Peter E. Madsen – Concerns about Boston

One might call it the Hub Snub.

In an atmosphere cloaked with pessimism, panelists delivered a stinging assessment of the local real estate market last Wednesday at a program sponsored by the National Association of Industrial and Office Properties. The theme, “Real Estate Investment 2002: Where Are the Opportunities?” emoted a stream of dour predictions from the five speakers on hand, with most predicting that the region faces a difficult stretch in the coming months.

“We are pretty wary of Boston,” said Charles F. Wu, managing director of Charlesbank Capital Partners, a locally based real estate investment firm. “Right now, it is very hard for buyers to get the confidence that we have hit bottom here.”

Pembroke Real Estate is also concerned, Managing Director Peter E. Madsen told the packed audience gathered at Boston’s Swissotel. The private real estate arm of Fidelity Investments, Pembroke is developing office space worldwide in such areas as London and Japan, but Madsen added that “the mantra of my company today is ‘Not Boston office.'”

Program moderator James F. McCaffrey of Trammell Crow Co. in Boston agreed that commercial real estate has deteriorated dramatically during the past nine months, with the office market experiencing a double whammy of rising vacancies and falling rental rates for the first time in a decade. Adding to the uncertainty has been a lack of leasing activity, McCaffrey said, making it harder to determine where the market is headed.

“Many people believe rents are going to fall to a level that represents a significant discount to replacement cost,” he said. Because of that, he said, investors “have been on the sidelines looking for market stabilization or for some real sign of distress.”

In other words, until investors gain confidence in the market or see a chance to steal a property, completing deals will be difficult. Investors seeking returns of 15 to 20 percent will likely only find those opportunities in suburban office properties populated by technology companies, said McCaffrey, and most buyers are unwilling to commit to such a volatile property.

Downtown office buildings might attract attention, but McCaffrey said there is a dearth of such properties on the market at present. The same is true for multifamily deals. Although multifamily “is on the hit list of every institutional investor,” McCaffrey said it is hard to find the size and quality of properties needed to interest institutional capital.

Formerly affiliated with Harvard University, Charlesbank closed its first private fund not financed by the school in August 2000. While the $500 million investment vehicle targets such typical real estate as office, industrial and retail buildings, Wu said his firm is willing to “look outside the box,” having scooped up properties as diverse as self-storage facilities, trailer parks and assisted living, with the latter of particular interest at present to Charlesbank.

“We’re always looking for the areas where most of the capital is not,” Wu said. Geographically, Charlesbank sees Cleveland as one hot prospect, he said. As for its hometown, Wu said that the firm would not invest in Boston “unless there was something special about the transaction.”

‘No Pressure’

Real estate observers had anticipated more chances to buy properties from so-called opportunity funds, but that activity has been limited to date, said panelist Jonathan G. Davis, chief executive officer of the Davis Cos. Even though many such players have reached the five- to seven-year timeframe in which they would typically dispose of assets they have repositioned, many funds have resisted trading in a down market.

“They recognize the bid/ask spread is just too great to make it desirable [to sell],” said Davis. “The decision has generally been to hold on.”

Wu concurred, maintaining that lower interest rates have helped because of the refinancing option fund operators currently can utilize. “[The current] financing rates are unheard of,” Wu said.

“A lot of potential stress … on the opportunity funds has been relaxed by the interest rates,” he said. “There’s no pressure to sell.”

Most of the panelists said there would be more deals done if the properties were available. Still, Wu noted that the brief investment downturn in 1998 was more driven by a dearth of capital worried over global economic issues. Now, the capital is plentiful but the real estate is troubled, making investors tread carefully.

“There is a lot of capital out there … but we don’t feel the pressure to invest,” Wu said. “We can be very patient.”

Covering Southern Connecticut to Southern New Hampshire, the Davis Cos. has been especially active during the past five years, but Davis said his firm is treading carefully in seeking out investment deals. Instead, the firm is concentrating on its existing portfolio of 4 million square feet, he said. That portfolio, which is 98.5 percent occupied, “provides us the flexibility to not do deals when it makes sense to not do deals,” Davis said.

Boston’s position as one of the country’s top targets for real estate investment has been battered of late, but Fleet Real Estate Finance Group Managing Director Kenneth J. Witkin said he is generally upbeat about the overall health of the local market. There has been little overbuilding similar to that seen in the recession of the early 1990s, he said, with speculative construction virtually nonexistent. Most landlords have the wherewithal to weather the economic storm, he said, with many properties sporting leases that were signed at the peak of the market.

“There’s a lot of cash flow in these developments,” Witkin said. “Most of our clients are able to carry 15 percent, 16 percent, 18 percent vacancies … It’s a very stable environment right now, and we see that continuing.”

One concern that has gripped the industry of late is the issue of terrorism insurance, and both Watkin and Madsen agreed it is a formidable obstacle. Since Sept. 11, insurers have been reluctant to write policies covering acts of terrorism, while most lenders will not finance a property unless it has such protection.

Madsen said Pembroke’s entire portfolio of 3.5 million square feet is covered by a blanket insurance policy that expires on April 1. “It is unspeakably expensive,” he said, while Watkin said the stalemate has been troublesome, especially for stand-alone assets such as an office tower.

“The single-asset securitization market, without terrorism insurance, has stopped,” he said. “It’s just not happening.”