Better in Boston

Friday, December 5, 2008



Think there's a lot of interest in Boston about where the real estate market is headed? NAIOP Massachusetts and SIOR drew an SRO crowd at the Hyatt this week, 40 people stan ding outside the ballroom through six intense presentations. And it wasn't all bad news.

The National Association of Industrial and Office Properties, formerly abbreviated as NAIOP, is now actually called NAIOP. Officially, NAIOP, The Forum for Commercial Real Estate. (Get it? In a world of mixed use, they're now on record as representing not only office and warehouse stuff, but retail too.)

So NAIOP (pronounced "nay-op")looks at the whole big picture, and the Masschusetts organization, largest in the country, has done a great job of, as they say, "drilling down" to get solid information for the industry over the years. Otherwise you wouldn't have 460 professionals getting up early to attend.

Joining with the Society of Industrial and Office Realtors, NAIOP puts on a yearly market outlook, in addition to NAIOP's many regular programs. Yesterday it was "What's Next in 2009? the Annual Market Forecast."

Sponsors were DTZ FHO Partners, Eastdil Secured, Jones Lang LaSalle, Newmark Knight Frank, Richards Barry Joyce & Partners, Banker & Tradesman, and Sasaki. The first five of those had representatives on a panel that was moderated handily and humorously, and keynoted by, Northeastern University economist Barry Bluestone.

Here's a summary.

Bluestone said, "We're probably halfway through this recession," which of course we all were informed this week officially began last December. In one of the many positive pieces of news, we also learned this week that Massachusetts' recession really started months later. Sometimes its good to lag.

Bluestone said his numbers on the economy were official Washington data, "George Bush's numbers." There was a hint of sarcasm in that.

We're going into the fifth year of declining GDP, Blueston said. Unemployment is now 6.5 percent and will probably peak at 8.5 to 9 percent in the spring.

If you add it all up, the US had total debt of $50 billion from the nation's inception through the New Deal. It had $250 billion in WWII. It rose from $1 trillion to $4 trillion under Bush I, to $5.6 trillion under Clinton, and is now $11 trillion.

An increase of almost $1 trillion in one year puts that annual debt at 7/8 of GDP.

Family incomes have been flat since 2001, but families didn't stop spending. They've been doing it by going into debt, spending against the supposedly never-ending increase in the values of their homes. Corporate profits rose during that time from 7.1 percent to 14 percent, but in July were heading down to about an 11-percent level and still falling.

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What's in store on the national front? Major public infrastructure investment ("mini-WPA"); aid to state and local governments, industry bailouts, and no early change in tax policy (despite election promises to the contrary). Also lower interest rates and bank rescues.

GDP will be back up in the third or fourth quarter of '09. Office lags the rest of the economy, will be back in '10.

*******

Turning to Boston and Eastern Massachusetts, Glenn Verette, partner at DTZ FHO, said there's been 50,000 square feet of absorption downtown so far this year. It's a very different economy than when driven by financial services 15 years ago; now it's more diverse.

Sublease peaked in 2002 at 2.3 million square feet available. Today it's 870,000 and may grow but still is a far cry from then.

Only three buildings are under construction, and new development is 45 percent leased overall, so supply is under control. Those are One Marina Park Drive at Fan Pier (the only spec building of the three), Russia Wharf, and Two Financial Center.

Boston added 1.2 million square feet of new space 1994-1999 -- the only time previously that supply has been as low as today.

About 9.5 million new square feet of office are proposed, some approved already.

There are 32 buildings in the Class A marketdowntown, but they average 31 years old. "Who would have though Boston Properties could have attracted Ropes and Gray to a building built in 1965?" (But they did a first-rate improvement on the space, Verette said.)

Tenants are "pressing the pause button," waiting for lower prices. 2009 will be challenging, particularly in the first half. Rents will go down a little, incentives up. Fringe and noncore will struggle the most. "Make the process simple" for tenants, he advised.

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Bob Richards of RBJ talked about Cambridge. Very little space available for 50,000-and-up blocks of space.

Suburbs attracted 79 percent of Greater Boston lab space market demand in the first three quarters of this year (including one large one).

Life sciences companies are looking for more workers in the Boston area than in any other life-sciences center in the country.

It would be a big positive shift if life science jumps to the South Boston Waterfront, Fan Pier, as has been widely reported as a possibility.

*******

Alex Dauria of Jones Lang LaSalle talked about the suburbs, with its total supply 83.8 million square feet.

Year-to-date absorption is minus 338,817 square feet -- compared to an positive of 2.27 million in 2007. Availability remains at about 20 percent.

Waltham is almost as big as Cambridge in size today.

Comparing 2001 and 2008: 2001 was tech-driven, with phantom absorption, excess new supply, and a flood of sublease. 2008 is financial-services-driven, with conservative, pre-commitment- driven leasing, constrained new development, and tenants watching and waiting.

From '97 to '01 there was 20 million square feet in new supply. "That's' astounding," Dauria said. From '02 to '08: 5 million new square feet.

Companies want to keep their employees happy (like staying near transit) and "won't go to Burlington for a $10 delta" in rent if they're really prefer to be closer to Boston.

The immediate future: Unless there are widespread layoffs, rents drift down slightly; lab sector will contribute to stability but not be a panacea; and "the financial structure of some assets will force actionable plans unique to market conditions."

(Boy, how long did it take them to torture those words and put them together? We gather what he meant was some landlords have room to wait and some don't - and will be vulnerable to opportunity buyers.)

*******

Austin Smith of Newmark Knight Frank, the global real estate advisers, was "bullish on the industrial sector" and made that industrial sector more interesting than it usually comes across.

In past there downturns there was a flight to quality; this time tenants are battening down the hatches and taking the flight to value.

He then pointed out Subaru Pier, or "Boston Cargo Terminal," 510 square feet. "It's somewhat of a sleeper," he said.

With a pier of over 1,000 feet, "This is a real opportunity for the City of Boston and the Commonwealth of Massachusetts to create a world-class industrial complex."

(Our question: Will the city push this one forward in the current lagging economy like it's trying to do with some creative negotiating in the Fort Point Channel?) Overall in industrial, there's 2.1 million square feet looking in the market for industrial.

Bluestone had touted his recent report saying manufacturing is undergoing a resurgence in the Bay State, but Smith said it's leaving, including the remaining shoe manufacturers (like Reebok). (Actually, several people politely suggested Bluestone was a little too optimistic.)

Exceptions in manufacturing: solar panels in two locations.

"I never thought I'd be talking about telco again," Smith said. But some companies are requiring 200-300 watts per square foot, and not much of that exists even in what was built during the telco boom that busted a little less than a decade ago. "There is an opportunity there for the next generation," he said.

Location is important. "Shipping by rail is tremendously more efficient than shipping by truck."

Land - there's a tremendous amount of land available in distressed condition (improved with sewers and so forth. "I would keep your eyes out for well located, well -serviced land," and be ready when the economy picks up to build first.

*******

Ok, the downer was Frank Petz of Eastdil Secured. But very convincing stuff. Enough of this shrouded optimism, he said.

"This is going to get ugly. It's different in the capital markets." It's getting nasty in New York, and anybody here from down there is here for therapy, he said.

"It's debt that drove the capital markets to where they were, drove pricing, and it's debt that's driving it down," he said.

He even quoted sage Sam Zell from recently: "Keep it clean till 2013." (But then Sam bought the Chicago company, didn't he?) A lot of things are being priced in a way that investors suspect they might not even get their principal back.

Large national banks are out, Citibank on the ropes; regional banks have done a good job, Petz said.

Assumable mortgages were used in 50 percent of transactions having taken place in 2008.

"We're talking all-time high spreads here for real estate."

Capital will be forming (it's starting to, in the private equity area) and out in the market mid-'09. But "they'll charge you 8-9 percent" interest, he said.

Boston is obviously one of the better markets in the country. And looking better.

Anything that's big is struggling to get done. Checks for $150 million or $200 million for development are unlikely.

And the worse news is, "We've got a ton of debt coming due," stuff written in '06 and ' 07.

Half is CMBS. Half is fixed-rate, half floating-rate. Lots of debt is going to expire, and banks are saying, "Get me out."

CMBS was half the market in the last 3-4 years, and that was 30-70 equity-to-debt on average.

Some of it was interest-only, so none of the nut has been paid off.

Today 60 percent debt is max, he said.

But, "In all this negativity there's opportunity for investors," he said.

In equity and sales market, he said, summing up: There's stagnation and repricing.

Sales year to date in 1007: $11.5 billion. This year: $1.5 billion.

"It's been an iced year, basically," Petz said. There's a lack of confidence in anything that moves forward out there."

The equity money is not jumping in yet - waiting for repricing.

He said the REIT market is down 67 percent from peak, which equates to 27 percent value reduction (considering 70 percent loan-to-value).

"We're going to have to take our medicine," he said, and there will be: less debt, and at higher cost.

Also not good: Real estate allocations of investors is decreasing (even Harvard's endowment is down, as the Globe reported).

Limited sales are taking place, mostly stress and distressed.

Again, the good news in Boston is supply is in check. Opportunities are in debt positions - that's where the stress is, and the biggest discounts. And repricing, getting a better deal.

Oh, and Bluestone added in the Q and A session that 70 percent of GDP is consumption. That is now at around 67 percent, because people ran up their credit cards. And he thinks government will fill the gap next year with stimulus.

"I believe we will have a trillion-dollar spending package. Will that be enough? We are in a classic Keynsian model. (Back to the '30s? That's what Amity Shlaes' new book, "The Forgotten Man," would tell us.)

Bluestone said more will go into stimulus than to autos or banking industries. The big question is how much will be put into into infrastructure.

He said he thinks the "foreclosure problem" has to be addressed, because it's at the heart of the cause. He didn't say how you do that.

Answering a question about the auto industry and bailout talks, Bluestone was eloquent on the new relationship that has to be developed, he said, between employer and labor. One that's realistic. (We observed that government regulations, particularly CAFE standards requiring a certain percentage of cars to be built because they're energy efficient, even when they aren't as profitable as other models, may be substantially responsible for some of this mess. Bluestone disagrees.)