NORTHEAST SNAPSHOT, FEBRUARY 2005

BOSTON OFFICE MARKET

Despite the signs of improved conditions, the Boston office market continues to bump along the bottom of the cycle. However, some pockets of growth are being revealed. The market continues to be tenant-driven, but in certain segments, landlords are beginning to see increased occupancy and moderate rent increases. Yet, with the current market conditions, new office development has slowed in Boston.

In 2004, four new office projects were introduced to the market: 33 Arch Street, a 650,000-square-foot tower located in the midtown section of the Financial District; 100 Cambridge Street, a 550,000-square-foot Class A rehab in the government center section of the Financial District; 601 Congress Street, Manulife’s Boston headquarters consisting of 420,000 square feet; and Channel Center, a mixed-use rehab and new construction blend in the South Boston Waterfront. Due to the scarcity of development sites in Boston, the development trends lean toward rehabilitating old buildings and building on infill sites.

One trend that has surfaced due to lack of raw space and significant vacancies is the conversion of under-performing office buildings into residential space. An example of this trend is the sale of a Class B historical building at 441 Stuart Street to Gold Associates. Gold Associates purchased the building and will convert it to high-end condominiums. These conversions have helped with the absorption of existing office space.

There are very few projects in the immediate pipeline in Boston due to adverse market conditions. Equity Office’s Russia Wharf is the only project that is fully designed and permitted. Once Equity sees an imminent change in market conditions, it’s likely that the project will get off the ground. Since this is the only new project with legs, the hope is that demand will grow at a fast enough rate to absorb this new space.

When development picks up again, the South Boston Waterfront will be the most popular development area of the city — it is the only part of the city that has raw land to develop. Vehicular access is excellent, the waterfront views are spectacular, and retail will soon be built to accommodate the new convention center currently under development.

The most positive news in 2004 was the amount of space that was leased. This velocity reflects the aggregate space leased, including renewals, relocations, growth and contractions. More than 5 million square feet of space was leased, an amount equal to space leased in 2000. This comprises more than 300 transactions with an average size of 17,000 square feet. 750,000 square feet of the 5 million accounted for new growth. Absorption was flat at 150,000 square feet in 2004. This means that despite the increased vacancy rate, slightly more space was leased or taken off the market than was put on the market.

The vacancy rate increased from 15.2 percent to 16.7 percent in 2004. The sublease market was the largest contributor to this increase. The amount of available sublease space increased from approximately 1.8 million square feet to 2.6 million square feet as many of the corporate giants such as Manulife, State Street and Deutsche Bank consolidated and created new space in the market. Bank of America’s decision to move its client wealth group to Boston helped mitigate some of the damage relating to that excess space.

Spaces with high-rise views have experienced a significantly lower vacancy rate than lower level space or Class B offerings. The vacancy rate for floors 20 and above in major Class A towers is only 6 percent. The rate for the top floors is lower because much of the empty space resulting from corporate consolidation is located in the lower floors of these buildings. Also, many people who lost their jobs as a result of consolidation are starting their own firms and absorbing high-rise spaces that are 15,000 square feet or less. Demand is increasing for high-rise space, and vacancy and rents are reflecting that trend. The weighted average asking rate was flat at approximately $33.55 per square foot at year-end 2004. Class A rents ranged between $32 and $45 per square foot.

What does all this mean for 2005? Meredith & Grew is confident that the improvement in economic conditions will translate into moderate job growth in 2005. It looks as though the Boston office market has finally turned the corner and conditions will start to improve slightly for landlords in the coming year. Expect a moderate increase in absorption, rents staying flat or increasing very little, and vacancy rates dropping somewhat. Tenants will continue to focus on the fundamentals. The flight to quality and the desire to be centrally located should be a trend that continues into 2005.

— Ronald K. Perry is an executive vice president and Kristin E. Blount is a vice president at Meredith & Grew Inc.

©2005 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.