first half of 2002, with the biggest boost coming when Novartis committed to 255,000 square feet at 100 Technology Square. The firm is said to be seeking additional laboratory space in that East Cambridge market. With Boston ranking first in research monies from the National Institute of Health, Richards said most believe the interest in Cambridge lab space will continue this year, although he also warned that the city is beginning to receive competition from suburban property owners eager to grab a share of the biomedical pie.

Given the ongoing woes of the suburbs, it is certainly understandable why landlords might be seeking new users, with panelist Garry R. Holmes delivering a disconcerting overview of that 76.5 million-square-foot market. The president of R.W. Holmes Realty said the suburbs have seen negative absorption of 725,000 square feet in 2002, with vacancies at 24.8 percent and average rents plummeting to $24.50 per square foot.

Holmes said landlords will continue to struggle to raise rents in the current environment, particularly with the Central Route 128 submarket currently sporting a 29.5 percent vacancy rate, only slightly better than the worst showing, a 30.2 percent mark posted in the technology-heavy Interstate 495 submarket.

“It’s pretty alarming,” Holmes said of the core submarket’s vacancies. “That’s really ground zero, and for all intents and purposes it sets the stage for rents” elsewhere in the suburbs. As a result, he said, landlords in the Route 128 North and South markets are forced to be even more aggressive in pricing product. Free rent and generous build-out allowances are commonplace, he said, with the greatest activity coming from tenants trading up for more desirable space.

As with Boston and Cambridge, subleasing continues to hinder any suburban rebound, said Holmes, estimating such opportunities account for 40 percent of the 19 million square feet available for lease. The suburbs have averaged 1.75 million square feet of net absorption annually during the past decade, Holmes said. Even if it is able to attain that pace during the next five years, the suburban vacancy rate would only be whittled down to 12 percent, Holmes said, adding that reaching the average this year seems a fantasy at present.

“This is not a scenario that is going to turn itself around soon,” said Holmes, adding, “We are really going to have to grind it out over the next 18 months” to make a dent in the supply.

‘Modest Recovery’

The Massachusetts industrial market has also seen some erosion, but speaker Gregory Klemmer of Klemmer Assoc. said that sector has fared much better than office space, partly due to the conversion of numerous industrial buildings into other uses during the prolonged real estate boom. From the mid-1990s to the peak in 2000, 5.5 million square feet of industrial supply was eliminated for office and flex space, said Klemmer, while another 2.2 million square feet was snapped up when developers became enthralled with the ill-fated telecommunications boom.

As a result, the vacancy rate has remained in check for industrial supply, while rents have also been relatively steady. “The mood is good, considering everything that has gone on,” said Klemmer, with land and industrial product especially scarce north of Boston. Among the upbeat developments in the first half was Jordan’s Furniture’s plans for a 750,000-square-foot distribution center in Taunton, as well as a 203,000-square-foot lease by Analogic in Haverhill.

The investment front is also showing signs of strength, said Smith, who told the audience of 500 that the property sales fundamentals are the exact opposite of the office leasing effort. Whereas that market is plagued by low demand and excess supply, investment sales have seen plenty of investor interest, but little in the way of deals to chase. Unlike the early 1990s, when the recession led to massive property foreclosures and distressed sales, Smith said building owners have enough equity in place to weather the current storm. Coupled with low interest rates that have increased the refinancing business, owners are receiving enough operating income that they do not have to sell in the current climate.

Investors, meanwhile, have remained bullish on Boston, said Smith, with few apparently concerned over the office market’s difficulties. He noted that Lafayette Corporate Center in Boston’s Downtown Crossing district was purchased recently by the Abbey Group, while One Boston Place is under agreement, with Teachers Insurance and Annuity Association said to have tied up that 41-story Boston office tower. And interest at One Beacon St., another downtown tower, appears to be brisk. “Boston is still a very desirable marketplace globally,” said Smith, adding there is a broad spectrum of investors chasing deals.

Given the spread between bidding and asking prices, Smith said it has been harder to complete deals in the first half of 2002. In reference to the ongoing World Cup soccer matches, Smith likened the investment activity to that sport by saying that the first six months saw “tons of action and not a lot of scoring.”

As for the remainder of 2002, Smith predicted investor demand will prompt more sellers to enter the pool. Core, stable assets will generate the most competition, he said, while value-added plays could lag behind if investors do not adjust their underwriting criteria.

Another glimmer of hope at the NAIOP-SIOR program came from keynote speaker Sara Johnson. The economist, managing director of DRI-WEFA, said gains are already being made in economic conditions, with the recession bottoming out last November. Strong consumer spending has helped limit the recession’s impact, she said, while quelling concerns that the economy could lapse back into another recession in the coming months.

There is only a 25 percent chance that a so-called “double-dip recession” will occur, said Johnson. But while things are on the upswing, the economist added that there will not be a robust boost at the outset, as seen in previous recoveries. “The good news is that the recovery has started, but so far it has been a modest recovery,” she said.

The national office vacancy rate has risen from an average of 8 to 15 percent, said Johnson, with high-tech markets such as San Francisco, San Jose, Calif., and Austin, Texas, among the most heavily impacted. Locally, Boston’s financial services industry should begin to turn around, she said, while the manufacturing arena should also see an uptick.

Job growth among office workers will not be especially solid, said Johnson, who said Massachusetts has lost 68,000 jobs since January 2001. Another concern, she said, is that venture capital spending for new startups has been anemic, while the Interstate 495 office sector shows little sign of activity. “That market is simply not going to come back,” said Johnson.