Soaring Rents
Pinch Businesses
Across the U.S.Second-Quarter Jump
Is Sharpest Since 2000;
'I Was a Little Shocked'
By JENNIFER S. FORSYTH
July 5, 2007
Office rents are skyrocketing across the nation, driving up costs for businesses large and small, thanks to a dearth of space in some major markets and a new breed of deep-pocketed landlords who can afford to hold out for premium tenants.
Nationwide, effective rents on office properties -- the amount tenants pay after concessions -- jumped an average of 3.1% during this year's second quarter, up from gains of 2.8% in the first quarter and 2.1% in the year-earlier period, according to a report scheduled for release today by real-estate research firm Reis Inc.
That was the sharpest quarterly increase since the third quarter of 2000, before the combined effects of the technology-stock bust and the Sept. 11, 2001, terrorist attacks caused office vacancies to rise and rental rates to fall.
 The red-hot commercial sector offers a sharp contrast with the housing market, which has been slumping for the past two years or so.
In some cities, today's higher rents reflect strong economic fundamentals. In New York and Washington, for example, fatter corporate profits are spurring companies to step up hiring, fueling demand for additional space at a time when supply is tight. Vacancy rates in some of these markets have fallen to single digits, in part because high land prices and strict zoning requirements have kept a lid on construction of new office buildings.
In other markets, such as Boston and San Francisco, rising rents are the byproduct of a deal-making frenzy that has left large numbers of office buildings in the hands of nontraditional landlords such as private-equity firm Blackstone Group LP and investment bank Morgan Stanley.
In the past two years, investors, aided by cheap debt and ample supplies of capital, have aggressively bid up the prices of office properties. Real-estate brokers say these new landlords are taking a harder line in lease negotiations, seeking to push rents high enough to offset the lofty sums they paid for their properties.
Meanwhile, demand for office space has been growing. Net absorption -- a measure of the space taken up by commercial tenants -- increased markedly during the latest quarter, a sign that the economy is producing more office jobs, says Sam Chandan, chief economist for Reis. Nationwide, the office-vacancy rate, at 12.7%, is the lowest since the third quarter of 2001.
In some cities on the nation's East and West Coasts, office rents are rising far more rapidly than the national average. Landlords were able to push effective rents in Manhattan up 7.8% overall during the second quarter, with rent increases for trophy properties reaching into the double digits. All three main office markets -- Manhattan's midtown, "midtown south" and downtown, which includes Wall Street -- have rock-bottom vacancy rates, though downtown rents are considerably cheaper than in midtown.
"I don't see the New York market softening anytime soon," says Robert Emden, a principal at brokerage PBS Real Estate.
In the past two weeks, closely held Tishman Speyer, one of New York's largest real-estate companies, has raised rents between $8 and $20 per square foot to as much as $120 per square foot at New York's Rockefeller Center -- the elegant set of Art Deco buildings that provides the backdrop for the city's most famous Christmas tree. The unexpectedly sharp increase put some businesses there in a bind as they negotiate new leases.
 Office tenants in Washington are also feeling the pinch. The nonprofit International Center for Research on Women, which studies gender issues in developing countries, worked with tenant-representation firm Staubach Co. to find new space after it was forced out of its home at 1717 Massachusetts Ave. when the building sold last year. The organization didn't want to relocate to the suburbs, because its constituency was mostly in the city and most of its employees live there.
Luis Guardia, the center's chief financial officer, says it was quoted $41 per square foot for comparable space, up more than 20% from its previous rent of $34 per square foot. "I was a little shocked by the price," he said.
The center ended up agreeing to pay $42 a square foot, after the building changed hands during negotiations.
In the strongest markets, which include Seattle and west Los Angeles as well as New York and Washington, fewer new office buildings are being built these days than during previous peaks in the commercial real-estate market. That is because of both high construction costs and a condominium boom that has gobbled up building sites.
In these markets, companies will have to pay higher rates or settle for less desirable locations. "I think there will be a lot of soul-searching," says Susan Pepper, a Washington-based senior vice president for Grubb & Ellis, a real-estate services firm.
But rents are jumping even in markets such as Boston, San Francisco and downtown Los Angeles, where office-space supplies aren't quite as tight. In recent years, so many buildings in those markets have changed hands at such lofty prices that landlords are trying to raise rents to boost their returns, regardless of market conditions, real-estate brokers say.
In San Francisco, 63 office buildings were sold or are in contract to sell so far this year at an average price per square foot of $495 -- a record sum, according to Real Capital Analytics. Landlords in the city have pushed effective rents up 19% over the past 12 months, according to Reis, even though the vacancy rate for office space is still above 10%, and 9 million square feet of space is available there.
"This has nothing to do with supply and demand," says Kevin Brennan, a San Francisco-based executive vice president at Studley Inc., a tenant-representation firm. "There's just too much money being paid for buildings."
Jim Costello, senior economist for Torto Wheaton Research, has dubbed this trend the "EOP effect," referring to the $23 billion acquisition of Equity Office Properties Trust by private-equity firm Blackstone Group. Since the deal, which involved 543 buildings, closed in February, many of the buildings have been sold and resold -- each time at higher prices.
Indeed, the elevated prices and substantial debt put on some buildings has caused some concern in the commercial mortgage-backed securities market. But there haven't been any signs yet of the kinds of problems that have hit investors holding securities backed by subprime housing loans.
Blackstone is just one of the new names that have muscled their way into office markets in the past two years. Others include Morgan Stanley, which paid $2.65 billion -- or $675 per square foot -- to acquire 10 Equity Office properties in San Francisco from Blackstone.
A Morgan Stanley spokeswoman says the purchase price for the properties was in line with other recent acquisitions of buildings in which tenants are paying rent at well below current rates.
But tenants are discovering that doing business with private firms and other new players in the market is different than doing business with EOP, which was a publicly traded real-estate investment trust. EOP had to be mindful of how its revenue and vacancy rates would look to analysts and public shareholders when it disclosed them in its quarterly financial results. It would sometimes keep its buildings full even if that meant forgoing potentially higher rents in the future.
By contrast, the deep-pocketed private-equity firms and institutional investors that have moved into the business can afford to keep space vacant rather than lease it for less than they had counted on, analysts say.
The EOP effect may be most visible in Boston, where Blackstone owns about 30% of the top-quality office space in the central business district, thanks to its acquisition of EOP. When Blackstone struck its deal with EOP in November, it asked the REIT to stop making new leases. After Blackstone bought the properties, it started demanding rates that were up 20% from previous leases -- despite the fact that little had changed in the market. Other landlords quickly followed suit.
A Blackstone spokesman declined to comment, but someone familiar with the firm's thinking says its rental rates reflect local market conditions.
Law firm Deutsch Williams Brooks DeRensis & Holland P.C. gave up on its 20-year home at 99 Summer St. in Boston's financial district after its landlord asked it to pay about $14 more per square foot than it had been paying under its old lease. Instead, the firm is preparing to move into space in the Boston Design Center, located on the city's south waterfront.
"The reaction of tenants and brokers was, 'How can this be happening?' " says David Martel, executive director of real-estate advisory firm Cushman & Wakefield in Boston. "They were saying, 'Uh-oh, there's a new sheriff in town.' "
To be sure, landlords aren't in the driver's seat everywhere. Relatively cheap space is still up for grabs in most markets in the Midwest and South. Even with the high prices paid for buildings in Chicago, for example, rents there are actually slightly below what they were in 2000 because so many new office buildings are going up in the city, says Michael Flynn, executive vice president of NAI Hiffman, a real-estate services firm.
But elsewhere, companies have been in for shocks. French bank BNP Paribas SA saw the crunch coming and began to discuss whether it would be financially prudent to have all its New York employees in its current midtown Manhattan locations of 787 Seventh Ave. and 919 Third Ave. Working with Cushman & Wakefield, the bank considered relocating at least some employees to the surrounding boroughs of Brooklyn or Queens.
In the end, it settled on a location in Jersey City, N.J., just across the Hudson River from Manhattan. By Sept. 15, the bank plans to split its headquarters in the U.S., with about 1,000 employees in Jersey City and 2,000 in Manhattan. It hopes the split will help keep its business going in the event of a disaster in one of the two locations. It will also produce a cost savings of more than 50% compared with taking more space in midtown, says Larry Sobin, the company's chief operating officer for North America. |
发表于 2007-7-5 12:16:01
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