Looking Back
We will teleport back to the end of 2019, just before COVID-19 took the United States by storm.
The Greater Boston’s office market had yet another productive year as it continued its swift pace to close out 2019. Vacancies are at their lowest since the dot-com era, absorption climbed close to 1.4 million square feet, rents continue to escalate, and demand remains robust. Over 7 million square feet are currently under construction, the highest in almost 20 years. With strong gains in select clusters of Boston and Cambridge, lead asking rents have increased by 3.5% over the past year across the metropolitan area. Tenants with expiring leases face a lack of large-block availability, leading to increased construction to address the shortfall.
However, these projects will not be delivered to the market until after 2021. The next 12 to 24 months should remain a landlords’ market since the next wave of development is focused on build-to-suit projects in 2021.
The suburban market remained strong with a vacancy rate of just 16.3%, which is expected to continue in 2020. Rents continue to rise, with a 3.6% increase year-over-year. Nearly all the markets posted positive gains for the year, though two major exceptions, Route 128 South and Route 495 North, were unable to overcome the departure of State Street and Eisai, respectively. Lab conversions continue to be the centerpiece of this growth throughout the suburbs. This market segment should continue its ascent in 2020.
Where the Market Stands Today
Of course, the COVID-19 pandemic has changed office markets everywhere. How is the Greater Boston office market doing now?
The number of vaccinated people in Massachusetts is approaching 6 million doses administered and 2.5 million fully vaccinated residents. This means we’re finally seeing the light at the end of the tunnel.
Boston’s office market ended the first quarter of 2021 on a slightly more positive note than previous quarters. While physical occupancies remain low, we see it slowly increasing. Consequently, first-quarter figures show an apparent settling of the market. Negative absorption continued, the amount of sublease space has begun to stabilize, and asking rents declined for the first time this cycle. Vacancies ended the quarter at 15.7%, which was more than a 7% increase from this time last year.
Subleases are creating more interest among tenants with active requirements due to shorter terms, minimal capital output, more favorable economics, and flexibility. With so much sublet space on the market, interested tenants have the option to go bargain-hunting for space. They have been targeting Class A buildings instead of Class B buildings that they were targeting in the pre-pandemic era. As companies further evaluate real estate needs, sublease space may rise again in the coming quarters, but not likely with the same intensity as experienced in 2020.
The evolution of the suburban life science market remains a key strategy for Greater Boston. Labs have become a major driver of the development pipeline and investment sale activity as demand continues to come out from Cambridge. Developers and operators are most active in the Urban Edge, specifically Watertown, Somerville, and Allston-Brighton, as well as within the North and West - Route 128 submarkets, like Waltham and Lexington. Former Sasaki headquarters at 64 Pleasant Street in Watertown and 100 Crosby Drive in Bedford both recently changed hands and are now slated for repositioning. Biomanufacturing continues to grow in importance, and new lab facilities are being planned throughout the suburbs. There is now more than 5 million square feet of office space that is being converted to life science facilities.
Additionally, industry analysts are watching to see if the effects of COVID-19 have created a trend for employers to move away from the urban core and to the suburbs. The rent differential between Boston and the suburbs remains significant, offering office using tenants a substantial cost savings. The suburbs also provide a way for employees to avoid public transit, which still has a long way to go from usage levels pre-pandemic. Therefore, the first quarter of 2021 gave us our first look at tenants exploring a suburban move. Companies like Pegasystems are reportedly close to finalizing a large lease in the suburbs in a “hub and spoke model.” If more companies follow Pegasystems’ lead, it could generate strong momentum towards the suburbs.
Looking Forward
While office fundamentals in the greater Boston region are expected to stabilize in 2021, the first half of the year will likely bring continued rent decline and increased vacancy and sublease availability. With widespread vaccine distribution achieved by the second half of 2021, business leaders and employees are expected to gain the confidence needed to begin a slow return to the office over the summer months, bringing a renewed interest and attention to real estate discussions.
Added to this, many companies will return to the office and at that time, get a better understanding of what their space needs may be in the new normal after the pandemic. We don’t have a crystal ball and can’t always predict what will happen, but our assumption is that leasing velocity should pick up again in 2022.
However, employers will continue to evaluate space needs over the next year. They’ll have to adjust their office space to find the right footprint for their individual organizations. Employers will have to adapt to the new hybrid workplace and office footprint. There will undoubtedly be major changes in how the office is structured. We believe there will be more hotel/hot desks. We’re also expecting an increase in the square footage per employee closer to the numbers we saw in the early 2000s with 250-300/SF per employee. Companies who have pushed the density to the limit will have to re-examine their workplace planning. The issue for most office spaces is when those companies signed the lease some were closer to 130-140/SF per employee.
Vacancies are likely to persist throughout 2021, which means that it’s unlikely that direct rents will increase significantly. 2020 saw significant additions of sublease space as a direct result of the pandemic, especially in the downtown office market, most notably the Financial District. This increase in supply, the majority of which is at discounted rents, favors tenants and limits landlords’ ability to increase rent on direct space.
The split between Class A and B rents widened further in the first quarter. While rents in Class A only fell slightly, Class B did experience a decline. Total sublet availability in Class A dropped by 170,000 square feet while it slightly rose in Class B. Class A’s outperformance should remain if hybrid work continues. When the market is struggling, one of the biggest trends you see is a flight to quality. Some tenants currently in Class B may find if they reduce their footprint, they can afford the steeper Class A rents. Another major factor is sublease space that can be had at a significant discount. For example, some Class A sublease spaces in the downtown market are on offer for we saw back in 2014 and 2015. Employers may try to use the Class A’s superior amenities to draw workers back into the office, so that they opt for in-office work instead of working remotely.
The suburban Boston office market is expected to recover faster than the urban office market, which has been hit considerably harder during this recession. Employers in downtown Boston are deeply dependent on mass transit which will continue to serve as a major disruptor for employees returning to work until later in 2021. Suburban alternatives are benefiting from limited-story buildings with minimal elevator needs and free onsite parking. In the short and mid-term, many will find new ways to commute to work other than taking cars and public transit.
Finally, it seems like a return to some normalcy in our everyday lives is quickly approaching. With Massachusetts Governor Charlie Baker and Boston Mayor announcing a plan to fully reopen the state to 100% capacity, as of May 29th. It comes as a nice surprise, considering that the original plan for lifting all COVID restrictions was slated for the end of August. With this news, we still anticipate a slow return back to the office, although the anticipation is by Q2 2022, we will start to see a full recovery.
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