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Caution in Beantown

The stagnant national economy and the fallout from the dot-com crash have put a damper on Boston's real estate markets. Although most of the city's markets are still relatively healthy, industry sources report that some sectors, most notably office, are showing signs of weakness as sublease space from technology and other failed companies continues to flood the suburban market.

Regardless, Boston has the strength to ride out the storm, predicts Stewart Forbes, managing director in the Boston office of New York-based Grubb & Ellis. The diversity of the city and its intellectual capital give Forbes cause for optimism. Educational and healthcare institutions — along with pockets of biotech, telecommunications, defense and financial strongholds — fuel Boston's economic engine, he explained.

With the increased emphasis on security after the Sept. 11 World Trade Center and Pentagon attacks, Forbes expects Boston's esteemed educational institutions such as the Massachusetts Institute of Technology, Harvard University and Boston University to play a large role in providing solutions to the nation's security crisis. “Development of security technology is as likely to come from this part of the world as any other,” he said.

Boston's employment scenario is encouraging. In September, the unemployment rate inched up to 3.8%, a rate that nonetheless is lower than the national average, according to Stephen Coyle, senior strategist at Property and Portfolio Research, a Boston-based real estate research firm.

Despite the dot-com crash, most employees laid off from tech companies have been able to find new jobs. “Employment remains at record levels with jobs still being added, especially in sectors that impact the office market,” said Robert Kasvinsky, vice president at Boston-based Spaulding & Slye Colliers, a real estate brokerage firm. “The service sector has seen managerial, engineering, insurance, financial services and healthcare hiring, although the pace has slowed.”

Kasvinsky said job losses have occurred primarily in the manufacturing and temporary work categories. However, manufacturing is not a major state employer, so thus far the drop-off hasn't had a major impact.

The main issue now is whether the economic uncertainty that has settled in since Sept. 11 will cause the Boston real estate markets to falter, said Ed Shanahan, CEO of the Greater Boston Real Estate Board, a real estate association. Following the terrorist attacks, the real estate markets seem to be at a standstill, he explained.

Office market faces challenges

Through June 30, the Boston CBD office vacancy rate registered 8.8% with 4.5 million sq. ft. of available space and average rental rates of $58 per sq. ft., according to a report by Insignia/ESG. With its vacancy rate a whopping 20.1% and 2.8 million sq. ft of available space, the Cambridge office market was experiencing a greater tech fallout. Rental rates in Cambridge stood at $47.45 per sq. ft.

Meanwhile, vacancy in the suburban office market stood at 14.3% with 8.5 million sq. ft. of available space and rental rates of $28.48 per sq. ft., according to Insignia/ESG. Rental rates in the suburbs are about 10% to 15% below the peak prices recorded at the end of 2000, according to Spaulding & Slye Colliers.

“The Boston office market, although it's not really as strong as it was, continues to be relatively healthy,” Shanahan said. He said the softening economy during the summer months and the amount of sublease space available, primarily in the suburban markets, have combined to create a perception of instability.

Currently, the primary concern in the real estate community is the post-Sept. 11 market reaction. “I believe consumer confidence is the key,” Kasvinsky said. “Remember that consumer spending accounts for two-thirds of the overall economy, so that is really the wild card.” How people in Boston respond to the terrorist attacks may play a big role in how well Boston's real estate markets fare.

Forbes said the terrorist attacks have intensified the uncertainty surrounding the city's real estate markets. “From the standpoint of making projections and forecasts, people are going to have a difficult time,” he noted.

Part of the difficulty in determining where the market is headed is the lag time experienced by real estate. “We won't see the results of what we're experiencing for probably three months,” Forbes said. However, Forbes added that he already has noticed that fewer deals are closing now than before Sept. 11. “The time period required to close a transaction has been dramatically lengthened, which is understandable given the decision-makers' economic environment,” he said.

The Cambridge office market slowed in the first quarter of 2001, and then stabilized in the second quarter with demand coming from the biotechnology industry, according to the Insignia/ESG report. Biotech tenants have been virtually the only activity in 2001 in the Cambridge market, according to the report, which added that these companies at mid-year demanded an additional 1 million sq. ft. of space in the 50,000 sq. ft. to 100,000 sq. ft. range.

Three factors caused the softening of the suburban office market: the relocation of several large tenants, an increase in sublease space returning to the market and a limited supply of construction, according to Insignia/ESG. These trends caused pricing per square foot to fall 9% during the first half of 2001, from $31.34 per sq. ft. to $28.48 per sq. ft. Even so, industry sources agree that the diversified tenant base of the CBD also is present in the suburban market, so this market is expected to rebound.

Office development, slow and steady

With Boston's strict development requirements, new construction in the CBD continues to be limited, according to industry sources. Unlike the recession of the early 1990s, when new construction dwarfed demand, the supply coming on line has been restrained by tightened lending standards, Shanahan said.

A total of 815,000 sq. ft. of office space was delivered to the Boston office market this year, according to Spaulding & Slye Colliers:

  • 10 St. Ave., a 585,000 sq. ft. office building in the Back Bay submarket.

  • 343 Congress St., a 120,000 sq. ft. rehabilitated office in the South Boston Waterfront.

  • 321 Summer St., 110,000 sq. ft. of rehabbed office space in the South Boston Waterfront.

A good portion of the new supply arriving in the next few years is preleased, including:

  • 111 Huntington Ave., an 867,352 sq. ft. office tower (96% leased, completion scheduled for late this year).

  • World Trade Center West, a 532,362 sq. ft. office building (70% leased, completion expected in 2002).

  • One Lincoln Street, a 1 million sq. ft. office tower (100% leased, completion slated for 2003).

In the first half of 2001, Boston brokerage firm SSB Realty negotiated the largest lease in downtown Boston's history when it arranged 1 million sq. ft. of space for State Street Bank in One Lincoln Street, which was the first speculative office building developed in the CBD since the late 1980s.

The construction of the $350 million project began in April 2000, after Florham Park-N.J.-based Gale & Wentworth, a real estate firm, entered into a development joint venture with Boston-based Columbia Plaza Associates, a local minority partner. The project is receiving financing from Morgan Stanley Real Estate Funds and the State Teachers Retirement System of Ohio.

Two additional office buildings under construction are 33 Arch St., a 602,155 sq. ft. office building in the Financial District and 131 Dartmouth St., a 369,172 sq. ft. office building in the Back Bay market, according to Spaulding & Slye Colliers. In addition to these projects, there are several proposed projects totaling approximately 6.4 million sq. ft. slated for delivery between 2002 and 2006. However, uncertainty over financing makes it unclear which of these projects will even make it to the groundbreaking stage.

Industrial market remains tight

The Boston industrial market, which is mostly located outside of downtown in the 495/North and 495/South markets in metropolitan Boston, continues to be tight without a lot of supply or weakening prices, said Brad Spencer, vice president in the Boston office of Grubb & Ellis.

“The industrial market, although not booming, has not experienced the increased subleasing, growth of availability or precipitous rent decline that the office market has,” Spencer said. Instead, the market continues to hold relatively steady, with rents ranging from $6 per sq. ft. to $8 per sq. ft., which is down about 5% to 10% from rents in 2000.

Overall, availability in the market has crept up slightly from approximately 7% in 2000 to 8% this year. “Availability will likely reach 10% by year's end, driven by additional sublease space that is anticipated to come to market,” said William Bailey, a principal of Spaulding & Slye Colliers. “As a result, we expect average rental rates to plateau or dip moderately in case of a delayed economic recovery.”

However, a stable tenant roster ranging from manufacturing to building trade companies to electronic distribution firms — combined with limited new supply coming down the pike — should keep the industrial market fairly strong, Spencer predicts.

According to Spaulding & Slye Colliers, six projects were delivered to the industrial market this year totaling 836,326 sq. ft. Four of the six projects were introduced to the market 100% preleased. Three projects totaling 482,950 sq. ft. are under construction in the 495/South and 495/North corridor, all of which were 100% available at press time.

Multifamily market going gangbusters

With a limited supply and strong demand, the multifamily market in Boston continues to boom. For the past five years, rents have increased by double digits, as demand continues to outstrip supply, said Dana Pope, a senior vice president at Dolben Cos., a real estate firm based in Burlington.

“There are more people looking for apartments than there are apartments,” Pope said. “Land isn't zoned for new apartments.”

Shanahan of the Greater Boston Real Estate Board said there has been pent-up demand around for so long that it will take awhile for it to be absorbed, although vacancy rates have increased moderately. “There's no question that the market has softened somewhat, as rental vacancy is approximately 5% now,” he said. He added that since 1997, the vacancy rate typically has ranged between 1% and 2%.

The main issue is the lack of new supply coming on line. Boston's zoning laws and permitting process make it difficult to undertake multifamily development. According to a report by the Archdiocese of Boston last fall, 80,000 units will be built in the greater Boston area in the next five years to provide for the region's current and future housing needs.

Hotel and retail face tougher times

Boston is a prime travel destination with its historical buildings and sites from the American Revolutionary War. Walkers can stroll the Freedom Trail and visit the famous church where the bell once rang to alert city residents that the British were coming, or attend a reenactment of the Boston Tea Party at the harbor. However, the tourism industry in Boston has slowed to a screeching halt, as in most markets in the nation, in the wake of the terrorist attacks. The lodging industry can only hope that the slowdown will be short-lived.

Hotels have been hit hardest, with occupancies down 70%, according to industry sources. The hotel sector also is being forced to cut jobs and increase operating efficiencies, so unemployment in the travel and tourism sector is likely to rise, especially when airline job cuts are added to the mix.

A project that is intended to remake the Boston skyline is the $1.2 billion Fan Pier development in the South Boston Seaport District. However, the project may face additional obstacles following the terrorist attacks. Economic conditions, building heights, and the development's proximity to Boston's Logan International Airport are all issues that will be studied before the project can move forward. The Federal Aviation Administration could impose more restrictions on building heights, which are now set at a maximum of 85 feet to prevent new structures from blocking Boston's skyline.

Fan Pier is a nine-building, mixed-use waterfront development that includes hotels, residential buildings, office buildings, street-level retail, the new Institute of Contemporary Art, parks, an extension of Harborwalk, a protected cove and a public marina.

The Fan Pier development team is a collaborative effort between Chicago-based Hyatt Development Corp., development manager Spaulding & Slye Colliers, master planner Urban Strategies and Boston-based architects Childs Bertman Tseckares.

Retail experienced a definite slowdown during the week of Sept. 11, but is starting to rally, although spending by visitors has yet to reach pre-Sept. 11 levels, said Coyle of Property & Portfolio Research. The recession that most economists say the nation is in, or about to enter, will also hurt retailers, he said.

Although luxury goods are out of favor, value and discounted items are popular. Retailers are responding to this trend. One new entrant to the market, H & M, a Swedish discount clothier, has done very well because of its affordable prices, Coyle said.

A bright outlook

Industry sources believe that Boston is positioned to weather the economic downturn better than most cities in the nation. The primary reason is that the city has entered this uncertain period with no large overhang of supply as it navigates the already soft markets.

According to Susan Leff, senior vice president in the Boston office of KeyCRE, a commercial real estate lender and subsidiary of Cleveland-based KeyCorp, the Boston lending market is much more restrained than a year ago. After the attacks, financing uncertainty has increased and the proposed $800 million Boston convention center faces some hurdles. One major concern is that if a 1,120-room hotel isn't financed, then the convention center could be in peril.

Leff noted that KeyCRE is experiencing healthy competition in the lending market. KeyCRE's balance sheet in the Boston market this year includes $250 million in a variety of financing vehicles, and Leff emphasized that although underwriting standards have tightened, there's still money available for the right project in the right location.

Cristina Gair is an associate editor at NREI.

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