Highlights from Boston: The Investment World’s Newest Heavyweight

Elisif_20140417_6337This post was submitted by T.J Winick, Vice President at Solomon McCown.

Event Photos  |  Curbed article  |  Banker & Tradesman article  |  Recap Video

NAIOP’s recent event, Boston – The Investment World’s Newest Heavyweight, assured us once again that Boston is in the city to invest in when it comes to commercial real estate.

Throughout the event, panelists including Charles River Realty Investors President Brian Kavoogian, Cushman & Wakefield New England Area President Rob Griffin, AEW Managing Director Bob Plumb, DivcoWest CEO Stuart Shiff, and Blackstone Principal Jacob Werner touted Boston’s young and vibrant workforce along with its high level of innovation, top-notch schools and universities, and impressive CRE market. “[Here in Boston] it’s a very well educated labor force that draws from traditional financial services, technology and a growing biotech business,” said Werner.

The city is the 5th largest office market in the U.S. and is currently second only to San Francisco in terms of CRE vacancies. While panelists made several favorable comparisons between Boston and the “City by the Bay”, San Francisco is, unquestionably, the leader in development. It has a total of 3.5 million square-feet under construction at the moment, compared with Boston’s 2 million square-feet. San Francisco’s overall rental rates are overall back at 2007 levels while Boston remains approximately 20 percent below 2007 rates; in fact, Boston’s rental rates are still considered “cheap.” However, based on the city’s similarities (coastal, hubs of innovation) and with the belief that San Francisco is a bellwether, Boston’s CRE outlook remains bullish. “There’s real scarcity in [Boston] and scarcity is how you ultimately create value,” noted Kavoogian.

Another area of comparison: Massachusetts trails only California when it comes to NIH Funding. According to Cushman’s Griffin, Massachusetts General Hospital alone receives more NIH dollars than 90% of states. He also noted how the biotech and biopharmaceutical sectors continue to add more and more jobs and create new drugs. “If you’re a global investor and you look at Boston,” said Plumb, “you’ve got all the ingredients for job growth.” And the Boston area’s hottest markets for start-ups (Boston, Cambridge, and Waltham) have experienced an impressive 318 new deals as the market has bounced back. “Focusing on those markets that are both gateway and technology-related markets has been appealing to us,” said Shiff.

In addition to those three markets, there is also hope for Boston’s Central Business District (CBD) despite all the Seaport District’s development. The CBD is currently experiencing 15 percent in rent growth. The panel felt that once the CBD integrates more residential and retail projects into its urban dynamic, it will become “gold”.

Although the panel’s take was overwhelming positive, they did caution listeners to keep a couple of things in mind: Boston has 25,000 new apartments (many which are luxury) inside Route 128 currently under construction. It’s crucial the region creates jobs that meet those rents and attracts a suitable workforce. Also, in terms of capital markets, the industry needs to start thinking about rising interest rates–which are likely to increase as the economy continues to slowly improve.

Strategies for Today and Predictions for Tomorrow

The following blog post was submitted by Ally Quinby, Account Executive at Solomon McCown.

NAIOP Massachusetts’ Smart Money in Real Estate event, on September 19, gathered together a distinguished panel of Boston’s real estate professionals to discuss the state of today’s market, as well as their predictions for the future.

To set the table for the event, NAIOP MA disseminated a poll to members regarding their current perceptions and future predictions. Doug Poutasse, Executive Vice President, Head of Strategy and Research at Bentall Kennedy, and moderator of the panel, leveraged the results from the poll during the discussion.

In regards to real estate investment, Jeff Furber, CEO of AEW Capital Management, listed the four qualities investors are seeking currently: Safety, Income, Control and Liquidity. Tier 1 core costal markets like Boston have been a major beneficiary of this fact due to the lack of risk associated with investing in stable regions.

Similarly, Jon Davis, CEO of The Davis Companies, believes there are many value-add opportunities in healthier cities, “Here in Boston, we are transforming neighborhoods. Take Kendall Square and the Fort Point Channel; there is so much vibrancy in these areas.”

According to one panelist, what the Boston area is lacking is supply of retail space. Despite the recent buzz around grocery-anchored retail centers, Tom DeSimone, Executive Vice President of WS Development, believes centers like this are “overplayed” and the increase in food sold outside grocery stores across the country, in retail shops like Wal-Mart, will be a problem in the future. In agreement, Mark Weld, Managing Director of Clarion Partners, said, “Distressed debt is aggregating in grocery-anchored retail centers across the country that people thought were on the path to growth.”

Looking forward, all the panelists agreed the looming effects of sequestration raise many questions for real estate professionals across the country. Despite the increased activity seen in markets like Boston, New York, San Francisco and Washington, D.C., uncertainty of this type has its effects. According to Jon Davis, “cleaning up from sequestration is the single biggest risk” we are facing today. There is no indication of whether or not Congress is going to be able to come together.

General sentiment among the panelists regarding the economic future was mild, noting there will not likely be significant improvement or dramatic decline in the state of the market.  Instead, all panelists agreed success today—and in the future—will rely heavily on partnering with the right people for leverage. Especially in times like these, what matters is one’s character and ability to execute.

A Tale of Two Cities: Commercial Real Estate Investment in Boston

The BBJ reports that a PricewaterhouseCoopers national survey confirms what we, here in Boston, have been seeing for this past year, that real estate values are living a double life.  There is a very healthy market here for core assets with low vacancies and long term leases – long enough to get through this downturn and, hopefully hit inflation in rents.

With low interest rates, credit becoming more available for credit worthy borrowers, and a ton of investor money looking for low risk real estate investments, cap rates are falling (and prices are climbing for sellers.)  More owners are considering the sale of their properties, not only due to financial pressures, but because this is a good market to sell class A properties into.  There are already a number of apartment projects that have hit the street with asking prices in the 4-6% cap range – and they will most likely sell at those prices.

Except for the other real estate. You know, the kind of property that the opportunity funds were looking to buy at a deep discount.       

Oh that there were more of that product out there.  But that is the problem.  Generally, banks and/or regulators have not pushed borrowers over the cliff (ala 1990s.) So, with limited core and distressed product and a crush of investor dollars, there is no sign that prices will moderate anytime soon for the quality stuff, or that the problem property will be priced to sell.

At the NAIOP Main Event breakfast: “Investors Unplugged,” this seemed to be the theme.  But there were some concerns voiced even about the core quality product.  The big question seemed to be can you buy at the current low returns and have an exit strategy that justifies the acquisition price.  What if interest rates rise?  Generally, cap rates rise too.  And if you can’t count on cap rates dropping to appreciate your investment, then you must be convinced that vacancies are going to drop sufficiently for rents to go up.  Will that happen in all markets?  Only those with the ability to grow the job market.  (Note, Massachusetts employment has been relatively flat from 1990 to 2010!)

And for those distressed properties counting on leasing up the vacancies, how long an absorption period are you plugging into your underwriting assumptions and how much will those rents need to rise?

Lastly, the answer to the question for each of the NAIOP participants of what can you pay for an asset today, was what is the appropriate rate of return on your capital?  That is going to be very different for the pension fund, opportunity fund, sovereign fund or REIT.

So, get ready for a bumpy ride through 2011.  Some players are rooting for the FDIC to pull the plug on life support, while others are just looking for a little more forebearance.  How that works out will be the key to the pricing of real estate product.