About 3 million square feet of office space is currently under construction in Boston, according to figures compiled by Cushman & Wakefield.
As it braces for another turbulent year, commercial real estate appears to have one advantage that was missing at the start of 2001 – low expectations.
The expectations have been adjusted down to meet the market, said George J. Fantini Jr., founder of Fantini & Gorga/iCap Advisors. Things are a little clearer now than they were last year.
Unlike 12 months ago, when many insisted the economic downturn was temporary, Fantini said the problems are now in full view, providing for keener response by industry professionals. On the development end, for example, he predicted there would be few, if any, new office projects launched in 2002 because rental rates do not exist to support such development. With strict underwriting in place, developers would need a pot of equity to get a building under way, Fantini said.
Why would a developer put a pot of equity into a project that is marginally feasible?’ he said. Clearly, development activity is going to be stressed.
Cushman & Wakefield estimates there is just over 6 million square feet of office space under construction in suburban Boston and another 3 million square feet under way in the city. Cushman & Wakefield Managing Director Randy Harwood said he believes the amount is manageable, noting it is considerably less than what was in the pipeline during the real estate crash of the early 1990s.
It’s not a drastic situation like we had 10 years ago, Harwood said. The users and suppliers of space were much more disciplined this time around.
As with Fantini, Harwood said he thinks speculative office development will be rare in the coming months. I think 2002 is going to be tough, he said, with little improvement anticipated until the following year. Cushman & Wakefield projects that rents in Boston will fall at least another dollar to $48.49 per square foot before stabilizing, while vacancies will continue to rise from the current 11.6 percent, but will drop back to single digits by 2003.
On the suburban front, Cushman & Wakefield pegs the current vacancy rate at 16.6 percent, nearly triple the 5.5 percent seen at the start of 2001. Reflective of new construction and higher vacancy rates, Cushman & Wakefield anticipates suburban asking rents will bottom out at $28 from the current mark of $32.25 per square foot.
We’re of the opinion that it is going to be a relatively slow six months, and hopefully things will have stabilized by the mid-year [point], said Cushman & Wakefield Managing Director Kevin Hanna.
McCall & Almy principal William F. McCall said he sees no improvement on the horizon, largely because companies continue to lay off workers. The demand side of our business is based on one thing – job growth – and right now, America and our area is going the other way, McCall said, adding, I truly don’t see a turnaround anytime soon.
Accepting ‘Reality’
Given that, it could be a difficult year for those office building projects that are moving forward, including a 160,000-square-foot building nearing completion in Wakefield, as well as 131 Dartmouth St and 33 Arch St., a pair of towers underway in Boston. If you have a project that’s ready for immediate delivery, it’s not good, acknowledged Fantini, although he and others said there is likely enough lead time between now and 33 Arch St.’s opening to allow for an economic rebound.
CB Richard Ellis/Whittier Partners principal Gary J. Lemire agreed that Boston is facing a challenging year, but said he nonetheless anticipates investor interest will remain strong for Massachusetts assets. I’m optimistic there are deals that will get done, said Lemire. It’s not going to be great, but I think it’s going to be OK.
Investment sales were slower in 2001 than they have been in some time, but Lemire attributed the decline more to sellers than buyers, with many owners unwilling to adjust their asking price to get a deal completed. Unlike 10 years ago when properties were often overleveraged, Lemire said owners today are better positioned with the assets, making it less likely there will be a forced sale.
Fantini said the chasm in pricing widens when a market is in transition as it has been during the past year. Once it becomes evident that values are headed down, Fantini said he believes there will be a greater impetus for compromise.
The bid/ask gap will narrow as sellers begin to recognize that the high prices they have been holding out for are not going to be achieved, Fantini said. They are going to have to accept the reality of the market and adjust their prices downward.
And Fantini predicted that phenomenon would begin to take hold in 2002. Once it does, buyers will once again flock to the market seeking deals, according to Fantini. There’s plenty of cash on the sidelines, he said.
Others question whether there will be such a correction, however. Harwood said many owners will think twice about selling into a down market, especially when they have the option of refinancing or are not in a distressed condition that forces their hand. Unless the seller really has to [trade a property], I think most people will hold off, he said. They don’t have a gun to their head like they did 10 years ago.
Equity Residential Properties Trust remained in a holding pattern for much of 2001. President Doug Crocker cited a surge of institutional capital as one reason, with interest in multifamily properties driving up prices to a level where yields were diminished substantially. With institutional capital less of a factor, Crocker said Equity may become more active in purchasing properties during 2002.
Equity is upbeat about the national multifamily sector for the long term, although Crocker said occupancy for apartments will drop in the first two quarters before rebounding in the third quarter. That is because of aggressive new construction efforts that delivered some 300,000 new units annually. The market will not reach 250,000 starts in 2002, said Crocker, and will fall to between 175,000 and 200,000 units by 2003.
Assuming even a mild economic recovery, the apartment market will tighten up dramatically in 2003, setting the stage for improved fundamentals, said Crocker.
