COVER STORY, AUGUST 2007

KEEPING TABS ON THE TRENDS
A snapshot of the office leasing market across the Northeast.
Dan Marcec

Office leasing has continued strongly throughout the Northeast, as the major markets are seeing significant absorption and rising rents across the board. Northeast Real Estate Business recently spoke with commercial real estate executives in three Northeastern cities to gain a snapshot of how each office market is faring in order to piece together a picture of the region as a whole.

Manhattan, New York City

Once complete, 11 Times Square in Manhattan, New York City, will bring approximately 1.1 million square feet of Class A office space to this thriving market.

Manhattan’s office market continues to perform well, defined particularly by the fact that overall vacancy has been declining steadily since 2007 began, while in that same period asking rental rates have escalated to record prices.

James Delmonte, vice president and director of research with Jones Lang LaSalle’s New York office, explains that Manhattan saw a higher volume of leasing activity to this point in 2006, but the reason 2007 has not kept pace is simply due to the fact that there is less space to lease. As a result, he says, “renewal activity has been a major focus of space users as availability remains low.”

For some of Midtown Manhattan’s highest quality office properties, overall average rental rates have skyrocketed nearly 12 percent in the last  3 quarters, from $93.25 per square foot in September 2006 to $104.14 per square foot at mid-year 2007, according to JLL’s research. With certain spaces going as high as $150 per square foot, the proverbial ball is firmly in the landlords’ court with regards to lease negotiations throughout the New York office market. Not only is Midtown flourishing, but also Lower Manhattan is seeing increasing rents, as average rates for top properties during that same 9-month span rose 28 percent from $52.10 per square foot to $66.64 per square foot. The most sought-after office space in that submarket is asking as much as $75 per square foot.

The hot conditions in the Manhattan office market is not limited to Class A space, however. “Average rental rates for Manhattan’s Class A buildings have climbed high enough to cause tenants to push their space search into secondary submarkets and buildings, and this activity is fueling rent growth throughout the city,” Delmonte says. “As a result, the increase in Class B rents matches the pace of rent growth posted by New York City’s Class A office buildings over the past few months.” In that light, Class B office rents have risen almost $10 per square foot since year-end 2006, ascending nearly 23 percent from $42.14 per square foot to $51.96 per square foot in that time period.

Financial and legal services continue to stand at the forefront of office leasing activity in Manhattan, with the two business sectors combining to lease nearly half of the deals greater than 10,000 square feet — according to Delmonte, at mid-year 2007, financial services and law firms had signed on for 5.17 million square feet of Manhattan office space, which is equivalent to 48 percent of the leasing volume for deals of that magnitude. Communications, media and entertainment companies came the closest to matching that kind of activity in leasing spaces greater than 10,000 square feet, representing 10.7 percent of that sector at a total of 1.15 million square feet.

With trophy-quality buildings reaching historically high rental rates, all three of Manhattan’s office submarkets continue to outperform suburban markets substantially. Only in Greenwich, Connecticut, have rents even approached the $100 per square foot averages in the Midtown submarket.

“New York remains the financial center of the country, and it is more imperative than ever for national and global businesses to maintain a Manhattan address,” says Delmonte. “Major corporations also have learned they have to stay in New York to retain access to the city’s unmatched labor market.”

Philadelphia

The first half of 2007 was very strong for the Philadelphia office market, though a slight slow-down has been incurred by upward pressure on interest rates. Average rental rates are stabilizing, and depending on location and quality of the building, there has been significant growth as well. According to Bob Walters, senior managing director at CB Richard Ellis, both the suburban and the urban markets are reflecting these positive trends.

“From an absorption standpoint, we anticipate significantly positive growth in the CBD and suburban markets for 2007,” says Walters. “There is a trend of flight to quality — certainly in the downtown market — of Class B moving to Class A, Class A moving to Class AA, and even Class C product is being redeveloped into new uses. With these excellent opportunities available, tenants can take advantage of rents and move their company into an improved environment.”

The healthcare industry is growing substantially, and major employers such as the University of Pennsylvania and the Children’s Hospital of Philadelphia in University City are looking to grow toward the CBD as there is a non-existent or limited supply of office space in their current location. In that respect, a number of transactions have landed or are in negotiations as these employers are seeing the need to grow, and have the opportunity to do so in the downtown submarket.

By year-end, the vacancy rate appears to be moving toward the 10 percent to 11 percent range overall, and particularly the Class A market is solidifying. “There continues to be downward pressure on vacancy rates within the CBD, and rental rates continue to inch upward as rent concessions are quickly drying up,” says Jeffrey Seligsohn, principal at Seligsohn Soens Hess/TCN Worldwide. “The 100 percent lease-up of the Comcast Center has given a positive boost to Class A rental rates, in turn, slightly widening the gap between Class A and Class B rates.”

Currently, all product types in the office market are strong due to the sector’s overall health. With the multifamily and industrial markets remaining extremely competitive as well, funds from local, regional, national and international players are coming online, contributing to upward momentum across the board. Specifically, according to Seligsohn, start-up companies are looking for high-ceilinged, open-plan space.

Though landlords have the upper hand in negotiations with respect to the Class B market, the Class A sector is moving from a tenant-dominated sector to a more balanced scenario. “With some of the concessions and some amenities offered to various tenants diminishing in size and number, the market is becoming more traditional, bringing a balance between landlord and tenant,” says Walters.

Seligsohn agrees, but offers a caveat. “The Class A market remains somewhat mixed; however, as more of the larger blocks of Class A space continue to be absorbed, this dynamic may switch to a pro-landlord market quickly,” he says. “There has been renewed interest in the CBD from emerging companies as well as established companies looking for additional locations.”

Overall, financial services and law firms are dominating leasing activity with significant growth needs, and some are handling expansions or recalibrating their operations by moving back office or administrative support to new locations. The pharmaceutical industry is growing in the suburbs, demonstrated by a 150,000-square-foot lease signed by Shire Pharmaceutical. “Pharma continues to show strength and expansion, and is an integral element to our overall office market well being,” says Walters. “Healthcare, legal, financial and pharma — those are the drivers for our office expansion.”

The investment market has been strong as well, adding to the overall space available for lease. Though rates have ticked up slightly in the past months, quality activity is occurring throughout the Philadelphia tri-state area, with both institutional and private capital coming into play.

“Investment real estate is still very strong with many players chasing ever dwindling product,” says Seligsohn. “The dramatic slowdown in the condominium market, as well as an upward movement in interest rates, has proven to slow transactions in the last few months. The pending expansion of the convention center has fueled some hotel conversion speculation. As a result, assets with this type of potential are in high demand.”

Generally, both the urban and suburban markets will look back on 2007 with a sense of positive growth, absorption and reduced vacancies. While the first half of 2007 saw a greater number of deals in the downtown submarket, Walters believes the suburban markets will enjoy more significant transactions in the second half of this year. “Being more of a timing issue than anything, this overall health and strengthening of the market in suburban and urban sectors remains an important trend,” he says.

Boston

The key trends fundamental to the overall Boston office market continuing to improve and tighten are twofold: one, the vacancy continues to decline; and two, the investment market is “red hot,” according to Ron Perry, executive vice president of Meredith & Grew.

In the 57 million-square-foot Boston office market, with the financial district and Back Bay comprising 80 percent of that, vacancies have dropped to 9.5 percent overall, due highly to the fact that there has been no new inventory developed over the past few years. As a result, strong absorption continued for the third straight year, with 850,000 square feet being taken through mid-year 2007. A hefty demand from professional services has improved fundamentals by supporting that absorption and pushing up rents.

On the investment side, high-end properties are significantly in demand, and there has been a tremendous influx of interest at the Class B level as well; the financial services sector has been highly interested in that first-class product, resulting in the increased movement toward Class B properties.

Though interest rates have increased in recent months, financing has been attractive and buildings have been going for record prices per square foot; with a large amount of capital from pension funds and REITs as well as international firms. All across the board, the market is moving forward.

From an owner’s standpoint, Boston is in excellent shape as prices rise and the market tightens. Financial firms are leading the way in the leasing market, followed closely by the law firms. Looking out toward the suburban market, the story is much the same. With another 120 million square feet of product, that area continues to tighten, with some tenant favorability in negotiations as well.

“Looking at the conditions of single-digit vacancy, sales prices bringing many new owners to town, and seeing fundamentals bring higher prices, the pendulum of negotiation has swung in favor of the landlords,” says Perry. “With 2 million square feet in recent lease transactions and with an additional 1.5 million square feet online, landlords are becoming more bullish in their pricing. Given that kind of demand and activity, we won’t have new inventory probably for 2 or 3 more years; there are some plans on the board, but the market should tighten before it grows out.”


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