COVER STORY, JUNE 2006

A STABLE INVESTMENT
Assurance of stability lures investors back to the Northeast.
Mitchell R. LaBar

As the overheated western and southern Florida property sectors begin to moderate, investors should reconsider the stability offered by commercial properties in the Northeast. These mature markets are excellent targets for investors because job growth is expected to increase across the region, spurring continued demand for all types of product, particularly multifamily and retail. Across the Northeast, the rental apartment and office property sectors are making great strides.

Multifamily

New York City

As developers scramble to revitalize and rehab every last piece of available land in Manhattan and prime submarkets of Brooklyn, the anomalous New York City market will continue to prosper. The median price of local multifamily properties rose 26 percent last year to $189,000 per unit, and cap rates fell to a low of 5 percent. Sales to condo converters contributed to the rapid price appreciation, as conversion deals claimed more than 5,300 units at a median price of approximately $500,000 per unit. The city’s vacancy rate is expected to decline, while asking rents are set to rise by the greatest rate in 5 years.

With the local for-sale market cooling, however, conversion-oriented buying could slow in 2006 and limit the magnitude of value growth. In some submarkets, such as Harlem/North Manhattan, properties are trading for less than the market’s median price. Still, the median price in this submarket rose 27 percent last year to $104,000 per unit. Prospective residents’ more favorable perceptions of the area are forcing a gradual reassessment of property underwriting and should push asset prices higher.

Boston

An influx of residents relocating to the Boston metro area due to increased job growth will support expansion of the local renter pool. This year, the greatest improvement in the city’s multifamily market is expected in the close-in Brookline submarket, where vacancy is forecasted to fall 70 basis points to 4.2 percent. Job growth in the city of Boston will also help push vacancy lower in the desirable Central City/Back Bay submarket, where a 40-basis-point decline to 4.1 percent is anticipated. Some builders are switching apartment projects over to condominiums prior to completion. The Highpoint complex in the South Shore submarket is an example. Original plans called for the entire 1,040-unit development to be rentals, but 128 of the 522 units built in Phase I were sold as condos.

Connecticut

In the New Haven/Stamford, Connecticut, market, apartment demand will continue to be muted by the area’s relatively older population, modest employment and population growth, and its high cost of living. In Stamford and Bridgeport, where vacancy is lower than the market average, the scarcity of developable land has led to an ongoing push for redevelopment of buildings in downtown areas. Stamford’s strengths are its waterfront properties and accessibility to New York City, both of which make the city attractive to residents and high-end developers. Downtown Bridgeport is being reshaped as part of a phased project called Downtown North. In addition, downtown New Haven has experienced a rebirth by capitalizing on its cultural attractions and is becoming a popular area for residents priced out of the New York market.

The median sales price per unit in the metro area held fairly constant from 2004 to 2005, rising from $81,400 to $83,300. Much of the sales activity in 2005 occurred in New Haven, Bridgeport and Stamford, involving mostly smaller properties. Due to the dearth of new development, existing properties typically generate strong investor interest. One trend that should continue in 2006 is the shift in investor focus from selling assets soon after purchase to raising property income by increasing occupancy and pushing up rental rates.

Office

New York City

In New York City, the office market is set to improve significantly this year. More investors will begin to turn their sights on all types of office product, from class A to C. Specifically, look for a significant amount of investment in Midtown and Midtown South. Instead of striving for a Park Avenue or Madison Avenue address, many retailers are reshaping the way businesses is done in Midtown South. As a result, leasing activity in 2006 is forecasted to be robust, especially in Midtown and Midtown South, which is expected to push vacancy in both submarkets down 90 basis points to 120 basis points in the high-6 percent range.

Headline-grabbing deals are the norm in New York City, and 2006 should be no exception. REITs, institutions and other large buyers will remain active in the market due to the solid fundamentals. Competition among these groups helped drive up the median price by 30 percent over the last year to $332 per square foot. Investors with less than $10 million to spend will also be active buyers, finding properties with decent returns, sometimes in the shadows of trophy buildings in submarkets such as Midtown or Downtown. For example, small properties south of 42nd Street and east of Sixth Avenue often have stable, long-term office tenants. Private capital will continue competing intensely for such assets, which often price at cap rates in the low-7 percent range.

Boston

Improvements in the local economy last year pushed Boston’s office market recovery into gear, and additional strengthening of market fundamentals is expected in 2006. The convergence of increasing demand fueled by employment gains and limited new construction led to a substantial decrease in vacancy over the past year. This has created a much brighter environment for Boston office property owners, who will continue to reduce concessions this year, in addition to raising rents for the first time since 2000. One situation to monitor that could dampen the outlook, though, is Cincinnati-based Procter & Gamble’s $57 billion acquisition of Boston’s Gillette. A total of 5,000 job cuts are expected, and although there has been no announcement of when and where job losses will occur, a portion will likely be at Gillette’s corporate headquarters. This could impact the supporting office-using service firms in the Back Bay area.

Retail

While competition for Northeast retail properties at various price points will remain high, it will not be as high as it was in 2005. However, we do warn of a potential slowdown in retail spending. An anticipated dramatic reduction in the amount of disposable income over the next couple of years has sent up a warning flag. When you start thinking about the amount of money that was in equity lines and home refinances, I have heard numbers stating that 70 percent of that refinance and home equity money was spent consumer-spending style. That marketplace has started to dry up. If that’s the case, those retail sales are going to start to lag this year.

New York City

Again, in the anomalous New York City market, the redevelopment of retail properties in urban infill areas and the continued investment in such properties remains in high demand. Strong investor interest has truly emerged for the $2 million to $9 million retail strip center. There is a feeling that tenants have had more leverage in the past than landlords have.

For deals under $10 million, Tri-state investors are eyeing up Manhattan and outer-borough retail assets. Most of the buyers interested in properties under $10 million still have wealth as a result of the last 6 to 8 years. Today, there is still a lot of local northeastern capital floating around looking for the right deals. As long as the anchor is of decent credit, there will always be a buyer for those properties. They have very aggressive cap rates.

Boston

In Boston, retailers are targeting the city due to its affluent market, which presently is underserved by existing retail, and its high barriers to entry lessen competition for those that are able to penetrate the area. In fact, there currently is a backlog of retailers who are looking to pierce this market, creating an excess of available demand for owners of Boston retail property. To illustrate, Nordstrom will be opening four stores within the Boston market over the next several years, yet it has tried to enter the market unsuccessfully for the past 25 years. One of the most attractive features of the local market is its high median household incomes. The median at the end of 2005 was $71,087 per year, a 6 percent gain from the previous year and 55.4 percent higher than the U.S. median. In 2006, a 3.4 percent gain to $73,474 per year is expected. Retail sales, benefiting from this extra spending capital, rose 6 percent in 2005 and are forecasted to increase 4.4 percent this year.

The Boston retail investment market is currently red-hot, which should continue throughout 2006. The median price for all retail properties last year was $148 per square foot and is expected to rise this year. Over the past 2 years the number of transactions has grown exponentially and prices have risen with cap rates falling in the mid-to-high 6 percent range. One of the interesting changes witnessed within the local market is that there has been a large influx of institutional investors and that segment is now the foremost source of capital for retail real estate purchases. Recently, restaurants have been the most popular types of single-tenant acquisitions, with a median price of $174 per square foot. Recent multi-tenant transactions have almost exclusively featured storefronts, strip centers and neighborhood/community centers. Leasing activity for all property types will remain strong this year as owners are bolstered by the knowledge that there is a backlog of retailers interested in Boston space.

The Future of Investing in the Northeast

In the past 3 years, an ample amount of Northeast capital was redirected into Florida, Vegas, or Southern California. Now, on a larger scale, that investment capital is being brought back to the Northeast because those markets have started to cool. This year, we can expect to see more capital return to the Northeast as it seeks out high quality, stable investment properties.

Mitchell R. LaBar is senior vice president/managing director and regional manager of Marcus & Millichap’s Manhattan office.

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