Mutual Fund Inflows, the Boston Office Market, and the Recovery

If you're waiting for the Boston office market to recover, you missed the turning point. A market turns when its underlying drivers turn. And they have.

According to the Investment Company Institute, the national association of U.S. investment companies, all categories of mutual funds, with the exception of money market funds, continued to experience net inflows in June, a trend that has picked up speed throughout the year.

Long-term funds — stock, bond, and hybrid funds — had a net inflow of $43.00 billion in June, vs. an inflow of $52.82 billion in May. These are the funds, particularly those actively managed, that Boston specializes in. The foundation of Boston’s longstanding role as a global money management center stemmed largely from the iconic image of the prudent bond investment firms of the city. Net inflows into international funds exceeded slightly those into the US. The clipper ship opened the Far East to the world in the 1800’s, and Boston’s fund families are considered the leaders in global investing.

Boston-based funds exceeded the rate of increase with a net inflow percentage increase of 1.9% in June alone, nearly double the national average. In June, Fidelity and MFS were the two top-selling mutual fund groups in the world. Natixis, State Street Global, Eaton Vance, and GMO all reported percentage increases well in excess of the national average. Natixis continued to have an extraordinary year with $1 B in net inflows in June, bringing its YTD inflows up to $7.6B. State Street at $923M, Eaton Vance at $861 M and GMO at $418M, among others, all registered significant gains. The strength of the underlying stock market has led to an increase in assets under management in Boston further in excess of net inflows.

What does this mean for the Boston office market? In short, it means the recovery is underway. While I do not expect to see substantial net growth through the end of the year, I similarly do not expect to see significant occupancy declines. And by the first quarter of 2010, the underlying recovery in Boston business will lead to robust market growth in 2010. Why the confidence in a contrarian position? Mutual funds and firms providing specialized services directly to the funds account for 19.8% of the Boston office market and over 37% of the Class A market. There is no city in the world with this level of concentration of mutual fund occupancy. Including private money management firms and the city’s world-recognized private equity firms brings the total “Investment Advisor” occupancy to 29.2% of the overall Boston market and a remarkable 44% of the Class A market. As the mutual funds go, so goes Boston.

There is, of course, more to the Boston office market than the mutual fund industry, and the City, although a peninsula, is not “an island unto itself.” The market has been buffeted by national and international winds. And so I add two facts to support my recovery statement.
1. The healthcare industry, area schools and universities, and all levels of government (Boston is unique in being both the largest city and the capital city of a major state) account for 13% of the private office market. And all three are growing, with total current demand for net new space of 450,000 through August 2011. Washington’s stimulus plan is a direct contributor to this growth.
2. The vacancy rate is only 8.4%. In most cities, that would be cause for rejoice and certainly indication of equilibrium. A vacancy rate of 6 to 7% is certainly considered equilibrium, even in Boston. To reach equilibrium, at 6.5%, Boston must record net absorption of 1.9 million square feet. That would represent growth in occupied space of 2.3%. For perspective, consider absorption trends in the Boston market over the last decade.

Since and including the year 1999, occupancy in Boston has expanded at a median growth rate of 1.6% and an average growth rate of 1.5%. Boston’s experienced its highest growth in 2000 at 4.9% and its largest decline in 2001 at 6.4%. To attach square footage to these numbers ignores the reality of a changing supply of inventory and/or vacant space throughout the decade but Boston, more or less absorbs roughly 650,000 on the median and 1.2 million rsf on the average In 2002, after the market’s largest decline, growth rose back to 1.0%. In 2005, the year following a smaller decline of 2.0% in 2004, the market made up the entire decline, growing at a rate of 2.1%.

Since 1982, Boston has never experienced two consecutive years of net absorption. As I write, we have lost 1 million square feet, year to date, in occupied space. We may lose more. We will not lose 2.9 million. My money is on 2010 and beyond.

Finally, the very nature of the business of Boston is investing in new business. I would contend that, with its concentration of specialized financial institutions, necessary government agencies, and core sources of new ideas, such as MIT or the Longwood Medical Center, Boston “knows how” to recover much more quickly than any other city. It is a city geared to the leading edge, be it in science, finance, or healthcare. As such it is a city geared to provide the channels of finance necessary for a strong local recovery. Look for net absorption of 350,000 in calendar year 2010 and 750,000 in 2011. By year end 2011, vacancy in Boston should be at or around 6.4%. I would consider that a nicely recovered market.