Wednesday, October 28, 2009

In the city of Boston, the Sublease Market carries no weight

We all have a tendency to generalize. On occasion, we do this because it is difficult to assess the individual components of the generalization. At times, we do this because the generalization has more or a "fear factor" than a closer look at the specifics. Sometimes generalization is driven by the audience to whom we are speaking, writing, or addressing in some manner.

The real estate industry is among the most notorious advocates of generalization in the services industry for all of the reasons above. When we make a statement about the "market", we tend to aggregate markets together that have little to do with each other except proximate geography. In Greater Boston, there is certainly a link between the Financial District market and the Route 495 South market but it is marginal. Although demand is driven in part by the service functions that the Financial District provides to the suburban industrial market, i.e. legal work, that link is not the determinant of either market's real estate health.

Likewise, when we generalize, we can scare the entire market (or coddle it) to increase the impact, in the eyes of the writer or speaker, of the generalization. For example, stating that "rents have fallen over 25% in the Greater Boston commercial market" is a lot more exciting, I suppose, than, stating that "rents have stabilized in the Back Bay and Financial District office markets while the warehouse and R&D markets along the I-90 corridor have seen rent reductions of as much as 40%." That's a measurable fear, depending on what frightens you, but it allows a participant in a market--landlord, financier, tenant--to assess the true market of interest.

Finally, our so called global companies simply can't gather information on 150 cities across the world; include all of them in their quarterly report, and even attempt to avoid generalization. Whether online or on paper, the tome would be enormous. This, again, is the "audience" issue. If your audience is global, your information is generalized.

Meanwhile back in Greater Boston, articles such as the one I cite below and many others issued by the brokerage houses, while accurate in the general sense, belie what is going on in the component markets.

There is less sublease space available in the city of Boston's office market today than there was at mid-year. There is less sublease space available in the city today than there was at the beginning of the year. The most recent high point of sublease vacancy in the market was in the third quarter of 2007. The amount of sublease space at that time was 4 times the amount available today.

Let's look even more closely at specifics. At 570,000 rentable square feet in a market whose total inventory is 72 million square feet and whose total--direct and sublease--vacancy is 6.7 million square feet, sublease vacancy account for 0.8% of market inventory and a mere 8.5% of total vacancy.

The peak of 2007 correlated with the mass confusion of the financial crises where forced or coerced purchases (Merrill to BoA, etc.) caused the new owners to dump space onto the sublease market as an immediate reaction to simply not knowing what to do. Over time, there was not a tremendous amount of actual subleasing transactions. There was, instead, a more logical removal of sublease space by the companies that had originally created the vacancy. The financial situation has generally stabilized and firms could begin to make business decisions inclusive of new divisions as opposed to immediate xenophobic "I may own you but I don't love you" decisions in 2007.

Considering the actual submarket statistics and the rationale behind the decline in Boston naturally begs the question of what the heck is going on in the suburbs. That I'll leave for the suburban specialists because you won't find it among the generalists, well-intentioned though they may be.

Friday, October 23, 2009


I have sat through more than my share of "forecast by panel." You've all been there. Pick an industry-OK, real estate. The moderator is in mortgage finance, there's a broker, an economist, a government official, and a CEO. What I have never attended is a "let's see if I was right" post-forecast party (or confession.) In fact, when have you ever read of a follow-up to an event you paid $100.00 to attend? When have you ever read a real estate expert, one year after the fact, write a new piece in the Wall Street Journal apologizing for being off by 100% in his or her prediction of the trend in rental rate. No, you pay an additional $100.00 to hear an entirely new and also entirely safe from scrutiny panel of experts deliver yet another forecast, and then you get a 6-week free trial invite from the WSJ.

If you are going to make forecast, then you better check your accuracy and put your errors or accuracies exactly in the place in which you first stated them. If you follow my blog, you might have noticed that I kind of like making forecasts, pretty much about everything, but particularly about the Boston economy and the Boston real estate market. Check any prior posting, as you please, and make a judgement on my accuracy. It's time for my personal "check up."

I posted my first blog on August 18 ("Mutual Fund Net Inflows, ...) with the opening sentence: "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." Reaction in the market to my post was, let's say, questionable. The basis for my statements was the noticeable increase in net cash flows into the City's mutual funds. Interestingly the blog was first picked up by USA today and by the Boston Globe as a "reference article" to Brookfield Properties' announcement on August 19 of its readiness, with $4.9 Billion in hand to buy "distressed debt." Remember the word "debt." It is an important distinction. More on that later.

I issued my 3rd quarter market report on October 8 ("Yes, we have net absorption...".) My report showed positive absorption in the A Markets, in which mutual funds and private money management firms account for over 47% of the market. It showed a tripling of gross demand across all markets heading into 2010 and 2011. My prediction in August for net absorption in 1010 was 350,000 square feet. Although this can not be tested until the end of 2010, I will admit to an error in my estmate. I increased my net absorption forecast in 2010--yes increased it--to 560,000 square feet. No other firm or research firm or economist has made a case--numbers, dollars, vacancy rates, in other words a real case--for any positive absorption sooner than 2011. I had underestimated what I saw as the underlying strength of the economy. Everybody else was running in the wrong direction. But don't worry, I'll make a prediction of predictions. I will predict that every brokerage firm in Boston's 4th quarter market report in 2009 will, without actually stating numbers, God forbid, will state that they "expect slight positive absorption."

Back to distress. In response to property owners traipsing to Washington DC for TARP money and overhyped NY Times Journalists describing the SArmageddon of Collapse due to "distressed properties", I posted an article on October 7 ("Boston Properties $700 Million...") rebutting a)the entire concept of "distressed debt" and b) stating that there would be plenty of fresh capital waiting on the sidelines. Let's go to point A. I will accept the concept of distressed "debt" as simply loans on property over due or by prudent measure about to be. There is no such thing as a distressed property. There is no such thing as a distressed owner. They may be experiencing distress but that is due to individual decisions they made in leveraging their properties. The concept of giving money to property owners is utterly preposterous. An office building is an asset, not a functioning or malfunctioning industry. To give money to a commercial property owner would be no different than giving money to me because I lost asset value in the stock market over the past 2 years.

Let's get back to Armageddon. I will let the following facts speak for themselves as to the readiness of waiting capital.

First week in July" Vornado raises $1 B with express purpose of debt-driven opportunities in the Eastern office markets.

August 13: Hines Interests raises $3.5 B with express purpose of purchasing distressed debt in the U.S.

August 19: Brookfield's announcement of $4.9 B intended for distressed debt with focus on Boston and NYC in the US.

September 2: Inland Diversified $5 B for US distressed debt.

November 7: Boston Properties $700 Million for Boston, NYC, and Washington distressed debt.

November 14: Prudential Real Estate Investors $500 M fund distressed debt.

That's the evidence. You can hold me to it. In fact, I wouldn't have it any other way.

Sunday, October 18, 2009

The End of the "Tyranny of Term" in Commercial Leasing: The New Lease, its Structure and Derivation

Due to the accelerating speed of change within and among companies, an acceleration enabled by and brought on by technology, the conventional view of the appropriate length of term of a commercial space lease must and will change.

Three main factors determine the length of time that a given business can or is willing to support a business plan of operation and thus maintain or hire staff to carry out the plan:

1. The ability of the firm to project revenue forward with an acceptable degree of accuracy.

2. How quickly the firm can alter its labor force and capital in the abandonment or modification of a current business plan to retool for an altered plan.

3. The speed of innovation and its consequent threat to a firm's business plan by a) the impact delivered by a firm's closest competitors and b) the impact delivered by a macroeconomic shift whether within an industry, a geographic area, or in a paradigm shift in business thinking.

None of these three factors is new. They have existed in varying form, within and outside the business world. For example, the respective strategic changes of the governments of France and England over the course of centuries of warfare would constantly change based on a) the ability or inability to deliver manpower in the form of armies to a variety of fronts; b) the ability to modify strategy, be it by approach or more typically by technological innovation to gain an upper hand, i.e. the Royal Navy; and c) the endless quest for allies, external to the direct conflict, but critically important in terms of access to capital and to ideas.

The examples of corporate "battles" if you will are far more numerous but based on these same factors. Consider the case of Wang. The firm began as a producer of sophisticated adding machines and advanced calculators. It remained a small but successful firm following this business plan for over a decade. And then An Wang created the word processor. Wang quadrupled in size in 2 years. Its competitors within the calculating field--IBM, HP, Texas Instruments--were knocked on their heels. And Wang, due to its ability to accurately forecast revenue, was able to maintain a business plan for several years that required tinkering but not a major shift of resources and capital. In doing so, complacency stepped in, and Wang found itself at a critical disadvantage in the second factor described above, the speed at which it could change business plans and retool to meet the new plan. And then IBM introduced the minicomputer. Wang was out of business within 8 years of that event. It did not attempt to build a minicomputer for 3 years and, when it did, IBM and a new player in the field, Digital Equipment, had already upped the ante by pounding through advance after advance. Wang's first minicomputer was 2 years out of date when it was brought to market.

Most firms can implement and execute an initial business plan. Few firms are able to optimally change the alignment of their resources to allow internal product change or, as demonstrated by the French and by Wang, to respond to the threat of competitive innovation.

As a commercial real estate broker, I deal with a critical component of the resource structure of a firm, assistance in providing working space in which firms carry out their business plans. And the real estate world is about to undergo an enormous shift in its own view of time.

There is no reason for a "standard" or "conventional" length of a real estate lease. The current 5 or 10-year default is at best a reflection of laziness and at worst a cause of misallocation of capital. It is artificial because it presumes that the time horizon of a business plan can be captured in a timeframe (the lease term) which has remained static for decades in a world where the length of the business plan has shrunken significantly.

In speaking to the vast majority of tenant clients, I have witnessed the shift during my own 27 year career. It was already out of date when I began as a broker in 1982. A minimum 5-year term was already too long for the conventional length of corporate insight. However, it was not radically out of line. General technological and communication changes, such as Wang's word processor or the IPhone, have enabled companies to respond to self-imposed, competitor imposed, or changes imposed by larger shifts in the macroeconomic atmosphere. But the real estate lease is still stuck in 1975.

This creates three distinct problems. The first and by far most important is that it sets the stage for individual business failure. The domino effect leading to this disaster begins when the firm’s need to shrink or expand, to accommodate a new business plan is restricted by the length of the lease term. The minimal protections granted by rights to sublease carry an implicit loss owing to lower price the market is willing to pay in a sublease where the layout, term, and lack of direct line of control to the Landlord are predetermined and unchangeable. Termination rights are no more than buyout rights. The price of freedom by way of termination often exceeds the ability of companies that simply want to adjust their space needs to pay. Unable to innovate and carrying an unmanageable rent burden, companies fail. And smaller companies will fail disproportionately.

The second problem is the consequent damage of tenant failure or default on the financial structure of the individuals or firms that provide the office space "asset"--landlords and lenders. Tenant default can create mortgage default which then generates an inhibition to new development.

The third component is the inefficient use of capital by tenants, landlords, and, as a result of the joint nature of the misuse, by our economy. For example, the damage of default is not limited to the specific loss of rent from the failure of a single tenant nor is it limited to the consequent diminution in building value of this particular loss of income. Tenant default leads to severe capital loss both in the write-off of what I will call "specific tenant improvement capital" and to the need to increase what I will call "forward improvement capital."

Let’s look at the first since it is the most obvious. Assume a landlord has paid for the construction necessary to accommodate the needs of a specific tenant, the “specific improvement capital.” Upon default, the landlord suffers a loss of income and a loss of unamortized improvements. Landlords may choose to record only a portion of the loss based on the so-called "reusability" of space, but trapped by their own 5 or 10 year conventional lease structure, this mode of thinking is not prudent nor realistic.

More than this, what is ignored is the increase in the aggregate cost of “forward improvement capital.” A default triggers an unexpected, and thus typically unplanned for, premature expenditure to secure a new tenant. Costs are both “hard”, such as the actual cost of reconstruction, and “soft” such as architectural fees and brokerage commissions. One could argue that forward capital would occur at some point in any case, even without lease default, simply because leases expire and tenants move. While this appears correct logically, it ignores the reality of the increased likelihood that a tenant will remain as a tenant beyond the expiration of an initial term simply because the tenant avoids its own expenditure of capital in a relocation. “A tenant at rest tends to remain at rest.” I apologize to Mr. Newton for this terrible paraphrase.

Let’s now look at the consequences of the artificial lease term. It prevents a company from adjusting its resources to fit a new business plan. This causes a reduction of income to the company because it is physically constrained from a realignment of resources to enable a new business plan. If severe, it causes a firm's demise and a loss of capital far greater than any real estate costs, i.e. capital paid for by a tenant within an office building. It can eliminate most if not all of the entire capital of a company. It then weaves it way through the financial markets by way of the landlord and lender who suffer the consequential damages of loss of rental income and capital and through the finances of other firms affected by the demise of the tenant in default, such as that tenant’s own suppliers and vendors.

The solution to this problem is simple. The length of the office term must no longer be based on a conventional and thus artificial period of time. It must be based on the function it serves, as a physical asset in which production occurs over the business plans of the tenant. It must also be based on the necessity for both the tenant and the landlord to properly recognize and account for the capital costs involved in the specific and forward improvements necessary for effective functioning of the commercial real estate market as an asset.
Below are the components of determination of rent.
Lt = The conventional lease term of today's real estate market, 5 or 10 years.
Lm = The length of a specific company's business plan.
Cs = The specific capital improvements necessary for a tenant's effective use of space.
Cf = The forward capital improvement necessary for a post occupancy refit.
H = The time that a Landlord plans to own a property.
Y = Landlord's yield or return on capital over the Landlord’s holding period (H).
I = Tenant's gross profit margin over the length of a single business plan.
R = Rent payable by a tenant to a Landlord over a lease term (Lt).

Given the above, Rent is defined as follows:
R = (Cs + Y) * Lt.

To solve the problems describe above, I submit the following realignment of definitions to our industry:

Allow Lt = Lm.

This simple adjustment replaces and repudiates the concept of a market-driven or capital-driven lease term. The proper length of term will now we determined by the user of the space who, at a price, can match business plan to lease plan.

I would posit the following theorem based on this adjustment:

By allowing lease term to match the business planning horizon, tenants will have the ability to maximize gross profit margin. Minimizing rent will no longer be the ultimate objective. By allowing the same, landlords will have the ability to maximize yield over holding periods by increasing the inherent value of space by decreasing the constraints now placed upon occupancy by term.

I will now proceed to my argument and my proof, humbly submitted.

Let’s review the individual components of cost and return, beginning with capital. In my proof, I will assume that capital costs include both direct and indirect costs incurred in the initial and subsequent leasing of commercial space.

Allowing for my proposal that Lm = Lt, there will be a shift in the benchmarking of a successful leasing outcome for a tenant, as follows:

The tenant's objective in an agreement to pay a specific rental over a specific term must be driven and measured entirely by effect of the outcome on the tenant’s gross profits margin.

The objective does not ignore the specific competitive market context, the office market, which will determine the “pure” rental component of Rent. But the outcome will no longer be a measurement against market. There will be no such phrase as an “above market” or “below market” transaction. The measurement of achievement will be strictly a measurement of enhancement of gross margin.

My assertion leads to my first elemental principle of the “successful tenant.”

The tenant that will achieve the highest rate of success will be the tenant best able to match a business plan to lease term, initial or altered.

This is the heart of the capital issue for the tenant. This argument is not an endorsement of a longer term. We oversimplify the cost of occupancy when we allow capital costs of occupancy to determine the length of term. Again, first consideration must be given to gross profit margin. For example, assume a tenant is capable of a two-year business plan. The Rent will be significantly higher than a tenant capable of a five-year plan and lower than a tenant capable of a short-term plan. But the Rent is not the measured objective. The tenant must analyze the marginal additional cost of higher rent to the marginal increase in gross profit margin. Capital depreciated over a short lease term adds cost but allows the freedom to match business plan to lease term.

It is perfectly reasonable for a tenant to pay $200.00 per square foot per year for two years while a tenant of identical size, capital requirement, location, and all other factors equal, pays $100.00 per square foot per year for 3 years. The differential is entirely due to the degree of importance and measurable value the first tenant attaches to the term as a direct determinant of gross profit margin.

Let us know consider the landlord. The landlord's objective, again set in a market context--the office market--is to achieve the highest yield (Y) over the preferred holding period, H. To the landlord, the objective of a rental negotiation is a measurement not against market but against desired yield, as follows:

Y = ((R * Lt) – C) / H

I propose the same realignment in the definition of term as I did in the analysis of the tenant perspective and objective.

Allow Lt = Lm.

Landlords that embrace this new philosophy must allow for the tenant to set the term according to the tenant's business plan. However, just as a given tenant will pay a higher or lesser amount based on the ability to increase gross profit margin by matching lease term to business plan, so too will the Landlord demand and receive a higher Rent on the margin to offset the marginal increase in capital costs due to changing periods of amortization. But by doing so, the Landlord does not simply match the return on a conventional term by charging for a lesser term. The price a tenant is willing to pay to lease space from a Landlord who embraces the concept that the business plan match the lease term will increase simply because the Landlord embraces the philosophy. This sounds horribly circular but, in many ways, the real estate leasing market is just that. The actions of a Landlord in one transaction affect the expectations of a tenant in the next transaction. It’s not unlike the 1970’s feel-good philosophy of “positive reinforcement.”

My assertion leads to my second elemental principle of the “successful landlord”:

The landlord that will achieve the highest rate of success will be the landlord best able to accommodate tenancies as determined by business plan of the tenant and successive business plans of forward tenants over a chosen holding period.

Because Cs is defined as the specific improvements dictated by a specific tenant, a tenant seeking a lesser term, will, at the margin, pay the landlord a higher rent to compensate for the higher yearly capital costs of a shortened capital amortization period. Landlords must stop making the argument that they "cannot do a three year deal because we can't amortize...." as a defense. This represents a failure to adapt in an economy whose time horizon of planning continues to shrink for all of the right reasons. And if a landlord's defense is to play the foil for the lender or other holder of beneficial rights or income from rent, then these recipients of return must also accept my case to allow Lt to equal Lm. If neither does, the real estate industry will find itself in a constant state of unnecessary capital write-offs, misallocation of capital, and consequent financial inhibition to develop new space, all brought on by unwillingness to accept current business management and mathematical fact, which I will demonstrate below.

In calculating capital costs, the landlord must not only account for the amortization of capital over the current term (Cs) but the necessity for additional capital thereafter (Cf). Therefore, I propose the following redefinition of the proper measurement of capital in a real estate lease.

The capital expenditure of a transaction is equal to the capital of the specific allowance as defined above AND the landlord's estimate of the forward capital of the following transaction. The variable that will ultimately be subject to scrutiny for success will measure return (pure rent) less all capital expended over the holding period.

In summary, I am proposing that the conventional lease term, artificially constructed and restrictive in allowing the tenant to match business plan with lease term be replaced by an approach to the lease driven by its underlying function--the business plan horizon of the occupant. Both parties will then pay or receive a premium for allowing flexibility, and neither party will look to "market" as an indicator of performance. The user, or tenant, will look to gross profit margin. The landlord will look to yield, or return, over the holding period.

Below is a mathematical “proof”, or more appropriately, example of my theory.

Assume capital cost for all Tenants at $40.00, and assume that all costs are paid for by the Landlord.

Assume all construction costs are fully amortized over the length of the lease term on a straight line basis without interest.

Assume that the "market" rent, as mutually negotiated by Landlord and Tenant, and not to be confused with Rent (R) as ultimately paid by a tenant, is $25.00 per square foot per year in both for both a one-year or two-year term.

Consider two tenants, the only difference between them being the marginal effect on Gross Profit Margin by an increase (or decrease) in the length of the term of a lease of space. Assume the gross profit at the beginning of the lease term to be examined is identical for both tenants at is identical at $1,000,000 per year. Assume that both require 20,000 square feet of space.

For "Tenant A", assume that each additional year of length in term decreases its Gross Profit Margin, as uniquely determined by Tenant A and derived from the foregone revenue or associated profit caused by Tenant A's inability to match the length its business plan, by 70% per year, or $700,000 per year.

Assume the marginal decrease for Tenant B at 25%, or $250,000 per year.

I will establish the method by which each Tenant will determine the appropriate lease term and amount of Rent each Tenant is willing to pay to secure the term. For simplicity, I will allow the option of either a one year or two year term.

Since the “market rent” is identical for both tenants, it is not a determinant of the term or the premium either Tenant will pay for its chosen term. In short, the decision is purely a capital decision.

The capital cost under a one year lease is: 20,000 x $40.00 = $800,000. For a two-year lease, the cost is $400,000. due to the ability of the Landlord to amortize the capital cost over a longer period.

Below is the logic and mathematics that will drive each Tenant’s decision on term and the amount of rent each will pay.

A one-year term will require Yearly Gross Rent of $1,050,000, of which $250,000 is considered “market rent” and $800,000 is considered “capital rent.”

A two-year term will require Yearly Gross Rent of $650,000, of which $250,000 is market rent and $400,000 capital rent.

Tenant A will choose to lease space for one year at $1,050,000 because the reduction in rent that would result in a two-year term ($400,000) is not sufficient to cover Tenant A’s risk of decrease in Gross Profit owing to the longer term ($700,000).

Tenant B will choose to lease space for two years at $650,000 because Tenant B’s risk of decrease in profit owing to a longer term ($250,000) is lower than the $400,000 in additional cost in a one-year lease. Tenant B can accept the risk for the low rent reward because of the lower correlation between length of lease and gross profit risk.

I will close by opening a door.

The elimination of the conventional lease term has the potential to ignite and create a new industry. The industry will be driven by tenants and landlords and involve all firms involved in design, construction, and the infrastructure of the working environment. The industry’s sole focus will be reusable construction. It is a new industry. It involves the creation of reusable space, NOT the renovation or refit of previously used space. Reusable construction is nothing less than the construction of the commercial building of the future. It will reflect the rapidity of change in business, allow for space to reflect optimal business planning, and allow landlords to achieve superior returns in meeting a very new world. The leaders in this new industry will redefine the commercial real estate property, by changing the very nature of our concepts of permanence.

Thursday, October 8, 2009

Yes, We have Net Absorption, we have Net Absorption Today!

The Boston Office Market turns the Corner

I apologize for bursting the bad news bubble that our market seems to be stuck in. I do my own research. I never follow the crowd. And I never see anybody making projections about the future market. Isn't that what strategic real estate firms should do?

I think the brokerage firms in Boston are the best in the country, and I have heard that many times over. Their market reports are well-written, well-formatted but relentlessly backwards-looking. And that's OK. We all need to take measure of what's happened over the past quarter or over the past year. But I like the future. It's where things happen.

So without further ado:

Driven by escalating net inflows into the City’s mutual funds industry over the past 9 months, Boston’s Class A office market registered positive net absorption for the first time in over 18 months. While the net gain in occupied space was small at 65,000, it still represents a remarkable turnaround from the 650,000 square feet of Class A space that was vacated through the first 6 months of the year.

The B markets continued to see declines in occupancy with an additional 270,000 square feet of space returned to the market. However this was well below the declines of 400,000 square foot registered in each of the first two quarters of the year.

Positive absorption in the A markets and negative absorption in the B markets does not represent a confused or paradoxical market trend. It is a textbook example of first stage recovery, as firms in B space attempt to grasp the brass ring of the A market before the carousel comes to a stop—which it will, very soon, as rates in the A market increase.

Of greater interest is projected gross leasing activity for 2010 and 2011, a figure that should comfort existing landlords and those seeking to start construction. Over the past 18 months, gross leasing activity, defined as all lease transactions regardless of whether the transactions represent instances of growth or decline, measured just over 2.4 million square feet, a paltry sum in a market of 72 million square feet. Based on the J. Adams Commercial proprietary database of Boston tenancies and its associated algorithms, we are projecting that gross leasing activity will exceed 7.3 million square feet in the next two years. This represents a turnover of over 14% of all occupied space in Boston. Every landlord will have its shot. Every tenant will have company in the market.

And movement sets the stage for recovery. We are predicting positive absorption of 650,000 square feet across all classes of space in 2010, particularly within the city’s 26 Class A “Premier” properties. By submarket, the Channel/Seaport market and the North Station/Government Center market will outperform all others on a percentage growth basis, continuing a trend that began in early 2008. Growth in the Channel/Seaport has been driven by the delivery of first class road and rail infrastructure to a market with a wide variety of property types, which rent at a 20% discount to comparable space in the core Financial District. North Station has been driven by a surge in government agency leasing because Boston is the only city in the “industrialized” states that is, at once, the population center, the regional business center, and the state capital.

As a final note, all of the analysts, landlords, and brokers should stop a moment, stop crying chicken little, and see exactly where we stand as a market. The vacancy rate for space available today, both direct and sublease is only 9.7%. At the troughs of the last two downturns in the market, the comparable figures were13.8% and 17.9%. Even adding the elusive category of “Available Space” which includes, basically, what landlords believe will someday be vacant, the figure tops out at 12.5%. If this were Dallas, we’d be having a block party.

Now consider inventory. The 5th largest office market in the country, the 2nd largest city in the world as measured by assets under management (exceeded only by London, a truly amazing statistic) is building.........................1.2 million square feet of new office space of which 600,000 remains available.

There’s a reason there are 47 law firms in the market today, a group that represents over 1.8 million square feet of aggregate demand with leases expiring, on average 2 years forward. The market is moving away from the tenants. In astronomy, it’s called the Hubble Shift. It’s time we refocus our telescopes.

The full report will be on my blog tomorrow--in detail.

Wednesday, October 7, 2009



Boston Properties Sells $700M In Notes--Another Bull in the Boston Office Market

The announcement by Boston Properties (NYSE:BXP) of its sale of $700 million in notes, and the specific announcement by Doug Linde that the company expects "opportunities" is evidence not only of the recovery in the Boston office market but is the clearest statement yet that there is ample money awaiting so-called distressed owners. It throws cold water over the concept of property ownership as stewardship of an industry. Real estate is an asset, nothing more.

The catchphrase of catastrophe in the commercial office market over the past 9 months has been the approaching meltdown of the office market and then the meltdown of the world when existing mortgages come due. And all of the commercial property owners will suffer on one of Dante's rings. I'm sorry. I'm not moved. I'm feeling musical.

"Don't weep for building owners, Argentina, the truth is they never left you."

The theory behind this nonsense is that the lack of liquidity within the traditional sources of mortgage debt will close the window on refinancing, forcing great gnashing of teeth and a second wave of worldwide financial upheaval.

Actually what will happen is what Boston Properties is preparing for. If an owner has too much debt on its property, due to underlying rental rates, then, as in any refinancing situation, the owner is going to have to a) come up with equity to fill the gap and/or b) convince potential lenders that it has the capacity and standing to deserve a new loan.

There are many owners who are indeed overleveraged and who do not have sufficient capital to fill the refinancing gap. There are other owners whose profile will not appeal to traditional lenders. Boston Properties and many others plan to be there to either buy the properties prior to the wakes or be ready to bid at the funeral. As Doug Linde, the president of Boston Properties, clearly states, "It's not a question of money. It's a question of opportunity."

The real problem is overleveraged property owners attempting to live in the past world of a now subdued and cautious traditional mortgage lending market.

The loss of an owner's equity in a property and therefore the "loss of the property" is a normal occurrence. In fact, the loss of any asset because you can't make the payments is a concept that has served as the backbone of lending since the Roman Empire.

The preposterous attempt by major commercial owners to seek Federal TARP money was not only pathetic, but illogical. (Don't count that effort dead yet--for some reason Barney Frank is supporting it). Office buildings are not an industry. They are the land component, if you will, of land, labor, and capital that defines a capitalist economy. Underlying rent from tenants and expected future rents establish property value. To seek TARP money or to worry about existing owners implies that taxpayers should support anyone who lost assets in the recession.

Just think of that concept. If you lost $500,000 in the stock market (an asset loss), you would be able to petition the Fed for TARP money so your assets can "recover." Wow, I might try that.

There is ample money from REITS, private pooled investment funds, and even, as evidenced by the recent sale of Independence Wharf in Boston to Credit Suisse (VX:CSGN), from the real estate subsidiaries of the recovering investment banking houses.

Ownership will change. Some owners will lose. The lenders who did not properly assess risk will lose. New owners will come. New lenders will play. The buildings will not disappear. The economy will not crumble. The office market will continue to play its role as an underlying asset, not an industry, and will reflect the health of the underlying economy. The person you pay your rent to will be someone you haven't met yet. That's all.

Friday, October 2, 2009

Let's take the long way because there's nothing to do there

I sat on the Surface Artery of the State Legislature from 1998 to 2000. Our assignment was to come up with a way to fund new development and public spaces on the Greenway. This article confirms something I knew when the committee disbanded accomplishing nothing.

There is a simple reason that the Greenway is the Deadway. And I do appreciate the Globe for clipping that phrase from me.

The reason is money. Not public money. Not donations. Not fundraisers.

The Greenway, as the young insurance executive pointed out is NOT a destination for anything. It isn't even a "thruway" to use the young man's phrase. Take an example. You get out of work on Federal Street and want to head to Faneuil Hall to meet a friend for a cocktail. Its about 5:30 in January. Tell me your path. I know what it isn't--walking two blocks east, crossing the traffic looniness that is Dewey Square, and then taking a long, boring, lonely, even scary loop around the Financial District, stopping every 2 minutes to cross to another boring, empty lot until after 45 minutes of tension, you risk your life to get back across the line of civilization and into Faneuil Hall.
No the route you will take is Federal to Milk to Congress, with a nice walk through Post Office Square Park, and right into Faneuil Hall.

Back to money. When I served on the aforementioned commission, the ratio of businessmen to public agencies and environmental groups was 1 to 15. I know. I was the "1." On behalf of the committee, I flew to Yerba Buena Park in San Francisco to see why it ticked. While on a visit to Australia, I spent time with the developers of the beautiful urban park along the river in Sydney. And guess what they and the other U.S. parks mentioned all had in common? Buildings housing fun things to do. Buildings owned by profit-making entities or ticket-selling cultural organizations. Not history museums or horticultural halls. Sony had its Exploraton right in Yerba Buena--free admission, free interactive gadgets, but also gift shops, restaurants, and FREE ADVERTISING FOR SONY. Sydney had one part of the artificial beach (yes they built the beach) lined with cabanas served by, yes--people selling beer (oh what will Longfellow think in his grave? He'd think he wants a beer, that's what.)

Why are we afraid to allow people to have fun and pay for it directly or indirectly on the Deadway? Why are we afraid to let anybody build anything near the Deadway? It is becoming a joke. "Hey kids, let's head into Boston today and see what's happening on the "Green"way. I heard they have some really neat neon lights, fountains that come on every 4 hours, and, if we're lucky, some really bad mimes and a guy who plays every Jimi Hendrix song backwards on the harmonica.

Build--build an opera house because we need one. Elevate a restaurant off the ground in front of Rowes Wharf so we can flow under it or choose to go up and enjoy some clam chowder and a beer inside of it. Have a competition to construct Venetian--like decorative bridges connecting parcel to parcel so we can actually describe the Greenway as a continous path and not the series of stop-and-go blocks that it is.

Let us keep moving and let us stop to do something. Anything. Yes, Mayor Menino, that does include U2. With activity on the Greenway, guess what would happen Mr. Mayor? New construction. Housing that doesn't sell at auction. Tax revenue. More tourists. More visitors from Stoneham for starters.

The so-called Greenway has become a bigger barrier than the Central Artery ever was. I am actually waxing nostalgic. I can see that rusting green paint but I can see people flowing under and around it. It's noisy, some of the lights don't work, but it's alive.

Thursday, October 1, 2009

And the Mutual Fund Beat Goes On

What a surprise! Four years, two months, and and 16 days after Ken Lewis blundered into Boston promising to cut costs, relocate functions, and move Columbia Management to New York, Ken is off golfing, his firm is under, oh, about 16 investigations, and Ameriprise Financial stepped in and grabbed the BoA-neglected Columbia Management family of funds for $1 Billion.

So what's the surprise? No matter who buys them, owns them, sells them, or threatens to move them, Boston's mutual funds never leave Boston because the highly paid, highly skilled employees that work for the funds do not want to and have no reason to. In other words, there is no surprise.

And Ameriprise and Jim Cracchiolo, its apparently asute chief executive, knows that. Rather than come in with threats and pomposity, Mr. Cracchiolo calmly announces that Michael Jones, Columbia’s president, will serve as president of the US asset management business, and that Colin Moore, Columbia’s chief investment officer, will continue to serve in his role AND that the Columbia will remain in Boston.

Cracchiolo knows that Boston is the center of mutual fund expertise. Unlike Ken Lewis, he understands that the best and brightest that Columbia has now and will now attract with Ameriprise as its owner, do not want to move to Minneapolis, the HQ of Ameriprise. And I really like Minneapolis. My college roommate was from Minneapolis. But anyone asked to move to Minneapolis at Columbia has 34 other options, including Fidelity, Wellington, Pioneer, Putnam, State Street Global, GMO, Natixis ( can I stop now..NO?..OK..I'll keep going), Eaton Vance, FLAG Management, MFS, Direxion, Bank of New York/Mellon, Loomis Sayles. OK I'll stop.

And what does this mean to Boston "by Square Foot?" What does this mean to the future of the Boston office market? It means the 115,000 square feet Columbia occupies at One Financial Center stays at One Financial Center. It provides further affirmation that the future of the downtown office market in Boston is very secure because the funds are staying and the funds are growing. It confirms what I am about to release in a formal report: Contrary to chicken little(s), the sky isn't falling in the Boston office market. In fact, we're all floating back up. IN THE THIRD QUARTER OF 2009, THE BOSTON CLASS A MARKET REGISTERED POSITIVE NET ABSORPTION.

See ya Ken. Hello Ameriprise. You're gonna love it here.