Tenuous Office Recovery

It's hard to judge the strength of any office market solely on the basis of vacancy, which is a good thing for Boston. Vacancy in the central business district (CBD) registered an unhealthy 16.8% at the end of 2005, though that's actually an improvement from 19% one year earlier. Similarly, the suburban office market dropped to 20.8% from 23%.

A closer look reveals that after two straight years of decline, rental rates for all classes of office space in the Boston market stabilized in 2005. Riding on the backs of legal and finance tenants, the market recorded 4.4 million sq. ft. of absorption, up 33% over the previous year. The increase in leasing demand boosted Class-A asking rents by 6.2% to $34.43 per sq. ft.

Another bright spot: The $14.6 billion Big Dig project, which re-routed Boston's central arterial highway through a 3.5-mile long tunnel, was finally completed in 2005. The final piece of the decades-long project is a 30-acre swath of parkland known as the Rose Kennedy Greenway. Park construction and street restoration will be finished early this month, and the Greenway should add value to many adjacent office and residential properties.

Double trouble?

Despite this good news, Boston's metropolitan market continues to lag the national office recovery — and local observers question if the market's near-term leasing momentum is sustainable. They cite two stubborn trends: an active mergers and acquisitions market, and a soft local economy.

Two large mergers within the past three years have reduced demand for headquarters space in the CBD. Last year, Procter & Gamble acquired Boston-based manufacturer Gillette in a $57 billion merger. Gillette occupies 435,119 sq. ft. in Boston Properties' signature Prudential Tower located in the Back Bay district. Since the acquisition of Gillette, market watchers believe that some of this space will be returned to the sublease market as the company's lease expires in 2009.

The Hancock Tower, another Back Bay office trophy, also felt the effects of the 2003 merger between John Hancock Financial Services and Manulife Financial Corp. While much of that space has since been absorbed by Bank of America, CoStar Group reports that roughly 300,000 sq. ft. of sublease space was vacant at the Hancock Tower as of mid-April.

“We're really not anticipating a strong economic recovery in Boston over the next five to six years,” says Paul Briggs, a senior economist at Boston-based real estate consulting firm Property & Portfolio Research (PPR). He forecasts 3.3 million sq. ft. of leasing absorption in 2006, a 1.1 million sq. ft. drop from last year's level of activity.

Briggs also believes that much of last year's leasing activity will carry CBD office tenants through the next seven to 10 years, making landlords highly dependent on built-in escalations to boost rents in many properties.

What's more, Boston's ability to create new office-using jobs has lagged the nation for years as bellwether local firms like Fidelity Investments move staff into lower-cost areas of the country (see sidebar, p. 57).

Boston's year-over-year employment growth through December registered 0.7%, or less than half the national average of 1.5%, reports Economy.com. Last year was no fluke, either. Boston has consistently lagged the nation in office-using job creation.

During the past 10 years, Boston posted a 10.96% increase in office-using jobs while the national average was nearly double that at 20.76%. Expect more of the same as the five-year forecast for Boston is even lower at 4.41%.

The problem isn't just limited to Boston, either. New England created new jobs at the slowest rate of any U.S. region during the fourth quarter, according to an April FDIC report, which also forecasts that regional job growth in New England will be sluggish over the next few years as many high-tech employers reluctantly add new jobs due to productivity gains.

“Boston's economic picture is most definitely mixed. We expect decent, rather than fantastic, job growth over the next few years,” says John Rivard, chief investment officer at private real estate firm Broadway Partners. The Manhattan investor, which owns 7 million sq. ft. of office property, focuses on value-added deals in and around large U.S. cities.

Rivard believes that the Boston office market presents a good value for investors today, particularly those interested in long-term holds. “People are buying office buildings in Boston now because they perceive a run-up in values coming in a few years,” says Rivard, who is actively pursuing a CBD office deal.

Last year, Broadway Partners bought a three-building office complex in the Boston suburb of Waltham for $62.3 million. The cap rate on that deal was 6.65%, according to Real Capital Analytics.

Drivers of space demand

The professional, scientific and technical service sectors are a major force in the office market. This combined grouping generated 28% of all office absorption in Boston last year, accounting for the single biggest share of demand.

As Briggs of PPR notes, metro Boston businesses are hard at work developing new technologies related to areas such as defense, health care and computer hardware/software. The trend suggests that the city will continue to attract capital and highly educated workers.

While smaller technology-related firms helped generate occupancy gains in the suburbs, law firms and banks accounted for much of the leasing demand in 2005 within the CBD. Law firm Bingham McCutchen, for example, signed a 15-year, 300,000 sq. ft. lease at One Federal Street, a downtown office tower, last summer. That deal was Boston's largest office lease of 2005.

“It would really help if some of these [technology] tenants started to lease office space in downtown Boston,” says Briggs of PPR. Most of these technology firms prefer to occupy space in suburban markets, which is where many of their engineers live. The suburban market also boasts lower occupancy costs. Class-A office rents in the CBD averaged $34.43 per sq. ft. at the end of March while suburban rents for similar space averaged $24.34 per sq. ft., or 29% less.

Hold, period

Despite tepid job growth and population losses, metro Boston is widely considered to be a safe place to park capital. Sellers have capitalized on this, too. The total volume of Boston office sales jumped from roughly $3.4 billion to $4.5 billion between 2004 and 2005, reports Real Capital Analytics. Sales volume through the first quarter of 2006, however, registered just $974 million, well below last year's first-quarter figure of $1.6 billion.

Why the disconnect between fundamentals and investor demand? For many institutional investors, slow and steady growth is key to their investment philosophy. Unlike highly leveraged profit takers on the private side of the business, many institutions such as pension funds find safety in a less volatile market.

Last November's $122 million sale of 101 Arch Street, a 22-story, Class-A office tower in Boston's financial district, was a fitting example. The 400,000 sq. ft. tower is 94% occupied.

The buyer was ING Clarion, the U.S. real estate arm of Dutch banking and insurance giant ING Group. Like many of the financial district's Class-A towers, the 101 Arch Street tenant roster includes financial and legal services firms such as ProMutual Group, Robert Half International and Kopelman & Paige.

Other large deals bear out this high level of institutional interest. Four of the five leading office buyers last year were institutions, among them Teachers Insurance & Annuity (TIAA) and RREEF Funds. The former spent $272.5 million — or $373 per sq. ft. — to buy the financial district's Keystone Building from Walton Street Capital last year. That deal ranked as Boston's most expensive office sale of 2005; ING Clarion's purchase of 101 Arch Street registered as the sixth largest deal.

“Institutional investors really see the Boston market as a longer-term play,” says John Moynihan, vice president of global asset management at Boston-based office developer Pembroke Real Estate, which owns 2.6 million sq. ft. of commercial real estate. The firm, owned by Fidelity Investments, controls $1.2 billion in Boston office space divided among three separate towers. Two of those towers were built within the past six years in the seaport district.

Supply is in check

One saving grace of the beleaguered office market has been a shallow construction pipeline. Roughly 1.1 million sq. ft. of CBD office space will be delivered this year, which represents about 2% of the CBD market's total inventory of 56 million sq. ft.

New office towers are proposed for the financial district, the South Boston waterfront and the South Station area. It's unclear, however, if these projects will be completed given the extensive bureaucratic hurdles developers have to clear in order to build in Boston.

It's also doubtful that much of this new space will be developed without solid leasing commitments from anchor tenants. Assuming that they are built, developers will add another 10 million sq. ft. of new space (or an average of 2 million sq. ft. annually) over the next four years, reports PPR.

Even a tiny amount of new construction, however, is too much if the Boston economy continues to underperform. Yet Boston's office-using economy is growing, albeit at a much slower rate than the rest of the nation, and this doesn't bother many local sources who still see the light at the end of this tunnel.

“The overall feeling here is that we lived through the Big Dig, so now the market is ready to tighten,” says office landlord Moynihan, referring to the most extensive public works project in U.S. history.

“The Greenway project will bring added value to the market,” predicts Moynihan. “And that's another reason investors see this as a good time to get into the market.”

Parke M. Chapman is NREI senior editor.



5.6 million
Source: Property & Portfolio Research


Source: Bureau of Labor Statistics


  1. Massachusetts General Hospital
    18,000 employees

  2. Brigham Women's Hospital
    10,000 employees

  3. Fidelity Investments
    8,400 employees



20.8% vacancy, 4Q 2005
23% vacancy, 4Q 2004
$28.97 rent per sq. ft., 4Q 2005
$29.07 rent per sq. ft., 4Q 2004
Source: Reis


4.7% vacancy, 4Q 2005
5.3% vacancy, 4Q 2004
$1,581 avg. effective rent, 4Q 2005
$1,553 avg. effective rent, 4Q 2004
Source: Reis


2.1% vacancy, 4Q 2005
2.9% vacancy, 4Q 2004
$20.02 rent per sq. ft., 4Q 2005
$19.60 rent per sq. ft., 4Q 2004
Source: Reis


20.2% vacancy, 4Q 2005
20% vacancy, 4Q 2004
$5.02 rent per sq. ft., 4Q 2005
$5.03 rent per sq. ft., 4Q 2004
Source: Reis


65.3% occupancy, 4Q 2005
64.2% occupancy, 4Q 2004
$129.69 average daily rate, 2005
$123.98 average daily rate, 2004
Source: Smith Travel Research


Park Lane Seaport II

This 21-story, mixed-use complex includes 465 residential units, a restaurant and retail space, plus a 480-car parking garage.

Cost: $130 million

Developer: The Fallon Cos.

Completion: Summer 2006

Westin Boston Seaport

This 790-room hotel will have 32,000 sq. ft. of meeting space. The second phase of the hotel may include as many as 330 extra guest rooms.

Cost: $200 million

Developer: The Fallon Cos.

Completion: Summer 2006

Center For Life Science Boston

This 705,000 sq. ft. medical office building will be anchored by Beth Israel Deaconess Medical Center. It will become the largest life science research facility in Boston's Longwood medical district.

Cost: $250 million

Developer: Lyme Properties LLC

Completion: Summer 2007

Will Fidelity relocate part of its workforce?

Market watchers are keeping close tabs on bellwether central business district (CBD) office tenant Fidelity Investments, the massive Boston-based mutual fund giant. The reason: Fidelity owns and leases some 6 million sq. ft. of Class-A office space, which is a sizeable chunk of Boston's 56 million sq. ft. CBD market. The company has threatened in recent years to relocate many of its staffers outside of the high-cost Boston region.

Last summer, for example, Fidelity announced plans to move some 1,500 Boston-based employees to Rhode Island within the next two years. Fidelity currently employs approximately 8,400 workers in Boston. It's unclear if the plans will come to fruition, and Fidelity declined to comment for this article. As recently as March, Fidelity was talking to North Carolina officials about building a $400 million campus in Raleigh for 5,000 employees.

“Fidelity is one of Boston's largest employers. But even if [Fidelity] moves all of these jobs outside of the state, the company will still have a large presence in the Boston office market,” says Mary Kelly, chief research officer at Boston-based real estate brokerage Meredith & Grew.

Kelly adds that sublease volume will climb sharply, if the planned relocations occur over the next few years. The CBD had roughly 1.37 million sq. ft. of vacant sublease space at the end of March, according to Meredith & Grew data, while direct vacancy totaled roughly 5.7 million sq. ft.

There was a time when Fidelity's appetite for space was legendary. Fidelity's Boston-area staff increased 35% between 1996 and 2003, according to the company. During the early 1990s, for example, Fidelity gobbled up an average of 10,000 sq. ft. of Class-A Boston office space per week as Boston's mutual fund sector bulked up. By 1994, Fidelity accounted for 42%, or nearly half, of all U.S. mutual fund inflows.

This growth spurt changed dramatically over the next 10 years as the mutual fund business diversified outside of Boston. Property & Portfolio Research, based locally, reports that Fidelity absorbed just 3.4% of all mutual fund inflows in 2004. As a result of increasing competition between mutual funds, Fidelity is moving many of its employees out of the pricey Boston market.

“The mutual fund business has really moved outside of Boston in recent years,” confirms Kelly. “And we expect that to continue.”
— Parke M. Chapman

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