What’s the Forecast for Commercial Real Estate?

By Tamara Small | This column originally appeared in Banker & Tradesman on July 9th, 2023

Since the beginning of 2020, fear of a recession has kept economists and policymakers up at night. But even now, despite high interest rates, consumer spending is up, and many are asking – is this the recession we planned for? At a recent mid-year economic overview hosted by NAIOP Massachusetts, the experts dug into the data.

Overall, domestic demand remains on a very solid footing. However, if the labor market and inflation cool too slowly, the Federal Reserve could choose to move forward with one or two rate hikes. A mild recession later this year is still expected, as consumers begin to face headwinds from tight credit, depleted savings, and a softening in the labor market.

What this means for commercial real estate nationally remains to be seen. In Massachusetts, a tight labor market, record high material costs and the cost of regulatory compliance with myriad new requirements facing the industry has meant that many projects simply cannot make the math work. High costs plus high interest rates mean that projects cannot achieve the rate of return needed to attract investors – and that hurts our housing production, our ability to attract and retain employers and our competitiveness.

As we continue to navigate the coming months, it is important policymakers do no harm to the industry so that as financing loosens up, projects can move forward without additional cost constraints.

Life Sciences, Office Cool

Whereas 2021 saw a white-hot life sciences market here in Massachusetts, with rents peaking and races to commit, 2023 is a different story. An excess of existing, immediate options and a softening of rents are the harbingers of a cooler market, with experts seeing a renewed focus on key clusters and purpose-built and second generation build outs.

Does this mean life sciences is leaving Massachusetts? Not likely – the fundamentals are there and major pharmaceutical firms continue to grow locally. Expect fewer companies to enter an IPO – translating into smaller lab footprints and a slow and steady market. Policymakers should be focused on retaining the incredible companies that start in Massachusetts.

In the office sector, it’s all been said before – flexible is the “new normal” and there is a significant flight to quality in the office market favoring amenity-rich class A space. But the non-premier asset classes are still battling the effects of remote work. Companies are struggling with what the future workplace encompasses, and while nationally we’re starting to see a drop in remote job postings, demand to fill those remote postings is still high.

In Boston, we’re seeing micro markets like the Seaport and Back Bay continue to be desirable given the amenity driven environment. However, the Financial District is quieter and the demand dynamics are forcing class B product to compete on price, both in rents and concessions given the lack of demand.

And we can’t forget about sublease space – the first quarter of this year saw over 4 million square feet of sublease space available in the suburbs; and over 5 million square feet of sublease space available in urban areas. This dynamic will continue to put pressure on the market. Policymakers examining older office buildings should consider incentives for revitalizing this space to ensure vibrant neighborhoods.

Retail Market Strong, Industrial Vacancies Up

Despite the looming recession predictions, the greater Boston retail market remains strong. Retail rents are up, as is tenant demand, and consumer spending is driving strong retail sales volume. Vacancies across all of Boston’s neighborhoods are less than 3 percent.

Just like office space, a flight to quality is driving what it means to have a desirable location – as is access to outdoor space and the public realm. Food and beverage, entertainment, wellness and amenities for office users are just some of the expanding uses in the market. As a top-100 “most walkable” city in the United States, with 16 million annual visitors, the fundamentals in Boston are strong.

On the industrial side, after historic declines in vacancies for seven straight quarters, we’re starting to see vacancies tick up, large projects put on hold, and demand shift to 200,000 square feet or less. However, with rents up 63 percent over five years ago, the market is still incredibly strong.

Regionally in New England, there are 17 speculative projects under construction, totaling a little over 5 million square feet – with another 4 million square feet being planned. This is a drop from the second quarter of 2022 which saw almost 8 million square feet under construction – but when compared with the 1.7 million square feet under construction in the first quarter of 2021, it’s clear that the market’s demand has still grown exponentially in the region over the past two years. These investments are critical to helping create jobs – and with other markets struggling, it’s important we continue to encourage meeting industrial demand here in Massachusetts.

In short, while some asset classes are doing better than others and while the next year may be bumpy, as long as policymakers focus on ways to help the market remain competitive, there is reason to be cautiously optimistic about commercial real estate in Massachusetts.

Tamara Small is CEO of NAIOP-MA, The Commercial Real Estate Development Association.