Despite the recent economic downturn, the Greater Boston area shows strong industrial activity.
A collective sigh of relief could be heard through-out the commercial real estate industry as the books were closed on 2001. On the whole, vacancy rates climbed steadily throughout the year and rental rates dropped. The U.S., and the commercial real estate market, entered a recession in March 2001 following the collapse of the technology sector, led primarily by the dot.coms, telecoms and related over expansion. The downturn rapidly spread to other industries including manufacturing, financial services and retail. No region within the country was spared this economic decline.
With companies consolidating or closing their doors completely, record amounts of sublease space were being returned to the market. Sublease availabilities reached over 70 million square feet in the suburban markets. This was double the amount of sublease space available in the central business districts. Much of this can be attributed to the types of industries that locate in these respective areas. Typically, financial services, law firms and other non-technology related companies are found in the downtown markets with the technology companies, such as software providers and dot.coms, in the non-CBD’s.
New construction that had been in the pipeline to satisfy pent-up demand from the technology sector was delivered to the market along with the sublease space. However, the CBDs had a well-balanced relationship between supply and demand due largely in part to the preleasing of much of the new construction. Approximately 90 percent of new construction delivered to the CBDs in 2001 was preleased. Washington appears to have had the strongest CBD market, followed by Atlanta and Los Angeles, both of which showed some signs of recovery by posting declining vacancy rates in the fourth quarter.
The suburban markets, however, were not as fortunate. Within the suburban areas nationwide, the construction deliveries exceeded demand by a large margin. The two exceptions to this were northern New Jersey and Los Angeles, markets still operating at or above market equilibrium.
The year-end 2001 industrial vacancy rate was 8.1 percent, up from 6 percent at year-end 2000. The lack of new industrial inventory delivered to the market during the period minimized the increase in the overall supply and vacancy rate. In the industrial market, manufacturing was the first sector hit by the recession with virtually no new manufacturing space delivered in 2001, resulting in a minimal increase in the vacancy rate.
Looking ahead in 2002, there are plenty of positive signs for the real estate market. During the past two years, overleasing occurred, not overbuilding, in many areas throughout the U.S. This was especially true in the CBD markets. Therefore, as the economy continues its recovery and demand for space increases, the vacancy rates will begin to stabilize, and in many areas, decrease. Rental rates will then begin to settle back into the pretechnology boom range. This is expected to happen first in the CBDs of the major U.S. markets because the majority of new construction delivered to the markets was in the non-CBD sector.
Industrial Strength
Nationally, several markets showed strong industrial activity, despite the downturn. These markets included Boston, Philadelphia, central and northern New Jersey, Dallas and Atlanta. On another positive note for the industrial sector, construction activity is projected to slow during 2002 and 2003 and be less speculative in nature. The dearth of current availabilities, coupled with the limited amount of new construction will continue to keep the rents relatively stable and the vacancy rates low.
Healthcare, life science, medical research and pharmaceutical industries actually showed signs of growth during the country’s downturn. In addition to these sectors, old-line manufacturing firms, computer hardware and chip manufacturing are expected to be among the first to emerge from the recession. Specifically, the computer hardware and chip manufacturers will begin to recover as demand returns and pressure mounts to restore inventories. Regional economies, including the Southeast, Southwest and “Rust Belt” (Illinois, Indiana, Michigan, Ohio and Pennsylvania), in which these industries are located, will be positively impacted by their recovery.
Another positive was the relative healthiness of landlords compared to that of tenants. Landlords maintained higher direct asking rental rates throughout 2001 despite increased vacancy rates. By and large, landlords were still paid for space left empty by companies downsizing, consolidating or closing their doors through rent or security deposits. Therefore, they did not immediately feel the pressure to decrease their rents until just recently when their direct space began competing against sublease space. Currently, landlords are offering incentives and concessions to lure prospective tenants to direct space. In doing so, they found tenants who prefer to deal directly with the landlord, than with a sublessor. Landlords have also been aggressive in their offers to renew existing tenants.
The recovery process for the real estate industry will be helped in part by the control of supply. During this downturn, lenders have restrained developers thus keeping large amounts of space from being developed and delivered to the market. The exceptions to this were the telecom and technology office markets that attempted to meet the burgeoning demand for space during the technology-driven surge in the economy. As suburban markets softened, they were left with large quantities of space never utilized by the dot.com and telecom industries.
The real estate industry has weathered recessions in the past. During the last downturn in the late 1980s and early 1990s, it led the economy into the recession with a flurry of over lending and overbuilding. Many have said it was the real estate industry that was “sick” in the previous recession. However, it has been the innocent bystander in the current recession, waiting impatiently for the tenants to return to the market. The year 2002 should see the imbalance between supply and demand slowly close as the economy continues to stabilize after a substantial growth period, which ended in 2000, a growth rate that was considered by many to have been an unsustainable anomaly.
