Back With a Vengeance

Real Estate Boston is part of the Forum LOCAL series of features in Real Estate Forum magazine. This is an HTML version of an article that ran in Real Estate Forum. To see the story in its original format, click here.

Industry watchers are using convincing words to describe the state of Boston's CRE market—words like “blessed,” “extremely strong,” “very competitive” and “acceleration.” All signs point to more growth in Beantown in quarters ahead.

Consider the baseline statistics. Boston has added about 158,000 new jobs since 2009, bringing unemployment down to 4.5%, according to Cushman & Wakefield. The New England metro's technology sector has been a strong driver, with 11.9% growth over the past few years creating 27,000 new jobs. At 9.4%, Boston's CBD vacancy rate is among the lowest of major US metros. Add to that a diverse industry base and it's not difficult to discern what makes Boston's commercial real estate sector tick.

David Cary, senior managing director of Integra Realty Resources' Boston office, is among those who peg Boston's commercial real estate market as “extremely strong,” with all sectors performing at or near peak levels. Year-over-year, he says, the market is brighter, with lower vacancy and higher rental rates across all sectors.

“For the past several years Boston has been on the radar for overseas investors,” Cary says. “However, over the past year foreign investment in Greater Boston has reached record heights with investors from Chile, Ireland, Hong Kong, Japan, Canada and Switzerland, among others, more than tripling their real estate investments in Boston over 2013 figures.”

Millennials Driving Growth

When our sister publication GlobeSt.com launched a dedicated Boston page in May, we discovered 2014 was Boston's strongest year since 2006—and experts are optimistic 2015 will be even stronger. New startups are emerging and the population is rising thanks to education, innovation and overall quality of life. Indeed, there are clear trend lines in Boston's commercial real estate growth story.

“The things that drive real estate in Boston and the advantages we have are clearly the amount of hospitals and universities, as well as the established big pharma groups that want to locate here,” J.R. McDonald, executive vice president of brokerage for Cushman & Wakefield, told GlobeSt.com. “There's the presence of the universities, which leads to a very strong, available workforce for a lot of the jobs in the tech and innovation fields. Those are the obvious drivers, in addition to a historically solid base in our CBD of financial, insurance and law services.”

Boston's life sciences sector is reaching a boiling point, according to a recent report from Newmark Grubb Knight Frank. In the first quarter, Dana-Farber occupied 160,000 square feet at the Longwood Center in Boston, Mass Innovation Labs moved into 120,000 square feet at 675 Kendall St. in Cambridge and Amgen took occupancy of 80,000 square feet at 200 Cambridge Park Dr. in Cambridge. Baxter, Agios Pharmaceuticals and other life sciences firms are also planning move-ins during the quarters ahead. NGKF pegs the vacancy rate at 11.7%.

Joyce and Edward Maher, vice chairman of capital markets for C&W, told GlobeSt.com that Millennials have been critical to the region's growth and will continue to play a major role in years to come.

Specifically, Joyce says Millennials are driving mixed-use development in the Boston CBD as well as at Assembly Row in Somerville where there are redevelopment initiatives being undertaken on underused land parcels. “The movement is also evident in some of the higher-performing suburban submarkets like 128 West and 128 North,” she says, “where developers are looking at mixed-use destination campuses with associated retail and entertainment to serve the workforce there.”

Edward says investors are following the movement of Millennials in the Boston area. “If you remember back three or four years ago the Back Bay market was all the rage,” he says. “Then it shifted to the Seaport District, which [then] Mayor Menino rechristened the Innovations District. A lot of people thought the Financial District was dead and gone. Then those crazy Millennials helped the CBD. Now there's a movement underway to rename the Financial District the Downtown Market, which more accurately reflects the diverse tenant base.”

Finding Boston's Big Opportunities

Commercial real estate opportunity abounds in Boston, but dealmakers have different opinions about where the biggest opportunities lie and where they are dwindling. Some point to redevelopment. Others point to specific submarkets. Still others are leaning into the core. One thing is certain, owners seem to have the upper hand.

Largely due to the year-over-year growth, Peter Brockelman, SVP at TD Bank who handles the commercial real estate business for the Northeast, says there are not many opportunities left for investors in core Boston markets. That's driving up pricing.

“The market is competitive and, as a result, buyers are paying aggressive, competitive prices without a willingness to pay higher,” Brockelman says. “However, investors may continue to pay higher prices as long as interest rates are low and there is a willingness from investors to deploy equity capital in Boston, and there are no signs of a lack of interest in our market.”

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Richard Rudman, a partner at DLA Piper in Boston who focuses on real estate development, finance, joint ventures, property acquisition, leasing and land use, is hearing one phrase repeatedly: build to the core. “It's an investment strategy where investors, looking for core investments, decide to get involved at the development stage, rather than competing with other investors to buy stabilized buildings.”

Cary agrees. On the investment front, he says the market is extremely competitive so it is difficult to find “big opportunities.” Investors continue to create value with creative value-add projects. Still, we have seen a few large trades this year. The Boston Stock Exchange sold for $48.8 million in May. The HGH Dermatology Building sold for $123 million in April. 315 on A, a 202-unit apartment community, sold for $130 million in April. And there are several mega hotel sales pending or rumored, including Courtyard Boston Billerica and Renaissance Boston.

On the flip side, developers have plenty of demand for new product, with redevelopment offering the strongest play in a city with few existing parcels for new ground up construction. “In the suburbs there has been considerable signs of new residential product,” Cary says. “For the first time in years, our firm is bidding on a lot of subdivision assignments and new condo developments.”

Instead of “building to the core,” John Rattigan, a partner in DLA Piper's Boston office that counsels developers and investors in the acquisition, development, sale and leasing of large-scale real estate projects, is looking beyond the core: “Some of the biggest opportunities for developers are in communities like Somerville, Dorchester and Allston, which are just beyond the core markets and are either well served by public transportation or will soon be seeing expanded service.”

Some of Boston's most notable developments underway in the current cycle include what locals are calling a massive repositioning of the 60-acre New England Executive Park, which will become The District and include a newly-constructed Marriott Residence Inn hotel. Boston's Seaport District development is expanding south as Skanska USA moves to develop a 215,000-square-foot office building in Marine Industrial Park. South Boston's Andrew Square could see a 735,000-square-foot mixed use development if DJ Properties wins the city's approval. And the list goes on.

Drilling Into the Sectors

That's the big picture, but when you drill down into individual sectors the story unfolds. With a growing biotechnology, financial services and technology sector, Boston is seeing an uptick in office leasing. Some of the larger deals on the office front have seen Novartis add 550,000 square feet to its Cambridge campus while PricewaterhouseCoopers will soon move into a new 450,000-square-foot Boston headquarters in the Seaport District.

Marcus & Millichap predicts the office vacancy will dip to 13.5% in 2015 and asking rents will reach $31.84 per square foot, a 4.8% gain. Medical office properties will be among the big winners as developers will deliver 2.2 million square feet of new office space this year. Rudman says some suburban office markets around Boston are still struggling and the greatest pain is being felt by older, inefficient buildings.

On the multifamily front, employment growth is driving new rentals. Marcus & Millichap sees strong demand near Harvard and MIT and in the Kendall Square area. The firm reports about 9,000 units under construction, compared to 6,200 units completed in 2014. Vacancy will increase to 4.3% after all the deliveries, but rents will rise 3.1% to average about $1,800 a month.

“Right now, mixed use and residential developments are particularly hot in the commercial real estate market,” says Angus Leary, president and general manager of the Eastern Region at Suffolk Construction. “Compared to last year, the residential market is shifting a bit from rental properties to high-rise condo developments. We're also seeing an increase in institutional projects, both in higher education and healthcare.”

Retail follows rooftops and with employment rising, Boston is seeing about 1.6 million square feet of new retail coming on line in 2015 after developers delivered 1.3 million square feet in 2014. The vacancy rate is tight at 3.4% and asking rents will rise 3.2% this year to $18.68 per square foot, according to Marcus & Millichap.

“The retail market has performed very well over the past several years as well, but has not been as 'hot' as other sectors,” Cary says. “New tenants to the market continue to fill vacancies left by tenants that no longer exist. There has also been a significant shift toward retail as many investors see it as a wealth preservation investment. Examples would be retail in the city, such as along Newbury Street, or net leased retail assets.”

Finally, the industrial sector is poised to continue growth after a strong 2014. According to JLL, warehouse and distribution properties continue to lead the recovery and rental rates increased 2.9% in the first quarter. Blocks of class A space larger than 300,000 square feet are reaching a record low and total vacancy tightened to 11.6% in the first quarter. The market has seen several institutional trades in the recent past with cap rates ranging from 5% to 6% for long-term net leased product.

“The strength has obviously been in modern, high clear height facilities,” Cary says. “The market continues to have some significant vacancies in older low clear height manufacturing product. There have been a number of large build-to-suit projects over the past couple of years with some still in the planning stages.”

The Only Bad News

There are plenty of positives to report in Boston's commercial real estate market. Remember, industry watchers are using many different words to describe the state of Boston's commercial real estate market, including blessed, extremely strong, very competitive and acceleration. After getting hit hard in the Great Recession, Boston has plenty to celebrate.

Of course, that doesn't mean these industry watchers are Pollyannas. Suffolk's Leary points to rising costs of construction materials and labor, which makes new development prohibitive for some. At the same time, some tenants are growing impatient waiting for projects to come online, according to Brockelman.

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“We're seeing a low inventory of apartments in the Seaport,” Brockelman says. “However, we will soon see a large number of units entering completion all at once, so this issue will be alleviated. In a growth market like this, we aren't seeing a lot of negatives. In terms of investors and developers, a lot of folks have missed the boat on entering the market, which can be viewed as a negative in terms of missed opportunity.”

One challenge that cannot be ignored is transportation issues. Rudman points to an urgent need to make public transit more reliable. Massachusetts Gov. Charlie Baker has acknowledged the failures of the Massachusetts Bay Transportation Authority and called for the creation of a new board to oversee management at the agency after problems in the city's commuter rail, subway and trolley lines were exposed last winter. Time will tell if he can fix the issues.

What Boston's Future Holds

Again, all signs point to more growth in Boston. Our gurus predict the market will remain extremely strong, very competitive and keep accelerating. TD Bank's Brockelman reports the market is active across all sectors, and while it may slow in development as projects enter completion, sales side will remain quite active, specifically projects at Copley Plaza, the Seaport District and the biomed space in Cambridge.

“Boston has become a first class international city in the eyes of both domestic and international investors,” Cary says. “Unless there is a dramatic shift in the economy or rates, the market will continue to do well.” Cary acknowledges that there is likely to be a market correction at some point because no market can continue to see the dramatic gains that have occurred over the past several years indefinitely. Nevertheless, he's bullish on Boston's future. So is Rattigan.

“Boston Mayor Marty Walsh, who has been in office now for 18 months, is from the construction trade unions and recently announced that the city is beginning work on a new master plan,” Rattigan says. “The mayor is a strong supporter of development, especially if it facilitates new jobs and housing that is affordable for middle-income workers. We are likely to see increasing interest in neighborhoods that have not seen much development, like Allston and Dorchester, where land is cheaper and more available than in core markets.”