When will recovery occur in Boston's office market? The consensus: later than sooner. On one hand, venture capital investment is inching upward and universities are churning out workers skilled in promising new industries such as biotech, wireless communication and micro-electronics.

On the other hand, the sting of recession lingers. The state has lost more than 175,000 jobs since its payroll peak in January 2001, its economy grew a meager 0.3% in the first three quarters of 2003 and a double-digit office vacancy rate has developers scouring for tenants.

James Adams, senior vice president at NAI Hunneman Commercial Corp. in Boston, believes this is the year that recovery will begin to take shape. After examining his database of more than 900 commercial tenants in downtown Boston and studying their real estate plans, he predicts positive absorption of 700,000 sq. ft. in the next 15 months or so — a sharp turnaround from negative 2.6 million sq. ft. in 2001 and negative 730,000 sq. ft. in 2002, yet nowhere near the irrationally exuberant spurt of 1.7 million sq. ft. absorbed in 2000. “For Boston, that's healthy by anyone's definition,” he says.

Pre-leasing Is Paramount

Boston's office sector is in the doldrums right now. Testament to that fact is 33 Arch Street, an office tower in the heart of downtown developed by Cambridge, Mass.-based Congress Group Ventures. Slated to open in January, the 600,000 sq. ft. tower has signed no tenant other than Congress Group itself for only 10,000 sq. ft. From the CBD out to the furthest suburbs, office sector fundamentals remain weak.

The vacancy rate for office space in Boston proper was about 16% in December, a few points higher than at the start of the year. Asking rents have drifted downward from more than $80 in 2000 to a citywide average of $34.70 per sq. ft. and $35.55 for Class-A space. The numbers only get worse heading out from the city. Vacancy is 25% in adjacent Cambridge, historically crammed with start-up technology businesses, and 30% or more in most parts of the region's suburban market of 117 million sq. ft.

Today, pre-leasing commitments mean the difference between life and death for a commercial project — buildings that have them will win financing. Speculative projects are extinct, for fear of opening empty, as in the example of 33 Arch Street. That development fell victim to poor timing, breaking ground in 2000 when the recession was expected to last only a few months.

How vital are tenants? The John Hancock Tower, the signature building in Boston's skyline, went on the market in 2002 with 96% of its 3 million sq. ft. of space committed. It sold to Beacon Capital Partners for $307 per sq. ft. Another gem is 1 Lincoln St., a 1 million sq. ft. downtown office tower newly opened and fully leased to State Street Corp. Its developer, New Jersey-based Gale Co., is shopping around the tower for as much as $700 per sq. ft. Gary Lemire, an investment specialist at CB Richard Ellis in Boston, believes the tower may well fetch that record price, “but that's a prime example of everything an investor wants.”

Tenants also are the lifeblood of development projects. Charles River Plaza is a 650,000 sq. ft. office and research development nestled a few blocks away from City Hall and adjacent to Massachusetts General Hospital. The hospital has committed to a long-term lease on the site. The $300 million project, developed by the Davis Cos. and financed by CIGNA, TIAA and the New York State Teachers' Pension Fund, broke ground last March.

Then there are the unfortunates without tenants. Empty buildings, particularly in the suburbs, fail to inspire interest from buyers and sell for as low as $45 per sq. ft. Some larger tenants buy their buildings outright: National Development of Newton, Mass., sold its Blue Hill Corporate Center, a 183,000 sq. ft. building in the southern suburb of Canton, to the parent company of Equiserve Co. last summer for $135 per sq. ft.

Boston-based Beacon Capital even revamped its plans for the Channel Center, a 1.5 million sq. ft. development of 18 low-rise buildings in Boston's Fort Point Channel neighborhood. When Beacon Capital purchased the seven-acre site in 2000, it hoped to bring 840,000 sq. ft. of office space to market while demand was hot.

By the time Beacon won the necessary permits, however, demand for commercial property had soured. Beacon shifted gears to deliver residential units instead; 600,000 sq. ft. of high-end condos and artist lofts should be on the market by December 2004. Doug Mitchell, Beacon Capital's senior vice president of development, is unsure when the commercial phase of the project will proceed.

“There's no defined schedule,” he says. “We'll take it forward as market conditions dictate. It's fair to say the office market in general will take a while to get going.”

Condos Lead the Way

Beacon Capital's move to multifamily housing is wise. Most multifamily developments in Boston these days are luxury condos, given the high cost of construction in Boston. Yet even with prices at $700,000 or more, buyers line up months early.

Boston developer Ron Druker is building Atelier, a 420,000 sq. ft. project in the city's tony South End neighborhood. The building has 103 units, three-quarters of which are priced at $1 million or higher, all complete with amenities such as nine-foot ceilings and marble countertops. Atelier will not open until summer. Ninety percent of the units are committed already. “The success we've had does defy some logic,” Druker admits. “It's amazing that we've done as well as we have.”

Atelier is not alone. Strada234 opened last fall in Boston's North End neighborhood with 88 units; 32 sold before the doors opened. Grandview, a 20-story tower overlooking Boston Common, will open 62 units by summer. Developed by Atlanta-based Radco Cos., prices will average $750 per sq. ft. Nine were sold by December.

“It's a very steady market over the years. There's a predictable pattern in place,” says Phil Restifo, president of J.S. Karlton in Greenwich, Conn., and developer of Strada234.

Aging baby boomers, who have sold their suburban homes for a king's ransom and now want to live in the city, drive the condo surge. Many boomers purchased their homes 20 or 30 years ago, amassed huge home equity, and now can afford downtown's eye-popping prices.

“That group is offsetting whatever other issue is in front of us,” be it war, terrorism or white-collar unemployment, says James Ahearn, president of the condo management firm Otis & Ahearn in Boston. “It really is that simple.” By his market surveys, luxury units have gone from 7.3% of Boston's total housing market in 1999 to 9.3% today.

Demand for apartments, meanwhile, has plunged from the soaring rents and rock-bottom vacancy that existed until 2001. Rapid job growth propelled that surge. With job creation stalled today, vacancy stands at 5% compared with about 1% three years ago, and rents are flat at around $24 per sq. ft.

Major apartment developments are few and far between. Cathartes Investments, for example, won permission from the city four years ago for a 700-apartment complex in South Boston. The project then floundered in local political infighting, and was never built. Cathartes' partners dissolved the group last month.

Hotel Supply Is Worrisome

Boston's hotel sector is more troubling. Occupancy rates and revenue per available room both declined in 2003, but total room supply increased by nearly 5% — an alarming divergence compared with similar major cities.

“The one issue here is room-supply growth,” says Bobby Bowers, an analyst with Smith Travel Research in Hendersonville, Tenn., which tracks hotel data. “Even when things get good, they'll have to get really good to fill all those rooms.” Bowers calculates that the Boston area has 63,500 hotel rooms, with another 1,200 under construction and 6,600 in planning.

Boston does have higher occupancy rates and revenue per room than the national average, but the trend is still downward: occupancy dropped from 77.1% in 2002 to 74.8% last year, while revenue per room dipped from $106.75 to $100.30. Still, several hotel projects have been proposed in conjunction with the Boston Convention and Exhibition Center that opens in June — although the center has confirmed only one convention so far.

Starwood Hotels & Resorts Worldwide Inc. wants to place a Westin Hotel at the convention center, in two phases of 800 and 300 rooms. Boston-based developer CWB Boylston Corp. wants to place a 150-room Mandarin Oriental Hotel in the Back Bay neighborhood of Boston, and a Regent Hotel is planned along the waterfront. The Mandarin and Regent both include luxury condos. Construction on all three hotels is expected to begin by summer.

The Westin secured $15 million in financing from the city, while the Regent received $10 million. The Mandarin originally received $15 million as well, but declined the sum amid criticism that public money should not go to high-end developments. The Mandarin is a $230 million proposal and its condos will sell for more than $2 million each.

Retail: Stronger and Stronger

Retail property has also held up well during the recession. According to Boston-based Property & Portfolio Research Inc., vacancy in 2003 stood at 10.5%, just three-tenths of a percentage point higher than 2002. The market experienced positive absorption of 1.8 million sq. ft., twice as much as the year before, while rents edged up 6 cents to $20.05 per sq. ft. “Retail very much has been the strongest segment” in Boston, says PPR analyst Paul Briggs.

Boston has little available land, so there are only a few new retail developments. Demand for existing retail projects, specifically enclosed malls or outdoor malls anchored with supermarkets, is high.

James Koury, an investment broker with Spaulding & Slye's Boston office, says he closed a sale on a 100,000 sq. ft. outdoor mall in Marlborough, on the outer rim of Boston's suburbs. At a 7.75% cap rate, the total price was $26.5 million and a record $265 per sq. ft.

Koury attributes the strong interest in retail to investors' lackluster interest in commercial. Investors doubt that office buildings can be filled or will generate sufficient returns, especially in the suburbs. The retail sector, meanwhile, has benefited from the expansion of chains such as Kohl's, Target and Wal-Mart, which neatly stepped into New England as old stalwarts such as Kmart and Ames faltered. Those new arrivals have kept the retail market afloat.

Even in downtown high-rent districts — peppered with “space available” signs these days — demand is deceptively strong, Koury says. Landlords know they have desirable locations, so they are willing to keep shops empty longer until a tenant meets their price, he explains. “There's just a huge demand out there.”

Matt Kelly is a Boston-based writer.

BOSTON - BY THE NUMBERS

POPULATION OF METRO AREA: 3.3 million

UNEMPLOYMENT RATE: 4.8%

LARGEST EMPLOYERS:

  1. Massachusetts General Hospital 14,907 employees
  2. Fidelity Investments 11,250 employees
  3. Beth Israel Deaconess Medical Center 8,658 employees


Source: Boston Redevelopment Authority

METRO AREA STATS

Office:

16.4% vacancy, 3Q 2003

13.4% vacancy, 3Q 2002

Rent per sq. ft.: $25.61 3Q 2003

Source: Meredith & Grew

Multifamily:

5.0% vacancy, 3Q 2003

4.9% vacancy, 3Q 2002

Monthly rent per sq. ft.: $23.99

Source: Property & Portfolio Research, National Real Estate Index/Global Real Analytics

Retail:

10.5% vacancy, 3Q 2003

10.2% vacancy, 3Q 2002

Rent per sq. ft: $20.05 3Q 2003

Source: Property & Portfolio Research, National Real Estate Index/Global Real Analytics

Industrial:

14.2% vacancy, 3Q 2003

14.0% vacancy, 3Q 2002

Rent per sq. ft.: $7.14 3Q 2003

Source: Property & Portfolio Research, National Real Estate Index/Global Real Analytics

Hotel:

74.8% occupancy, 3Q 2003

77.1% occupancy, 3Q 2002

RevPAR: $100.30 3Q 2003

Source: Smith Travel Research

MAJOR PROJECTS UNDER CONSTRUCTION:

Charles River Plaza, a 650,000 sq. ft. office and research project

Cost: $300 million

Owner: Davis Co.

Completion: mid-2005

Atelier, a 420,000 sq. ft. condo project in the South End neighborhood

Cost: $100 million

Developer: Ron Druker

Completion: Summer 2004

Grandview, a 20-story condo tower overlooking Boston Common

Cost: $80 million

Developer: Radco Cos.

Completion: Summer 2004

Mandarin Oriental Hotel, a 150-room hotel in the Back Bay neighborhood

Cost: $230 million

Developer: CWB Boylston Corp.

Completion: Spring 2006