Tamie R. Thompson is a principal of Spaulding & Slye Colliers in Boston.

The suburban Boston real estate market took off in late 1999, riding the nation’s longest-ever economic expansion. The boom was fueled by a well-funded technology sector that seemingly could not lose. Record absorption and limited options had tenants literally bidding for space, and landlords enjoying highest-ever rental rates. Speed to market was key and business models placed a premium on rapid staffing and expansion to capture market share. In many cases tenants leased up to 30 percent more space than they needed, in anticipation of future growth or simply for fear of being shut out of an airtight market.

In the third quarter of last year, at the height of the demand frenzy, Spaulding & Slye Colliers was tracking active requirements for suburban office space nearly two times the available supply in the market. Everyone accepted a 2000 market that was, in hindsight, clearly out of balance from a demand and rent perspective. Although vacancy and rents are returning to more sustainable levels, the suburban market is not in a free fall. In fact, the market is more balanced than last year and, in many ways, it is stronger than it was just 18 months ago.

Our preliminary data indicate that direct vacancy in the suburban office market will be in the 7 percent range at mid-year, three percentage points over the 3.6 percent recorded at the end of 2000, a year all agree will never be repeated. Vacancy at year-end 1999, a solid year for commercial real estate, stood at a comparable 6.5 percent.

Overall availability, which includes sublease space and future available space being actively marketed, was 9.2 percent in the first quarter, up from 7.0 percent at year-end 2000. Availability will be in the 13 percent range at mid-year, still on par with year-end 1999.

As tenants attempt to shed excess space, the sublease market has grown to nearly 3.3 million square feet in the suburbs, 35 percent of total availability. Though up significantly over the past six months, availability today is still much lower than the 20 percent recorded in 1991 when the market was at its weakest.

So what is everyone worried about? By historic standards the market has low vacancy. For any landlord in the market for more than 12 months, rent growth has been phenomenal. The biggest concern is direction the direction of the market. Momentum matters, and over the past six months the market experienced a dramatic shift in demand. Suburban requirements have dropped 65 percent from 7.2 million square feet six months ago to slightly over 2.5 million square feet today. As a result, showings have sharply declined, and actual lease signings have slowed to a trickle, down 75 percent from last year’s transaction rate.

Pre-leasing in new construction has tailed off as well. Eighty percent of the 3.7 million square feet delivered in 1999 was pre-leased. In 2000, pre-leasing soared to a record 94 percent in the 4.4 million square feet delivered. At mid-year 2001, pre-leasing for the 6.7 million square feet currently under construction (to be delivered over the next 18 months) is running at only 50 percent. Today’s business model focuses on profitability rather than capturing market share by pure growth. Companies have halted aggressive staffing and are waiting for a clearer picture on the direction of the economy.

Supply and Demand
What direction will rents take? Consider that despite the drop in active demand, with direct suburban vacancy in the 7 percent range, on average, landlords are collecting rent on over 93 percent of their assets. At least for now, most seem disciplined and willing to carry small pockets of vacant space rather than drop prices drastically. While quoted rents in the most sought-after Class A markets like Waltham and Burlington have dropped by 20 percent from year-end 2000, last year’s rents were unsustainable and are therefore not a good basis for comparison. Quoted rents remain up to 30 percent above year-end 1999 levels. However, while maintaining face rents, landlords are becoming more accommodating with tenant improvement allowances and other incentives.

Empty space, especially after landlords became accustomed to full buildings, can erode pricing in the market very quickly. Although the sublease market continues to grow, landlords have yet to panic because of the difficulty of subleasing. The average size of subleases in the Route 128/Mass Pike submarket, for example, is in the 9,000 to 16,000 square foot range and the average term is only 3.8 years. Small sizes, highly customized tech build-outs, short terms and financially strapped sub-landlords are not confidence boosters for tenants in the market.

Building owners recognize that most sublease options are not conducive to meeting long-term corporate real estate needs. Unless presented with a tenant with strong credit and a healthy buyout offer, landlords are content to let their tenants try their luck subleasing as they continue to pay for unused space.

Will lower asking rents remedy the market’s lack of demand? The current softening of demand is a direct result of the economy, not of high real estate costs. Last year, competition for limited available space escalated rents significantly, yet tenants continued to pay. If price was not the deterrent on the way up, why would it be the catalyst on the way down? There will likely be further erosion in rents in the short term due to competition for active tenants, but generally, lower rents will not change inactive tenants into active ones.

Companies are waiting for a sign that the economy is stabilizing. Expansion plans are a rarity these days, and tenants facing renewals will look to stay put at the right price or consolidate. Tenants with expansion or relocation requirements, however, will benefit from the hiatus in leasing activity and find excellent opportunities for the remainder of 2001 and into next year. For example, a tenant seeking 75,000 square feet or more has 51 suburban office alternatives in the market today, as compared to 30 options nine months ago. Until demand increases, landlords should stretch to keep or land a strong tenant.

With much less speculative development financed during this wave of construction, the supply side of the market remains in check. As a result, the suburban office market should rebound quickly as the economy improves. At mid-year 2001, economic indicators remain mixed, but factors such as the federal tax cut and lower interest rates are likely to give the national and regional economy a needed boost in the next six months.