Instability, Tighter Standards Hinder NE Office Markets

MBA (7/2/2008 ) Murray, Michael
Mary Kelly, chief research officer at Colliers Meredith & Grew, Boston, said residential market instability, inflationary concerns and a tight credit market are causing some office tenants in the Northeast to pause before executing transactions.

Based on Colliers Meredith & Grew’s Second Quarter 2008 Market Snapshot, net absorption across all Boston submarkets was "just over one million square feet," compared to more than 2.5 million square feet through the first six months of 2007. Kelly said leasing fundamentals are sluggish but holding steady as of the mid-point of this year.
"Employment conditions in greater Boston are generally positive, however, so that neither a drop-off in demand nor a significant amount of sublease activity—both early indicators of a negative turn for the office markets—have occurred," Kelly said.

The report details occupancy and absorption statistics for the office/R&D market in Boston, Cambridge and suburban Boston. During the most recent recession, suburban Boston was hit with dot-com busts, but has since recovered, with Cambridge now hosting top tech firms Google and Microsoft. Other high-tech firms have settled in surburban Waltham.

Despite the positive absorption, the addition of more than a half million square feet of new supply has kept the vacancy rate unchanged since the fourth quarter 2007 at 14.3 percent, Kelly said.

A report from Boston-based Property and Portfolio Research (PPR) said the city will handle the recession better than many metros because in the past two recessions Boston was at the forefront of factors that drove the recessions—including the dot-com bust. This time, however, PPR said the employment base remains stable with estimates of job loss at less than 1 percent.

“We don’t see any weakness in the dot-com, high tech sector this recession,” Mark Hickey, real estate economist at PPR. “Driving factors behind this recession are entirely different.”

The research firm called the first and second quarters of this year a "recession." It said job growth would slow through 2009—particularly in New York—but should return in 2010.

“New York is going to have more near-term weakness than Boston,” Hickey said. “It has more exposure to the lenders that have been impacted by the subprime crisis. Boston has not had that.”

PPR forecasts Boston office vacancies to move “sideways,” currently at 16.4 percent but staying within 50 basis points until new supply delivers in the central business district later. Hickey said financial sector layoffs will hit New York City harder than the Boston region because Boston represents “back-office” functions versus the “front office, volume-based financial jobs” in New York.

“Boston is primarily a back-office financial hub,” Hickey said. “Boston is where the mutual funds started and, still, where the custodial banks have a lot of presence.”

A mutual fund needs to have all of its securities held in a custodial bank, separate from the account manager—based on the fallout of the Great Depression, Hickey noted.

“As a result, Boston has always kept that banking presence for the mutual funds, and they also offer a [number] of services—legal, compliance [and] accounting. A lot of the companies like J.P. Morgan—for example—and Morgan Stanley, although they manage the fund out of New York, they keep the back-office operations in Boston.”

While Boston’s office returns weakened in the past year—1.8 percent as the credit crunch brought prices down—PPR forecasts stronger yields combined with the return of value gains in 2009 that would push returns to nearly 10 percent in 2010 with an overall forecast at 7 percent for total office returns.

In New York City, despite total employment growth of 1 percent year-over-year through March 1, PPR forecasts nearly 31,000 job cuts as a result of increasing financial sector losses. The research firm said these job losses would eventually cut into overall employment growth.

While vacancies in New York's office market increased during the first quarter for the first time since 2003, demand also fell flat in the first quarter this year, PPR reported. The drop in demand foreshadows “the tough times ahead for landlords,” the firm said.

PPR estimates vacancies to rise more than two percentage points in the next six quarters, as sublease space floods back to the market. However, from a long-term perspective, PPR called New York office “a safe bet” and that values would begin to rise again in 2009 as total returns average 8.1 percent.

Whether job losses cut into New York City retail could depend on severance packages and, perhaps, some employees “double dipping” and maintaining extra income during the summer and fall. Those packages, however, could lessen with more cuts.

PPR said overall job growth would fall to minimal levels in the near term, limiting the prospects for retail sales growth in New York City.