Kevin C. Phelan – Refinancing likely
Last year, everyone equated it to Al Gore, but in 2002, the term concession could become the watchword for the commercial real estate industry, or so one might have gathered after attending last week’s Trends in the Real Estate Forecast at the Sheraton Boston Hotel.
The single most important trend in 2002 will likely be landlord concessions, Meredith & Grew President Thomas J. Hynes Jr. told the audience of several hundred in his opening remarks. Hynes, whose firm was sponsoring the event for the 23rd year, said the reversal of fortune seen during the past 12 months is forcing property owners to be more aggressive in their leasing strategy. Other speakers concurred, including Meredith & Grew Senior Vice President James L. Elcock.
2002 will be the year that tenants will have as much leverage as they have ever had, or will have in the next several years, said Elcock, who outlined the suburban leasing market. Free rent and generous tenant improvement allowances are expected to be prominent tools for landlords as they try to grab what little demand exists.
The outlook from last Thursday’s program was in sharp contrast to that delivered during Meredith & Grew’s 2001 forecast, at which time most observers felt the slowdown seen in the fourth quarter of 2000 was merely a temporary lull. A hoped-for recovery never materialized, while conditions from the subsequent recession that began in March 2001 were exacerbated by the terrorist attacks several months later.
As the economy ran out of steam, the confluence of events was chilling, said Hynes, who noted that hundreds of startup companies crashed and burned as capital sources dried up, bringing a torrent of sublease offerings onto the landscape. The insatiable demand of those companies was a tripwire to the subsequent fall in the real estate market, Hynes said. Some maintain that building owners are not as burdened as they were in the crash of the early 1990s because companies today are paying rent on much of the unused space, but Hynes said the glut could mean trouble if velocity does not pick up soon.
Vacant space is vacant space, he said. Today’s tenants’ problems are tomorrow’s landlords’ problems. It affects us all.
Speaking on the capital markets, Executive Vice President Kevin C. Phelan agreed it could be a tumultuous year. I do think we are going to have to live with the overhang of the ‘R’ word [recession], he said, adding that the activity in the finance market will depend largely on whether the economy stabilizes over the near term.
Phelan said there are encouraging signs that there will be plenty of capital sources available, with insurers more than doubling their lending capacity in the coming year compared to 2001. Such firms as Prudential, Nationwide and Principal Financial Group are moving into the commercial mortgage backed securities market, he said, while commercial banks are under increased pressure to put money out, especially as several foreign and national players move into the Bay State market.
With historically low interest rates, refinancings could be a big story in 2002, Phelan said. And while investment properties in general are expected to be scarce, Phelan said interest among investors may spur some corporations to sell off their real estate as a way of raising cash.
We’re going to see free-and-clear corporate real estate liquefied a lot quicker than we have in the past, Phelan said, explaining firms see it as a way of putting their capital back to work.
Meredith & Grew Vice President Anthony W. Biette gave an overview of investment sales, faulting the dour economy for causing a dramatic slowdown in sales during the last half of 2001. With industry participants realizing that the industry was headed for difficult times, investment activity ground to a halt, with just $350 million worth of deals completed locally in the final six months of 2001. That compares to $1.4 billion in sales during the first six months.
Simply put, the business market detests uncertainty, and uncertainty reigned in 2001, Biette said. It was a rocky road in the investment market.
Part of the problem, and one that lingers at present, is a lack of leasing activity, which Biette explained has made it difficult to gauge where rents are. That has caused a disconnect between buyers and sellers in their assumptions, he said, with zero value for dark space. That is ironic compared to the end of the boom period when investors were keying in on properties that had substantial lease rollovers in the offing. Today, strong credit tenants and dedicated cash flow are the chief goals of investors.
Tenant Opportunity
Speaking on the downtown office market was Meredith & Grew Senior Vice President Ronald K. Perry, who acknowledged that conditions have deteriorated dramatically in the past 12 months. Clearly, 2001 was a transition year, he said, with a plethora of leasing opportunities now available after tenants had few choices the previous year.
Tenants needing more than 100,000 square feet of space had seven possibilities in 2001, but now can select from a dozen, Perry said. Those seeking 25,000 square feet, typical of a full-floor tenant, have 28 choices now compared just nine last year. Anyone needing 5,000 square feet, meanwhile, has seen their options leap from 14 to 89 options.
Sporting 52 million square feet, the Boston office market saw vacancies for direct space climb to 6.6 percent and the overall vacancy rate, including sublease space, jump to 11.6 percent. Rents have declined sharply, with the $90 per-square-foot leases commanded in some properties during 2000 nowhere to be seen last year. Perry estimated that the current rental rates run between $35 and $65 per square foot.
Conditions have plummeted even further across the river in Cambridge, Meredith & Grew Senior Vice President Joseph P. Flaherty noted in his report. Technology-rich Cambridge went from enjoying the best year ever in 2000 to suffering the worst year ever in 2001, he said, with office vacancy rates having skyrocketed to 18.3 percent after being virtually 0 percent one year ago.
There has been very little demand for office space and very few transactions of any size completed, he said. The problem is so acute, Flaherty said, that the Cambridge office market will probably not see a complete recovery for 24 to 36 months.
In the meantime, the city has been mollified by the continued strength of the biotech industry. Cambridge had 376,000 square feet of net absorption for biotech space in 2001, and Flaherty is tracking more than 1 million square feet of requirements for research and manufacturing space that will likely be committed to in the coming months.
Even greater pain has been experienced in the suburban office sector, with Elcock estimating that the 126 million-square-foot market had negative absorption of 9.79 million, a figure alarming by any standard. Most of 2001 was marked by major tenants retrenching, placing entire campuses up for sale or lease.
Wrapping up the trends program was Michael D. Fascitelli, president of Vornado Realty Trust, the only real estate investment trust that continues to hold a strong buy recommendation from Lehman Bros. Fascitelli expressed optimism towards the real estate market in general, adding he is a strong believer in the Bay State.
Don’t get too caught up with the [slowdown] in the Boston market, because long term it’s going to be great, he said, adding Vornado has previously tried to buy into the area but was typically outbid. The current struggles may lead to better pricing down the line, he said. Alluding to the figures provided by Meredith & Grew, Fascitelli said, I may have an opportunity to get into Boston based on these charts.
Overall, Fascitelli insisted real estate is fundamentally sound, but agreed there will be limited investment activity until the bid/ask gap is narrowed. As with many others, Vornado has plenty of capital to invest, he said, but Fascitelli nonetheless predicted sellers would refinance rather than sell at what they consider below-market value. Investors should also proceed with caution, he added.
I think it’s a great time to get your golf handicap down and wait for the next opportunity, he said.
