Federal Reserve Bank economist Yolanda K. Kodrzycki last week told commercial real estate owners and brokers that “business is way down.”
If the start of the new millennium is any barometer, it could be a long thousand years for commercial real estate.
Six months into 2001, the phenomenal boom period enjoyed by the industry during the past five years has all but evaporated. Plummeting rental rates, negative absorption and a cascade of space being returned to the market stand in sharp contrast to the record campaign enjoyed for most of 2000, panelists at a real estate forum acknowledged last week.
“Business is way down,” Federal Reserve Bank economist Yolanda K. Kodrzycki told a packed audience gathered at the Swissotel in Boston last Thursday. “Things are so far down, we hope there’s only one way to go.”
Kodrzycki was keynote speaker at the mid-year program, co-sponsored by the National Association of Industrial and Office Properties and the Society of Industrial and Office Realtors. While stressing that most of her colleagues still feel a recession can be avoided, Kodrzycki said business appears “sluggish” to this juncture, with the Fed’s latest survey of local business leaders providing a decidedly dour tone.
“Our contacts were nervous about the outlook,” said Kodrzycki. “It was certainly a negative feeling we got” from the respondents.
The 5.6 percent hike in the country’s gross domestic product last June was always considered unsustainable, Kodrzycki said, so few analysts worried when GDP growth slipped to a “subpar” 2.2 percent at the end of the third quarter. But when it dropped to 1.3 percent by year’s end, she said, “the concerns really started mounting.”
Massachusetts had lagged behind the rest of the country with the latest slowdown, but Kodrzycki told attendees that the Bay State is quickly catching up with other regions. After hitting a historic low of 2.3 percent in December, the state’s unemployment rate has jumped to 3.5 percent, said the economist, with unemployment insurance claims continuing to rise. Temporary job companies are being especially hard hit, Kodrzycki said, while demand for high-tech workers “has fallen off a cliff.”
“The view is that it’s not going to come roaring back,” Kodrzycki said of the local economy, although she did stress that commercial real estate remains one of the area’s stronger sectors, and in the coming months, “the positives will outweigh the negatives.” Among other things, Massachusetts continues to have a healthy balance of supply vs. demand for both office and housing stock, Kordrzycki said, adding that recent interest-rate cuts should start having a beneficial impact as the year progresses.
On the investment sales front, panelist Lisa Campoli of Insignia/ESG said there has been a shift in the type of buyers and their motivation, maintaining that “there is capital, but it is looking to exploit the volatility” of the market. Buyers of Class A assets, particularly pension funds, are increasingly selective in their targets, Campoli said.
“When the core players stay out of the deals, we all feel it,” she said. “And right now, they are sitting on the sidelines for certain types of assets.”
Although such investors are still willing to pursue properties in urban locales, most are forsaking suburban office product, for example. “Apartments are gold for all the obvious reasons,” Campoli said, including constricted supply and the difficulty of building additional facilities. Capitalization rates help illustrate that point, fluctuating between an average of 7.5 percent for multifamily deals up to 10.5 percent for suburban office buildings.
The perception of plentiful space in the state’s 63 million-square-foot suburban office market has cooled interest in those properties, Campoli explained, although she added that a savvy investor might want to take advantage of the decreased competition. “You’ve got an asset that’s clearly out of favor, and therefore a great buy,” she said.
From a leasing standpoint, the suburban market is not as desperate as it might seem, CB Richard Ellis/Whittier Partners principal Christopher Tosti said in his remarks. While admitting that activity is “very, very slow,” Tosti claimed the mood is bleaker than it should be because the market is being unfairly compared to last year’s record performance, a time when suburban rental rates soared to new highs and companies fought over the tiniest bit of space available.
“Actually, I think the market is pretty normal,” Tosti said. “It feels terrible, of course, but we’re really not in bad shape.”
Tosti estimated that the current suburban vacancy rate is 10.9 percent, up from 8.4 percent for the same period a year ago. A cautious approach among lenders has helped keep supply relatively in check, he said, while traditional companies are doing their best to fill in the void left by the demise of the technology industry. Still, Tosti did acknowledge that rents would continue to fall through the end of the year, quipping that, “We’ll be blue until ’02,” with demand remaining flat over the next several months.
‘A Tenants’ Problem’
Speaking on Cambridge, Spaulding & Slye Colliers principal Debra Gould said there is a range of opinions on whether the office market there will recover substantially in the coming months. Like the rest of metropolitan Boston, Cambridge enjoyed an outstanding 2000 only to see its record-low vacancy rate collapse in lock step with the technology crash.
After soaring by 46 percent to an average of $65 per square foot last year, rents have fallen between $12 and $20 per square foot since then, while available space has grown from 4 percent to an alarming 18 percent since the start of the year.
But because much of the space returning is in the form of sublease deals, Gould said there is a sense of stability among property owners.
“The problem right now is a tenant’s problem,” she said. “It’s not a landlord’s problem.”
Another positive for Cambridge is the continued health of the biotech and medical research sectors, Gould added, noting that many landlords with excess space are moving to convert them into laboratory uses. Office space at Technology Square (175,000 square feet), 300 Third St. (128,000 square feet) and 770 Memorial Drive (51,000 square feet) are all being repositioned as lab space, said Gould, lending further hope that the overall vacancy rate will ultimately return to healthy levels.
Across the river, Boston is feeling the impact of the slower economy as well, said Meredith & Grew Senior Vice President Ronald Perry, but he also downplayed the chances of a prolonged slump. Even with vacancy rates increasing from 4.9 percent to 7.1 percent since the start of the year, Perry said the market continues to hold its own, with little fear of a return to the 17.2 percent vacancy seen in 1991.
The office tower market, for example, remains especially tight, Perry said, with space above the 20th floor at just 4 percent vacancy, and offerings below the 20th floor at 6 percent vacancy. Most of the sublease space is located in fringe districts such as North Station or Fort Point Channel, where space can be had for as little as $35 per square foot. Top tower space is fetching upwards of $65 per square feet, he said.
Rents will continue to slip through the end of the year, said Perry, predicting that “we’ll have a soft landing for the second half of the year.”
One sector that has fared well thus far in 2001 is the industrial market, panelist Joseph P. Plunkett said during his overview. One reason, he said, is that high-tech companies never got heavily into that arena, meaning their demise had little impact on manufacturing, warehouse and distribution properties.
“The industrial market is very, very steady, and it is being anchored by old-economy tenants,” said Plunkett, a director at Cushman & Wakefield. Recent deals include a 350,000-square-foot commitment by Trader Joe’s at the Myles Standish Industrial Park, a 112,000-square-foot lease by Federal Express at the Raynham Woods Commerce Center and the TJX Cos. lease for 139,000 square feet at 145 Plymouth St. in Mansfield.
Vacancy rates vary widely, Plunkett said, from a low of 4.5 percent in the MetroWest market to 20.3 percent in Fall River and New Bedford. Average rents for warehouse space has been on the upswing, growing from $5.44 per square foot last year to $6.40 per square foot today.
