The recent $123 million purchase of 50 Milk St., a 21-story tower in Boston’s Financial District, is seen as one indicator that investors’ interest in office buildings has increased.
There was good news for everyone at last week’s Boston office market forecast sponsored by Meredith & Grew Oncor – with one glaring exception.
“Tenants beware,” M&G President Thomas J. Hynes Jr. cautioned an audience of commercial real estate investors, owners and users at the Langham Hotel. Battered by a weak economy and flood of company downsizings and mergers, office landlords are finally seeing the pendulum creep in their favor, maintained Hynes, a sentiment echoed by Ronald K. Perry in his overview of the Financial District and Back Bay submarkets, where 80 percent of the city’s office space is located.
“We think it has begun,” M&G’s downtown leasing chief said of the recovery, reporting a blip in rents for tower space in the best addresses and projecting leasing velocity of 5.5 million square feet this year. M&G anticipates Boston will reach 1 million square feet of net office absorption in 2006, a yardstick not achieved in the new millennium. Having already absorbed 450,000 square feet to date, the market should reach 750,000 square feet absorption in 2005, Perry said, but depressed rental rates still running from $33 per square foot to $47 per square foot (compared to a market high of $65 per square foot in 2000) will likely prevent new office construction from moving forward.
Personified by guest speaker John N. Spinney Jr., whose Investors Bank & Trust Co. (IBT) just leased 505,000 square feet in the Back Bay at a 20 percent cut in occupancy costs, Hynes acceded that tenants remain in control. But while there remain “great packages” of free rent and generous tenant improvement allowances, the veteran broker advised that improving fundamentals and other signs show the bleak leasing climate is changing. “There is an awful lot of money being spent betting that rents are going to go up,” Hynes said.
M&G Executive Vice President Lisa M. Campoli concurred that investors have increased their appetite for office buildings, citing the $448 per square foot paid for 50 Milk St., a 21-story Financial District tower bought in May by a client of TA Realty Assoc. That $123 million transaction is among several high-profile office building sales consummated this year. One million square feet has disappeared from Boston’s office inventory for conversion to residential, Campoli estimated, but confidence in the economy is also driving activity, even for Class B buildings. Among this spring’s many deals, for example, was the $37.5 million purchase of 18 Tremont St. by a New York group that is keeping the 202,000-square-foot property near Government Center as office space.
‘Ready to Move’
Given the lack of a mega-deal such as the $705 million sale of One Lincoln St. or the $910 million acquisition of the John Hancock Tower, total dollar volume could be down in 2005 compared to recent years, said Campoli. That prospect belies the stream of deals occurring locally, she stressed, so much so that overseas investors and institutional capital once focused on urban assets are now trudging to the suburbs, albeit targeting “only the best buildings in the best submarkets.”
To date, $656 million of commercial properties have been acquired in Greater Boston in 2005, with another $550 million pending, according to Campoli. Capitalization rates for downtown office buildings have dropped into the 7 percent range and even 6 percent for core deals, M&G reported. Given that buyers had targeted Boston throughout the recession, evidence that the region is turning the corner has “turbocharged the capital demand,” Campoli said.
Other investment trends identified by the investment sales specialist included a willingness among core buyers to acquire multi-tenanted buildings; the growing concept that vacancy can present value-added opportunities in the suburbs; and a continued availability of inexpensive debt. “There is absolutely no upward pressure on cap rates,” said Campoli, adding that should help keep the sales pace brisk.
“It’s really more of the same,” Campoli predicted of the 2005 campaign. “We think it is going to continue to be a very advantageous time to sell.”
The leasing end is doing its part, Perry agreed in his overview, with tenants in the small- to mid-sized range providing an encouraging start to 2005. After 300 transactions in 2004, M&G has recorded 130 agreements this year, Perry said, with leases averaging 18,000 square feet.
According to M&G, Boston’s office market bottomed out in the third quarter of last year, a period in which erosion of the sublease market was reversed by a glut of such space cascading on the scene following consolidation in Boston’s consumer, financial services and legal industries. After peaking at 2.5 million square feet in 2001, sublease space again reached that level last autumn, but the figure has now receded to 1.8 million square feet. The latter-day inventory is also less likely to bring rental rates down, Perry said. There is typically substantial term remaining, he said, and the space is leased by strong credit tenants vs. the fragile technology tenants who amassed the previous supply and subleased at bargain-basement rates.
Perry also detailed the continued bifurcation of the city’s leasing market, noting that vacancy rates are decidedly lower and rents actually tracking upward for high-rise space. An M&G survey of 39 towers in the Back Bay and Financial District showed a vacancy rate of 5.5 percent for space on the 20th floor and above, while rental rates averaged $38-$47 per square foot. Space below the 20th floor in those properties averaged $33-$37 per square foot and had a vacancy rate of 10.5 percent. Overall, the city has a vacancy rate of 16 percent in the 56 million square feet of office space tracked by M&G. Of that, 12 percent is direct vacancy and 4 percent is sublease.
Last Tuesday’s breakfast program also showcased the IBT leases, which together account for the largest amount of office space committed to in the city this year. M&G’s Downtown Brokerage Group assisted the private banking concern in a lengthy search resulting in a 355,000-square-foot renewal at the John Hancock Tower and 150,000 square feet deal at nearby Copley Place. Spinney, IBT’s chief financial officer, offered a brief synopsis of how the company identified the opportunity to rein in occupancy costs by conducting an extensive market search. The exercise, he insisted, was not merely poker playing with Beacon Capital Partners, owners of the Hancock Tower where IBT has been based since 1997.
“You’ve got to be ready to move,” said Spinney, who also suggested companies seeking space should limit their internal team and develop specific objectives that can be used to winnow down options. Backed by M&G’s team led by Perry, Senior Vice President Francis X. Durand and Assistant Vice President Roger W. Breslin, IBT ultimately considered eight scenarios that could accommodate its Boston space needs in both the Back Bay and Financial District. The decision to stay put was based partly on a cost analysis, Spinney said, which determined there would be no short-term savings from a relocation.
In return for staying put, IBT was able to garner space efficiencies and millions of dollars in savings, said Spinney, critical given that occupancy costs are the fourth-biggest expense for his organization. And while the firm did not receive some of the items it sought, such as increased parking, Spinney said the negotiations “got us the results we wanted” on the key issues, crediting M&G for the positive outcome. “We were not capable of doing it by ourselves,” he said, adding that “it all came back to Ron and his team.”
