Bad, Could Be Worse

Monday, September 8, 2008

School's back in session, and the professors are lecturing. It's the same in the real estate world, and class kicked off on Friday with the 2008 Real Estate Finance Association Fall Conference, and "An Update of the Boston Suburban Markets."

"Wow, it's really slow. How long is this going to go on?" Hans Nordby, chief strategist of Property and Portfolio Research , said he was hearing a year ago.

This year, he told a crowd of about 150 (so many the parking garage filled up) at the Westin Waltham Hotel, he's hearing -- exactly the same thing.

It's all about "de-leveraging and lack of interest in pursuing transactions. Nordby, followed by a panel of some of the big names in local real estate, went on to say why we're in this predicament.

Summing up the national picture in nontechnical terms, Nordby said it's bad, it's not terrible, it's going to get a little worse before it gets better, but it's not going to be awful.

"The job numbers, they look a little bad -- and they are," Nordby said.

About 360,000 jobs have been lost through July, he said, but because of lagging statistics those federal numbers are probably even worse.

The bright spot is that job losses won't be as bad as in the 2001-02 downturn. Productivity is up, with those fewer numbers of us each doing more work.

The stagnant real estate capital markets -- good credit or bad, almost nobody can borrow money for anything right now -- "have driven us into this recession," Nordby suggested.

Solutions are on the horizon, though. Banks are starting to get their books in order, and, "The quality of the deals is better than it was."

Except for some insurance companies, lenders are wary -- no money to lend.

German money usually comes to Boston, New York, District of Columbia area, and Miami. Why those? "Germans don't take connecting flights," Nordby said.

Japanese money tends to flow to Los Angeles and San Francisco. But even that foreign money isn't coming in to buy now, and probably won't till next year.

Nordby reviewed the different sectors locally.
Average vacancy in the housing market in the Boston area is 1.5 percent, and it's even lower now. In the apartment market the average is 5.8 percent; in the country it's 7.2 percent.

Not much is being built, so, "Two to three years from now this is going to be a really good place to be in the apartment market," Nordby said.

Both residential occupancy and generally healthy office occupancy in Boston reflect the fact that Boston is often where the boom is -- tech, defense, life sciences.

And, "In terms of what ails the country, this time it wasn't us." The tech markets,like San Francisco and us, are in relatively good shape. The bubble markets -- Florida, Atlanta, Las Vegas -- aren't.
"High growth, too much supply -- that's what most of the country is like," he said. Austin and San Antonio are overbuilding. In the Boston office market it's relatively stable.

Not a lot of office supply is under construction here.

Nordby called the current downturn a "w-shaped" recession. Vacancy dropped and rents went up in the western and other suburbs. Now he expects vacancy to go back up but "not as bad as five years ago."

"We'll see some rent losses. ... It's not the end of the world."

Boston is also in better shape in the retail vacancy corner than the country at large, where normal vacancy is 14 percent. It's less volatile, but it is going up.

REFA's panel moderator, the dependable Bill McCall of McCall & Almy, agreed that Boston office is in pretty good shape. "Demand is OK, but fragile," he said.

Decisions are being made today by the chief financial officers, and they're not taking a lot of extra space for possible expansion, like "the visionary CEOs did" in the past. "We don't have a big amount of space in the pipeline."

Cost of construction is a big issue. It costs at least $600 a foot to build in the city, and owners say, "I need to get 80 bucks" a square foot in rent to make money. "Today the numbers just don't work."
Lack of credit is going to continue to be a problem, he said, "And there's a lag effect, because you don't build instant buildings."
Adding to cost is the widespread demand for environmentally friendly digs. "Green buildings are hot," McCall said. "I'm too old to understand. To my mind it's just a blue wastebasket where you put your paper."

As is customary at Boston real estate events, panelists were candid about their wins and their losses.

Steve Rice of Mohawk Partners, which bought a 100-acre Raytheon property at Route 128 in Lexington in 2003, recalled that an adviser told him, "I'll say a prayer for you" when he closed.

Mohawk concentrated on biotech tenants, which pay a little higher rents than office ones. The market slowed. They got three. Two faded -- but Eli Lilly and Company bought one of them and paid almost what the company has agreed to for the term of the lease. "Being lucky is better than being smart," Rice said.

But clearly there's some skill and hard work here: The property was marketed as having another developable 100 million square feet -- but Mohawk is now permitted for an additional 270,000.

Tom DeSimone, executive vice president of W/S Development and S.R. Weiner & Associates, adopting a highly technical term that had been introduced earlier in a comment from the audience, talked about retail. "Retail does not suck," he said.

He measures success in retail by dividing a store's total cost of occupancy by sales -- occupancy cost percentages -- and said they've generally been going down for the last five years. "That's a case for confidence. That's a case for optimism."

And, he said, retail is all about confidence.
In fact, right now the discount club stores, Wal-Mart, the supermarkets with gas stations appended to them are doing well. People are looking for value.

"You might not be a Wal-Mart shopper two years ago. Today you are."

Same with restaurants. "Panera, McDonald's -- the places you can go for under $10" are doing well.

It used to be people quit eating out in an economic downturn. Now, "We are so ingrained to go out to eat" that we just choose cheaper restaurants.

Weiner's Legacy Place in Dedham is 70 percent leased and 90 percent committed, and fully financed. "It was a difficult process," DeSimone acknowledged. But, "We don't build unless we have signed leases."
Legacy Place was 67 percent leased and 85 percent committed when the loan to build closed.

Nationally among retailers, "You're seeing people get ready for a tough period," he said, quoting International Council of Shopping Center figures that forecast 7 percent more store closings this year than last (although about that same number open up annually too).

Jon Davis of The Davis Companies said he'd rather think about the 1.1 million square feet of property at Reservoir Woods in Waltham he's got leased than the 180,000 square feet of spec space he built that no one's spoken up for yet.

Still, there's interest. And, "The bigger the company that comes to talk to us, the greater the focus on green buildings," he said.
Rents are lower in the 'burbs because it only costs $275 to $350 a square foot to build -- half of what it is downtown. More with parking, less without. And the additional cost of a green building is 3-5 percent, Davis said.

Deane Dolben, president of The Dolben Company Inc., said Greater Boston has been undersupplied with apartments for years -- largely because of "nimbyism." (How can an area so known for it's political liberalism be so conservative when it comes to developmental change?)

When Dolben tells folks in Atlanta and Houston that we add 4,000 to 6,000 units a year in Boston, they tell him in their cities: "That was last month."

"Today it is extraordinarily difficult" to finance a project. "The capital is sitting on the sidelines," Dolben said.
Boston overbuilt in the condo area only a little bit. "There isn't a large overhang of condo supply," he said. "Construction has slowed dramatically." So what are these guys doing while things are in slow motion out there? Well, they look for opportunities.

And Davis noted that "The place to make money is in distressed situations." His company has bought mortgages, for 75-85 percent of value, and because things are worse in other places (like Florida) has expanded his horizons geographically.

Developers who are overleveraged are looking to "recapitalize existing partnerships," Davis said. "That should present a lot of opportunity."

He recalled someone joking that the opportunities were so widespread in the distress of an earlier period that, "The only mistake I made in the early '90s was doing any due diligence."



OLD BLACKSTONE
We referred last week to Yanni Tsipis's book on the Central Artery. Yanni sent us a couple of the wonderful archival pictures that were printed in his book, and here is one of them. It shows Blackstone Street, looking north from North Street, before the block on the right, or east, side was demolished for the elevated Central Artery highway in the 1950s. That side of Blackstone Street in the Haymarket area is flat and vacant now, but as one of the Rose Kennedy Greenway parcels it will be redeveloped. The next public meeting on that block, called Parcel 9, has been postponed from Sept. 9 to Sept. 23. It's at 6 p.m. at Mariner's House, 11 North Square in -- you know -- the North End.

NOLA'S BACK
Bonus tip for Journal readers:
You can drown your sorrows about the economy at 8 p.m. on Tuesday. The fabulous Nola Rose, one of New England's best country and western singers, is back from Nashville and playing at Sally O'Brien's Bar and Grill (