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Boston's High-Tech Hangover

Boston is an anxious place these days. Gone is the stellar real estate market of 2000, when office rents flirted with $100 per sq. ft. and vacancy was essentially non-existent. Plans to redevelop 1,000 acres along the waterfront and fill the suburbs with corporate campuses are stalled.

A malaise of high vacancy rates, falling rents and a development pipeline that clogged at the first hint of a recession have replaced the salad days of 2000.

And there is no relief in sight. “I don't see anything on the horizon to say it will change,” says Tim Weinhold, head of the Boston office of The Staubach Co., Dallas. “There's nothing to point at and say, ‘Ah, here's the change to get things going.’”

A Clogged Pipeline

A major cause of Boston's anxieties is the recent decline in development. Only one significant new office tower — the 532,300 sq. ft. World Trade Center West — has come to market this year. It is two-thirds leased. Many developers are scaling back the size and scope of their projects or revising plans to incorporate Boston's one bright sector — residential housing — at the expense of office space.

“Large-scale projects will be pushed back, or scaled back, or built in phases,” says John Rosenthal, president of Meredith Management in Newton, Mass. “Right now I wouldn't build office on spec by any stretch.”

Take the $300 million, 1.5 million sq. ft. Midway project. Located in Boston's Waterfront district, the development — owned by locally based Beacon Capital — originally was slated as an office project that could be divided into small sections for the dot-com startups that filled Boston in the 1990s. But with the tech wreck of 2000, that customer base has vanished, says Jack Hobbs, executive vice president of R.F. Walsh Co., the project's developer.

So the Midway plans were redrawn to convert the commercial space into several hundred condominiums, which are expected to be ready in 2004. The timing of the office and retail development, says Hobbs, remains up in the air.

In addition, 33 Arch St., a 600,000 sq. ft. office tower launched in the summer of 2001, now risks opening without any major tenants. Owned by Congress Group Ventures of Boston, Lend Lease Real Estate Investments of New York and others, the downtown tower — slated to open by early 2004 — has no significant tenant commitments.

And Congress Group has said it isn't willing to cut rock-bottom deals just to secure anchor tenants. Rather, the firm is banking on the office tower's appeal as a new property to lure away tenants from older buildings as their leases expire. With vacancy up from 5.9% in the second quarter of 2001 to 13.2% in the second quarter of 2002, according to Meredith & Grew, a full-service real estate firm, the immediate outlook is gloomy. “In the near-term, it's going to be a zero-sum game,” says Bob DeLaney, a principal in the Boston office of Dallas-based Trammell Crow Co.

Development Potential

The Waterfront area, or the Seaport District, is the site of Boston's chief development opportunity. A vast tract between downtown and the densely populated neighborhood of South Boston, this area initially consisted of industrial space crisscrossed with railroads and loading docks. More recently, it has been used for parking lots, fish-processing businesses and Boston's World Trade Center.

Throughout the 1990s, developers and city planners have envisioned the Waterfront as a new neighborhood, equal to the downtown business district or Boston's other chic business area, the Back Bay. By 2000, developer enthusiasm seemed to reach critical mass, but the recession halted any momentum.

Will the Waterfront be developed? Yes, because that is where the available land is. The real question is when.

In addition to the weak local economy, developers still have to overcome Boston's byzantine permitting process, and turf battles with zealous neighborhood groups. The Chicago-based Pritzker family has talked about a massive development on the waterfront since the 1980s. The family wants to build nearly 3 million sq. ft. of office, residential, hotel and retail space on land it owns at Fan Pier, the largest section of the Waterfront.

When state authorities finally issued permits in August to erect nine buildings, local opponents promptly filed a legal challenge. “I'd say it's a very, very open question whether Fan Pier will be developed in the next five years,” Weinhold says.

Several large-scale public works also are scheduled for construction in the Waterfront area. A new convention center, slated to open in the Waterfront district in 2004, is likely to spawn new hotel and retail development. A billion-dollar overhaul of Logan Airport also is well under way.

And then there's the “Big Dig.” Formally known as the Central Artery/Tunnel project, the Big Dig is a $15 billion project to expand and submerge Interstate 93, which was built as a massive overpass that runs through the heart of downtown, cutting off Boston's sweeping harbor from the central business district. The Big Dig's ultimate goal is to stitch those neighborhoods back together.

When the Big Dig was first envisioned in the 1980s, engineers and transportation officials estimated the cost at $2.5 billion. As time passed, however, the price went up — way up, as design changes and delays upped the cost to $14.6 billion. Despite the cost overruns, the Big Dig is actually near completion. By early next year the first underground lanes will open to general traffic, and the remaining underground lanes will open by spring 2004.

Despite the temporary commercial glut the project might create, the Big Dig will remove traffic snarls from downtown and create green space. Conventional wisdom in Boston is that the CBD will become an even more desirable place to work and socialize.

“I think you'll see a broader definition of what is considered ‘downtown,’” Weinhold says. He expects the CBD to rival the Back Bay or the Waterfront, since this prime location will have more parks and fewer clogged roads.

One sweeping proposal for the area is the $600 million South Station Tower. Owned and developed by Houston-based Hines, original plans called for a gleaming, 1.2 million sq. ft. tower rising more than 800 feet above the South Station transportation complex. A 500-room hotel and 430,000 sq. ft. of research space also were in the mix.

Hines hoped to break ground on the complex this year, but the Federal Aviation Administration asked that the tower be made shorter due to its proximity to Logan Airport flight paths, so Hines reduced the structure's height to 690 feet, or 47 stories. Final approval of the project is pending, so completion is not expected until 2007.

On the redevelopment front, Chicago-based Equity Office Properties Trust wants to renovate Russia Wharf, on the eastern side of I-93 and abutting Boston Harbor. The plan calls for more than 500,000 sq. ft. of commercial, hotel and condominium space in a $275 million construction project, due to come on line in 2006.

The Suburbs: Heaven and Hell

The recession has taken its toll most noticeably in Boston's suburbs. Municipalities such as Burlington, Watertown, Bedford and Chelmsford were bursting with activity in the late 1990s, but that growth was due almost entirely to telecommunications and software companies snapping up more space than they needed. As those two industries collapsed in the last two years, vacancy soared and rents plummeted.

Today, office vacancy rates in Boston's suburbs are over 20% and rising. And virtually no new space will be created for several years, says Mark Roth, a suburban market specialist at New York-based Cushman & Wakefield. He also notes that after the recession of 1990, new construction did not revive in the suburbs until vacancy rates consistently stayed below 10%. “At 24% or so, we've got a long way to go,” he says. “I don't even want to do the math.”

Corporate campuses had been the engine of suburban development throughout the 1990s. Cisco Systems had plans for a mammoth complex straddling three towns near Route 495, while Sun Microsystems wanted to locate thousands of workers in Burlington. EMC Corp. had planned 1 million sq. ft. of space in various projects near its Hopkinton headquarters. All of these projects are on hold, scaled back or sitting empty.

Retail Racks Up Growth

Retail space, in contrast, has weathered the recession much better than the office sector. For the last several years, vacancy rates have fluctuated between 6% and 9%. Regional department stores such as Bradlees and Ames stumbled into bankruptcy, but national giants Target, Wal-Mart and Kohl's have been eager to step into that space.

2nd quarter 2001 2nd quarter 2002
Office (City) 5.9% 13.2%
Source: Meredith & Grew
Industrial 8.0% 10.4%
Source: Grubb & Ellis
Multifamily 1.6% 3.1%
Source: M/PF Research Inc.
Retail 5.4% 6.4%
Source: Marcus & Millichap
Unless otherwise noted, statistics provided are for the metro area.

“Overall, it's a healthy market,” says William Beckeman, a partner with the retail analyst firm Finard Co. in Burlington.

According to Beckeman, the most attractive developments are open-air shopping centers anchored by a grocery store and satellite retail space. As many as three dozen projects are in various stages of planning around the Boston area, and could bring 1.5 million sq. ft. of retail space to market in the next several years.

Beckeman believes the Boston market as a whole can easily absorb that much new activity. Historical data indicates that the area can absorb at least 750,000 sq. ft. of space annually. “This is perceived as an insulated branch of real estate,” says Beckeman.

The Biotech Savior

Cambridge, Boston's next-door neighbor, has also suffered from the tech slowdown. Two years ago, tech companies paid top dollar for every inch of office and research space near Harvard University, Boston University and Massachusetts Institute of Technology. Not surprisingly, rents have since fallen from $70 per sq. ft. in the second quarter of 2001 to $30 per sq. ft. in the second quarter of 2002. Vacancy has risen above 20%, up from 13%. Two years ago, the rate was statistically zero.

But Cambridge does have a savior: the biotech industry. As the biotech capital of the United States, companies cannot find enough laboratory space for drug discovery and genetic research, even in this slow economy.

And because development of new properties in Cambridge is notoriously difficult, many commercial owners are even considering converting empty office space into lab space, says Katherine Doyle, principal of Thompson Doyle & Hennessey.

The big fish in the Cambridge pond is Swiss drug giant Novartis, which is planning to locate its global research headquarters in Kendall Square, the city's tech mecca. The looming presence of the drug manufacturer has sent smaller biotech firms scrambling to acquire space while it is still available. “Novartis took the space most immediately available,” Doyle says. The company has already signed 258,000 sq. ft. of space and at press time was reportedly eyeing an additional 500,000 sq. ft.

Multifamily: The Silver Lining

The multifamily market received a jolt in August when Thomas Flatley sold his 4,300-unit portfolio of New England apartments to Denver-based Aimco for $500 million. The sale is believed to be the largest and most expensive deal of its size in New England history. Aimco purchased 11 apartment communities from Flatley, with average rents topping $1,200 per month and occupancy near 95%.

The sale prompted some industry observers to wonder if Flatley's decision to cash out means the market is at its peak. Most observers say no. “I'm very keen on the Boston residential market,” says Rosenthal of Meredith Management.

Rosenthal also is developing a 900,000 sq. ft. mixed-use complex near the Massachusetts Turnpike in Boston's Kenmore Square neighborhood, due to come on line by 2006. The $200 million project will consist of two residential towers. About 100,000 sq. ft. is slated for small retail shops, and another 50,000 sq. ft. could go to restaurants and nightlife.

Andrew Chaban, CEO of Lowell, Mass.-based Princeton Properties, says his company is still looking to acquire new units. The firm currently owns about 5,500 units around Boston. “There's almost no end” to the number of investors willing to buy into a deal, he says. The problem is finding a seller. In the current economy, owners prefer to hold their investments rather than cash out and invest the profits in an uncertain market.

All in all, residential developers and owners like Chaban see good times ahead, as do their retail brethren. The industrial, office and hospitality sectors might be weak, but Boston, they emphasize, is always a primary destination for investment once capital starts to flow — and the other fundamentals are already in place.

“Fortunately Boston did not overbuild,” says Ted Wheatley, a senior vice president at The Staubach Co.'s Boston office. “What's missing is that there's no driver creating any sort of demand.”

Matt Kelly is a Boston-based writer.

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