Caution Creeps Into Boston Real Estate Scene

BOSTON-For all the upbeat regional trends reported–rising rents, healthy space absorption and limited construction–the tenor during Thursday’s commercial real estate review at the Seaport Hotel seemed surprisingly subdued. “We may be in a recession right now and not even know it,” advised Hans Nordby, moderator for the semi-annual event co-sponsored by the local chapters of Naiop and SIOR. The P&PR economist and a panel of industry experts offered data showing solid fundamentals and listed a cadre of hefty leasing requirements circulating the flex, industrial and office classes, but accompanying analysis was measured.

“Discipline has returned to the market,” said DTZ FHO Partners principal Brian Hines in assessing the 125-million-sf suburban flex/office sector. Hines described activity as “slow and steady,” even though the suburbs are on pace for three million sf of net positive absorption this year–triple the annual average–and deals are being completed in the mid-$40-per-sf range in core areas. Although rents are escalating, and the 1.2 million sf of new office construction is just 1% of the inventory, prospective tenants are unfazed by upward pricing and dwindling inventory, said Hines. One reason could be the 20 million sf of fallow product, including 44 options featuring 100,000 sf of contiguous space and seven in excess of 200,000 sf, while other companies are stepping lightly due to the uncertain economy and fallout from the credit crunch.

As in the case of Downtown, newer product and preferred locations are faring best, noted Hines, with the Interstate 495 North belt among those still struggling. Sporting a 23% availability rate, “that area still has a ways to go,” said Hines, although communities such as Bedford, Billerica and Chelmsford appear to be catching the eye of price conscious tenants, offering hope there. Patience is the key for landlords, said Hines, with sublease supply on the wane and tenant demand expected to rebound in early 2008. “That’s a good recipe for the suburban market,” he said.

Organic growth should help the suburbs feed off the recent improvements, said Hines, but he was less sure that threats among Cambridge and Downtown companies to migrate outwards will lead to substantial suburban absorption. Although companies such as the Bank of America, First Marblehead and J.P. Morgan have reportedly suggested such a strategy, Hines said firms that rely on younger employees often need an urban office to satisfy lifestyle and transit demands. “Our prognosis right now is that [widespread migration] is not likely to happen,” he said, which if true would be good news for Downtown and Cambridge landlords who are aggressively pushing rents.

The Boston overview was delivered by Meredith & Grew principal Kristin Blount, who put the vacancy rate for 56 million sf at 9% through Q3 and just over one million sf of positive absorption, acceptable but unremarkable after three superb years. “We’re expecting a strong finish,” she said of 2007, while expressing “cautious optimism” about the coming year, with more than 100 requirements being tracked that account for 3.3 million sf of demand. Blount joined others, however, in questioning whether aggressive lease escalations fueled by pricey building acquisitions will meet the assumptions of investors. Class B properties have become one option as class A becomes costlier and less available, but Blount says the increased demand is leading to higher class B rates as well.

Across the river in Cambridge, the challenge for office tenants has been a lack of inventory, relayed Cushman & Wakefield executive director Mark Winters. With developers favoring laboratory construction, no new office space has been added in five years, and the arrival of new players such as Google and Microsoft has eaten up much of the supply. “It may be time for new office construction,” Winters acceded, although the limited land and laboratory bent by developers could make that difficult to produce.

The 10 million sf of office and 7.5 million sf of laboratory space are both in solid shape fundamentally, said Winters, estimating the vacancy rate for each at around 10%. Cambridge tenants are predominantly small- and mid-sized, with a block of 20 prospects averaging just 24,000 sf in their requirements.

Given the disruption in the commercial real estate sales market, the crowd of several hundred remained in place to hear from final speaker Michael Smith of Jones Lang LaSalle, whose investment sales team has negotiated several transactions above $100 million in 2007. According to Smith, the year will likely be divided into two camps, one the hyperactive period that permeated through mid-year. The record $6.5 billion sold regionally in 2006 was already surpassed halfway through 2007, for example.

Since then, however, the debt woes have discombobulated buyers and sellers alike, said Smith, likening it to a middle school dance where the participants are too nervous to make an initial move for fear of embarrassing themselves. Bid pricing has swung wildly this autumn, said Smith, who estimates a re-pricing average around 3% to7%, and said some players may choose to wait a bit to sell properties. Equity is plentiful, he said, and foreign buyers will be active due to currency swings, but Smith said the uncertainty could foment delays until the market recalibrates itself. “I think 2008 is going to be a very interesting year,” he predicted.