MARKET HIGHLIGHT, NOVEMBER 2004

BOSTON’S COMMERCIAL REAL ESTATE OUTLOOK
PROMISING

Commercial real estate in Boston is experiencing ups and downs. Retail is outperforming the office and industrial sectors, but future prospects are promising.

The industrial market faces high vacancy rates. The second quarter of 2004 saw increased vacancy and negative absorption, but there continues to be demand for new, high-bay warehouse space. Boston’s office market continues to recover slowly. Vacancy rates have risen slightly throughout the year and a large amount of sublease space has been placed on the market recently. The redevelopment of Class B office buildings into residential properties is helping counter the new influx of sublease space, and the market is continuing its gradual recovery. The retail market throughout downtown Boston has experienced none of the troubles seen by the office and industrial sectors, as steady demand from retailers new and old spurs great rental rates and new developments.

Office

The Boston office market, consisting of more than 56 million square feet of inventory in eight submarkets, is showing gradual signs of recovery. The vacancy rate rose slightly in the second quarter to 15.6 percent, compared to 15.4 percent at the end of the first quarter 2004 and 15.2 percent at year-end 2003. The lowest vacancy rates are in the Fenway/Kenmore submarket, a 1.8 million-square-foot market, at 5.2 percent, and the highest are in the 4.1 million-square-foot South Boston Waterfront submarket, which is at 20.2 percent.

Net absorption for the first half of 2004 was strong at 796,896 square feet, which can be attributed to the opening of 100 Cambridge Street, a 550,000-square-foot building, in the first quarter 2004. This building is more than 80 percent leased to American Student Association, Barron & Stadfeld, Rogers Law Firm LLC, and specialized agencies of the Commonwealth of Massachusetts. The 650,000-square-foot 33 Arch Street building opened in the second quarter of 2004, with approximately 62 percent of the building leased to Digitas, the Securities and Exchange Commission (SEC), and the Massachusetts Department of Education.

The sublease market will prove to have a significant impact on the Boston office market through the remainder of the year. Available sublease space has declined at a steady rate of approximately 1 million square feet a year over the past 2 years; sublease space totaled approximately 1.5 million square feet at the end of the second quarter. However, since July, approximately 1.4 million square feet of sublease space has been placed on the market by some of the city’s major corporations. After its merger with John Hancock, Manulife is shedding approximately 700,000 square feet of space onto the sublease market. Additionally, Deutsche Bank is placing 300,000 square feet on the market and State Street is adding 250,000 square feet on the market within several different buildings.

Another trend that appears to be developing in the Boston market is the selling of Class B office buildings to developers for residential conversions. This is being driven by the abundance of capital from various buyers looking to buy residential properties in a low interest rate environment. With office vacancy around 15 percent and the need for new office developments on the decline, the condominium market appears to be one of the hottest segments in Boston.

There are two Boston submarkets that stand out as areas to watch for future growth. The South Boston Waterfront area has seen the largest amount of growth recently. This is highlighted by the opening of the new Boston Convention and Exhibition Center in June 2004 and the pending sale of the Fan Pier property and the McCourt sites. With the removal of the elevated MBTA (Massachusetts Bay Transportation Authority) lines, the completion of the Central Artery sites, redevelopment of Lovejoy Wharf and future development of the old Boston Garden site into luxury residences, the appearance of the North Station market is changing rapidly as well.

Overall, as we wrap up 2004, several indicators are showing that the Boston office market is slowly recovering as the economy continues its steady rebound. Vacancy rates in the 15 percent to 16 percent range and flat net absorption today should hold rental rates flat for the year. However, because of the significant additions to the sublease market, the rate of recovery will slow down as we head in 2005.

— Suzanne L. Sullivan, Research Manager, Meredith & Grew, Inc.

Industrial

Boston’s industrial inventory year-to-date totals 375 million square feet,of which 112 million is flex and 263 million is warehouse. The market ended the second quarter of 2004 with increased vacancy and negative absorption. The vacancy rate was 14.6 percent, compared to 14.3 percent at the end of the first quarter and 13.3 percent at year-end 2003. Flex projects reported a vacancy rate of 19.2 percent with warehouse properties reporting a 12.6 percent vacancy.

There was a net decrease in occupied space totaling 1.3 million square feet year-to-date. This is compared to negative 805,000 square feet of net absorption at year-end 2003. Significant transactions took place during the first half of the year: Rolf C. Hagen Corporation USA has decided to remain in the Route 495 South market, leasing 302,032 square feet at 305 Forbes Boulevard in Mansfield; and Straumann USA is expanding from its office in Waltham into 164,000 square feet at 100 Minuteman Park in Andover.

The sales activity for industrial product has decreased year-to-date as compared to last year. The current average price per square foot is $66.69 for industrial buildings. Cap rates have been lower in 2004, averaging 8.72 percent, compared an average of 10.88 percent during the same period last year. One of the largest transactions in the Boston market this year is the sale of Devens Commerce Center in Ayer to Mass Development. This 660,000-square-foot industrial building sold for $45.5 million, or $68.94 per square foot.

New developments this year will total 585,000 square feet. Two projects have been completed, including 55 Lyman Street, a 130,000-square-foot warehouse in Northborough recently committed to McKesson Corporation, and 165 Grove Street, a 55,500-square-foot warehouse in Franklin that is occupied by several tenants. Expeditors International has leased 44 percent of 3 Technology Drive, a 180,000-square-foot facility. In Littleton, GFI Partners is constructing a 240,000-square-foot warehouse, with a similar building to be constructed following its completion. A few of the major industrial property owners/developers in the Boston market include AMB Property Corporation, Campanelli Companies and Equity Industrial Partners. Tenants continue to favor new, well-located high-bay warehouse space with a reduced footprint and improved cubic storage capacity.

Average industrial rental rates have decreased to $7.06 per square foot, a 1 percent decrease in quoted rental rates from the end of the first quarter 2004, when rents were reported at $7.13 per square foot.

The forecast for the remainder of the year includes few additional large blocks of space being offered to the market. Overall availability will continue to increase and rental rates will decrease with the exception of high quality, efficient buildings increasing in rent.

— Leslie A. Ouellette, Vice President and Director of Research, Meredith & Grew, Inc.

Retail

The downtown Boston retail leasing market is still experiencing steady demand from a variety of retailers. From apparel, financial and service tenants to small chain restaurants, the downtown area is not lacking for tenants. Newbury Street and Boylston Street, both in Boston’s Back Bay, have rents as high as $150 per square foot. Washington Street, considered the most expensive street in Boston’s Central Business District, has rental rates well north of $100 per square foot.

There has been consistent demand from retailers that are new to the Boston market. Exhale, an exclusive New York spa, signed a 14,000-square foot lease at Heritage on the Garden for its first Boston spa. BoConcept, a Denmark-based furniture retailer, is opening its first Massachusetts showroom and will occupy 6,500 square feet in Putnam Square on Massachusetts Avenue in Cambridge. Another exciting new retailer coming to Boston is the high-end lighting company from Italy, Artemide, which will be opening a 4,500-square-foot store at 343 Congress Street.

Restaurant chains are also entering the Boston market. Qdoba, the fast-casual Mexican restaurant chain based in Colorado, just opened three high-profile locations. New Orleans-based Ruth’s Chris Steak House will open its first Boston restaurant at a 12,000-square-foot site in Old City Hall.

Boston is also experiencing activity from existing retailers. Long’s Jewelers, after leaving the downtown area 4 years ago, is returning to Boston this fall with a prominent 5,500-square-foot store in the Financial District. The Canadian-based Shreve, Crump and Low jewelry store will relocate to a two-floor, 22,000-square-foot space formerly occupied by FAO Schwarz on Boylston Street.

Development in the Boston area, specifically the Seaport District, is beginning to flourish. The area is fast becoming a vital and exciting part of Boston. New developments include the new Boston Convention and Exhibition Center; the Channel Center, a high-end mixed-use development with more than 80,000 square feet of new retail; the pending Fallon Company’s 465 luxury apartments and hotel project; the relocation of The Institute of Contemporary Art Museum; and Intercontinental’s new luxury hotel and condominiums at 500 Atlantic Avenue all coming on line.

With steady demand and limited amounts of prime space, the retail market has continued to be a bright spot. Cushman & Wakefield expects this trend to continue as more retailers enter the Boston market and developments are completed.

— Emily Ou, director, Brokerage Service Group, Cushman & Wakefield


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