If someone were to say that the office market is on fire, with rents going
through the ceiling, that someone would be correct. If someone else were to say
that the office market is tanking, with rents barely covering expenses, that
someone would be correct, too.
How can that be? How can two contradictory things be true? They can, because the office market is not all one thing. The apartment market is all one thing. If the value of three family houses in Malden is going up, the value of garden apartments in Danvers and of Avalon Bay complexes anywhere around Boston is probably going up, too. And, so, with the apartment market - and, really, with the residential market in general - an observer is free to generalize about up and down trends. Not so with the office market. The office market is like a garden made up of a dozen different kinds of plants. Under the same conditions of sun, soil, air, and water, some may go into serious decline while others do nothing but thrive.
Thirty years ago, it seemed that we could not build enough office buildings to meet the demand. We were moving from a blue collar economy to a white collar "information age" economy. Industrials were in decline, and office buildings were going up everywhere. For the most part, they were generic: brick on the outside, carpet and suspended ceilings on the inside. The main distinction was whether a building was in the Financial District or in the suburbs. It was roughly a 50/50 split between those locations. And both thrived, with plenty of demand.
Fast forward 30 years, and the picture has changed. Consider the different kinds of spaces that make up the office market:
• office/laboratory buildings
• medical offices
• small single-user buildings and office condominiums
• buildings for social service agencies
• big single-occupant buildings with the tenant's name on the facade
• multi-tenant buildings for tenants needing less than 6,000 square feet
• co-working, shared suites
The main proof of extreme good health in the office market is the office/lab sector. Thirty years ago, laboratory buildings struggled to get financing. Their build-out costs were high, and their occupants were low credit start-ups. Today, these buildings command the highest rents in the Greater Boston market, at $100 per square foot per year and up, net, at the best laboratory location, Kendall Square. The demand is so strong and Kendall Square's ability to meet it so limited that new space of this kind spills over to Somerville, the South Boston Seaport, the Fort Point Channel, and points as far west as the medical area at Worcester. Office/lab space, typically made up of about half office and half lab, is not an alternative for all locations. Try as you may, if your office building is on the South Shore, chances are you will not be able to convert it successfully to an office/lab.
An advantage for office/labs is that the laboratory space is immune to the work- from-home mode that may impact the market of standard office space for a long time. Laboratory work cannot be done from home. The bioscience market is helped, not hurt, by something like the coronavirus as companies like Moderna become more, not less, essential in a pandemic.
If you are in a town where all the office space is selling for about $150 per foot and one building has sold at $400, chances are, that building is a medical office. Build-out costs for medical offices are more than for standard offices because of their extensive partitioning into small examination rooms, each with built-in cabinetry and a sink. An established medical office has a variety of specialists - dentists, general practitioners, podiatrists, eye doctors, and others. Each benefits from the synergy with the others. Some benefit from near-hospital locations. Becoming a medical office is a process, and it cannot be successfully undertaken by just any office building.
Another formula for success in the suburbs is to be the Best Building in Town. The Best Building in Town is usually at a central location, within walking distance of coffee shops, lunch places, and a convenience store. It has good parking. It looks like the Best Building in Town. It has multiple small and mid-sized tenants, who want to be in it because it is Best, and being in the Best Building is best for their image. It can command higher-than-ordinary rent and still stay full. While other nearby buildings are sliding into high vacancy, this building is bobbing along on a high tide.
In lower income communities, an office building can maintain high occupancy through renting to government and social service agencies. In some places, those may be the only large-scale tenants available.
Small owner-occupant offices and office condominiums often maintain a high level of price that is independent of their ability to generate rent. These can maintain their value in spite of market-wide rising vacancy and sluggish rent.
For offices that fit none of these categories, continued good health is only possible if high vacancy has not crept into their submarket. That is often not the case. Along Route 495, for decades, vacancy has been high, rents have remained stagnant, and expenses have continued to rise, with the result that net incomes are reduced year after year. The reason that new construction of offices throughout the suburbs is virtually non-existent is that construction costs have exceeded selling prices for years. The net income squeeze can become extreme. At one very attractive Route 128 campus-style development from the 1980s, an owner net leased a portfolio of buildings to an operator whose plan was to profit from rents rising faster than expenses. The reverse occurred. After several years of operation, as the trend to declining net income became apparent, the operator abandoned the leases, and the buildings were returned to their original owner. Sometimes a high level of quality is no guarantee of strong performance.
The coronavirus looms as a threat to many buildings' continued performance. The obvious threat is the trend to work-from-home. As attractive as a downtown tower may be, if its tenants decide to go into "remote mode," the future can be as bleak as it is for some overbuilt suburbs.
24 Thorndike Street
Cambridge, MA 02141
Eric Reenstierna Associates LLC is a real estate appraisal firm taking on valuation and consultation assignments in Greater Boston, Massachusetts and New England. Eric Reenstierna, MAI, is the office's principal and is a commercial real estate appraiser.
24 Thorndike Street
Cambridge, Massachusetts 02141