COVER STORY, MAY 2008

NORTHEAST OFFICE REPORT

The Northeast office market continues to be a dynamic sector. This month our panel of experts talk about the office activity taking place in their respective markets.

Boston CBD

Ronald K. Perry, Colliers Meredith & Grew

There is no question that the fear of a recession and uncertainty in the economy are at the forefront as businesses plan for the year. While office market fundamentals in Boston remain vigorous — 2007 represented the fifth consecutive year of positive absorption and a vacancy rate that dipped into the single digits — the downturn in the economy on the one hand and single-digit vacancy rates on the other, have created a bit of a disconnect in the market.

Traditional drivers in Boston’s core office markets include financial, legal and professional services firms, with an average requirement of approximately 18,000 square feet; thus, the demand for office space is robust with nearly 100 tenants seeking more than 3.4 million square feet of space. In 2007, the Class A office market tightened and rents for premium space escalated to the $70 per square foot range, resulting in significant absorption in the Class B market. In 2008, rental increases are expected to be moderate while organic growth is anticipated to continue and the vacancy rate is forecast to drop below 8 percent.

The office leasing market still tends to favor landlords, but this is being tempered somewhat by uncertainty regarding the national economy. In the Boston CBD, premium view space in the Class A tower market is scarce and continues to command a rental premium. The vacancy rate in the Boston CBD is 8.7 percent with a 7.6 percent vacancy for Class A product and an 11.4 percent vacancy rate for Class B space.

The vacancy rate in the Cambridge office market is 11.6 percent and the suburbs of Boston are exhibiting a 17.7 percent vacancy rate. Overall, the office market vacancy rate is sitting at 14.5 percent. Recent leases include a 415,000-square-foot lease by Ropes & Gray at 800 Boylston Street in the Back Bay submarket, a 220,000-square-foot lease by Fidelity at 53 State Street in the Financial District and a 215,000-square-foot lease by Putnam Investments at One Post Office Square, also in the Financial District.

Given the area’s preeminence as one of the most significant life science clusters in the world, the biotech lab market is in high demand. The Boston lab market totals 2.7 million square feet and a 1 percent vacancy rate. Supply and availability is greater in the Cambridge and suburban lab markets, but still in high demand.

The Boston development pipeline, quiet for the past 3 years, gained momentum during 2007 with a number of developers moving ahead with projects that have been in the planning stages for some time. In addition to Boston Properties’ 520,000-square-foot office development at Russia Wharf, recent groundbreakings include: Fan Pier, a 500,000-square-foot office building in the Seaport District expected to be delivered in 2010. This represents the first of several buildings in what will be a 3 million-square-foot, mixed-use project that is being developed by The Fallon Company and Cornerstone Real Estate Advisers.

Directly behind South Station, Lincoln Property is developing Two Financial Center, a 210,000-square-foot office building that is slated for a 2009 delivery. It is also interesting to note that in January 2007, Boston became the first major city in the United States to incorporate green building requirements into its zoning code. Projects that exceed 50,000 square feet are now required to incorporate a minimum number of “green building” elements.

The fundamentals of the greater Boston office market helped push investment sales to an all time high last year with sales — including all property types and submarkets — reaching more than $12.5 billion. Most of this occurred in the first half of the year as conditions in the credit markets and the ensuing credit crunch slowed transaction volume in the second half considerably. Currently, however, despite ample availability of equity and a strong appetite for deals, many investors are sitting on the sidelines until the debt markets stabilize, and as such, buyer profiles have shifted to reflect the lower-leverage environment.

— Ronald K. Perry is the executive vice president of Colliers Meredith & Grew in Boston

Lower Manhattan

Elizabeth H. Berger, Alliance for Downtown New York

With low vacancy rates, increasing rental rates and a rapidly diversifying industry base, the Downtown office market is stronger than ever, despite the current turmoil in the financial services sector. Lower Manhattan is well-positioned to weather economic uncertainty, today, and in the months ahead.

Tenants from a wide variety of industries have relocated Downtown over the last 18 months, driving Class A office vacancy rates to below 6 percent and average office rents up to an average of $47.47 per square foot. This average rent represents a 23 percent year-over-year increase, but still offers a significant discount to Midtown rents.

Lower Manhattan’s value proposition has prompted nearly 200 companies from Midtown and other parts of the metropolitan area to move to the district since 2005, with 10 of the top 30 commercial leases signed in 2007 representing relocations.

The majority of these companies are involved in media, professional services and other non-financial industry activities, and include Global Hue, which signed for 40,000 square feet for 10 years at 123 William Street, Niche Media, which is relocating to 45,000 square feet at 100 Church Street and IPC Information Systems, a leading global provider of communications solutions that just consolidated its New York operations at One State Street Plaza. Other recent leases Downtown include Omnicom for 184,000 square feet at 195 Broadway, American Lawyer Media for 90,000 square feet at 120 Broadway and law and consulting firms Fragomen, DelRay & Bernsen, Monitor Group, Carfora Klar Gallo Vitucci Pinter & Cogan, AR Traffic Consultants Inc., E2 Consulting Group, Princeton Brand Econometrics and Medina Consultants.

Lower Manhattan’s remarkable revitalization and diversification safeguards its status as a world financial capital. Four state-of-the-art, Class A office buildings will open at the World Trade Center site in the next few years, and Goldman Sachs is currently completing construction of its 2.1 million-square-foot headquarters building on West Street. JP MorganChase also remains a big player in the landscape, occupying 70 percent of the 2 million-square-foot, soon-to be-landmarked Chase Plaza building and moving ahead with its commitment to build an office tower across from the World Trade Center site.

Larry Silverstein’s new 7 World Trade Center, which opened in 2006, is another extraordinary success story. Companies including Moody’s Investor Services, the Arnell Group and NCR Corp. signed large deals at the building in 2007, joining ABN Amro and Ameriprise Financial, and filling much of the building in the process at rents that would have been unthinkable in Lower Manhattan a few short years ago.

Finally, several notable commercial building sales took place in 2007. 60 Wall Street sold for $1.2 billion, 32 Old Slip sold for $750 million, 156 William Street sold for $156 million and 375 Pearl Street, also known as the Verizon Building, was sold for $172 million and is being refurbished as a luxury office building.

These building sales, as well as the continuing influx of businesses representing a wide range of industries, show strong optimism about Lower Manhattan as a place to invest and do business and are positive signs that Lower Manhattan’s best days are still ahead.

— Elizabeth H. Berger is the president of the Alliance for Downtown New York, which manages the Lower Manhattan Business Improvement District.

Midtown Manhattan

James Delmonte, Jones Lang LaSalle

The ongoing credit crunch in Manhattan has caused many corporations to adopt a wait-and-see attitude toward the market and fueled a drop in investment sale transactions. Despite the pullback, Midtown Manhattan remains a strong office market. Although office vacancy rates increased throughout the submarket, Midtown building owners achieved moderate rent increases in the first quarter of 2008.

Midtown Class A buildings posted a 7.7 percent increase in average asking rental rates in the first quarter of the year, rising to $97.50 per square foot from $90.57 per square foot at year-end 2007. Rents from Class B office properties in Midtown barely moved in the same time period, rising to $61.84 per square foot from $61.78 per square foot. Vacancy rates in Midtown rose 9.1 percent in the first quarter of the year, increasing to 7.9 percent from 7.2 percent at year-end 2007. Class B vacancy rates, meanwhile, fell 2.9 percent in the same time period, dropping to 7.7 percent from 8 percent.

While the change in average asking rents may seem counter intuitive given the rise in vacancy rates, it is important to note that spaces being placed back on the market are located within Midtown’s premium Class A office buildings. In fact, if blocks of space in the submarket’s trophy-class properties wind up being put on the market, they will be priced at above market rates and could drive further escalation in asking rents.

However, deals now in negotiation feature greater tenant concessions, including increasing free-rent periods and tenant improvement packages. In addition, many expect a certain quantity of sublease space to enter the market in 2008.

Half of the largest deals completed in Midtown in the first quarter of 2008 were renewals. Colgate Palmolive renewed its lease for 537,000 square feet at 300 Park Avenue and Dreyfus Service Corporate will continue to occupy 372,000 square feet at 200 Park Avenue. New leases include Ogilvy & Mather taking 554,800 square feet at 636 11th Avenue, and the United Nations signing for 554,800 square feet at 380 Madison Avenue.

Overall, New York’s Class A office properties posted the largest increase in average asking rental rates this quarter. Class A rents in Manhattan rose 8.2 percent in the first quarter of the year, reaching $87.51 per square foot from $80.90 per square foot at year-end 2007. Class B rents increased 1.4 percent in the same time period, rising to $56.06 per square foot from $55.28 per square foot. Overall office average asking rental rates rose 4.6 percent in the first quarter of the year, increasing to $72.07 per square foot from $68.87 per square foot in the fourth quarter of 2007.

Office vacancy rates rose throughout the city in the first quarter of the year. Overall vacancy rates rose 7.6 percent in the first quarter of 2008, increasing to 7.7 percent from 7.1 percent at year-end 2007. Class A vacancy rates grew 9 percent in the same time period, rising to 7.2 percent from 6.6 percent.

According to the latest employment data from the New York City Office of Management and Budget, private-sector employment levels have fallen for two consecutive months for the first time since 2003. The drop in overall employment was largely due to the downturn in the securities and banking sectors.

While comparisons with the previous economic downturn of 2001 to 2003 are inevitable, there are obvious differences. In many ways, the previous recession was a result of a “perfect storm” scenario, combining a weakening in the financial markets and subsequent layoffs, a sharp correction in the technology sector and the tragic events of Sept. 11, 2001. The end result was a massive unloading of long-term, high-quality sublease space, which at one point comprised more than 35 percent of the total availability in the New York office market.

Given the current economic climate, it is not unexpected for rents to begin leveling off. Tenants have more options as companies continue to shed unneeded space. To attract prospective tenants, landlords have begun to offer more concessions during negotiations than they have in the past few years. Despite the weakness in the market, Manhattan remains one of the healthiest office markets in the country.

— James Delmonte is vice president and director of research at Jones Lang LaSalle

Philadelphia

Steven J. Cousart, CB Richard Ellis

Despite a national economic downturn, the Philadelphia Central Business District (CBD) and Western Philadelphia suburban office markets experienced healthy growth in the first quarter of 2008. Within these two areas, a slight increase was detected in the average asking lease rates. At the same time, the direct vacancy rate increased in the Philadelphia CBD but remained below 9 percent for the second straight quarter. Direct vacancy in the Western Philadelphia suburban office market decreased again, for the ninth consecutive quarter, to 13.4 percent.

During this quarter, the Philadelphia CBD office market posted almost 1 million square feet of net absorption. This marks the tenth consecutive quarter of positive net absorption for the city. Due to recent leasing activity, large blocks of available space have become scarce and only four buildings offer 100,000 square feet of contiguous space for lease.

 In the fourth quarter of 2007, Unisys Corporation leased 90,000 square feet and Buchanan Ingersoll & Rooney leased an additional 77,000 square feet in Two Liberty Place, a class A trophy building owned by America’s Capital Partners.  Much of the reported net absorption in the first quarter of 2008 is attributed to the completion and near 100 percent occupancy of the Comcast Center, one of the more prominent office buildings ever developed in the city. Currently, only one building — the 154,844 square foot University Science Center, which is located in the University City section — is under construction in the Philadelphia CBD. 

Looking ahead, CB Richard Ellis predicts landlords in the Philadelphia CBD will take advantage of these favorable conditions and raise rental rates. Also, the lack of available blocks of space will force some tenants to renew their leases early as a defense against being “shut-out.” We further anticipate developers will attempt to launch a limited number of high profile construction projects, which are currently on the drawing board such as Brandywine Realty Trust’s Cira Centre South — construction slated to begin in July 2008.

Generally speaking, leasing activity in the Western Philadelphia suburbs has decreased since this time last year but the market is still characterized as healthy. The direct vacancy rate in the suburbs is expected to decline only slightly during 2008 and will linger around 13 percent. The first quarter of 2008 registered positive net absorption figures, continuing a trend established early in 2006. During this period, the Plymouth Meeting/Blue Bell submarket led the suburbs with close to 240,000 square feet of positive net absorption. 

There is relatively little office development in progress and the majority of buildings under construction are build-to-suit projects. The largest office project under construction is 3800 Horizon Boulevard in Trevose, a 200,348-square-foot project scheduled for completion in early 2009. Another substantial project is the 150,000-square-foot 505 Eagle View Boulevard building in Exton. This project has just become available and is already more than 80 percent leased. The two largest lease transactions recently completed in the suburban market were the Hartford Insurance Company at Four Walnut Grove in Horsham for 104, 561 square feet and the Sunoco, Inc. lease for 105,000 square feet at the Airport Business Complex in Tinicium. 

The Western Philadelphia suburban office market is being driven more by lease expirations than organic growth or corporate headquarter relocations. Given the downturn in overall business activity, the sharp increase in the cost of constructing tenant space and the significant cost of moving, many tenants are choosing to renew their leases. Some tenants, who need to downsize, are finding the relocation alternative less painful then staying put and tolerating massive renovations to existing facilities.  Financially based companies, in particular, are beginning to inundate the market with sublease opportunities in an effort to reduce their occupancy costs.

Vacancy in class A buildings is higher than one might expect at 13.43 percent. This is attributed to the fact that several buildings, introduced to the market last year, remain essentially vacant as the market resists the associated +$30.00 per square foot rents. Although tenants are taking longer to make decisions, rents are not showing any signs of weakening. 

While the rest of the country is struggling through the biggest economic downturn in recent memory, the Philadelphia Metropolitan Statistical Area, notorious for not booming in the good times or swooning in the bad, remains virtually unscathed.

— Steven J. Cousart is the first vice president at CB Richard Ellis in Wayne, Pennsylvania

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