How does one go about filling 350,000 square feet of empty Class A office space in a market still plagued by negative absorption? Very slowly, says Ted Oatis, a partner with The Chiofaro Co. in Boston.
In roughly two weeks, such a chunk of space will officially be vacated at International Place, the 1.9 million-square-foot tower complex anchoring the Financial District’s eastern border. The property’s largest tenant, the Boston law firm Ropes & Gray, more or less cleared out nine floors at the site’s largest skyscraper at the end of October, although its lease isn’t scheduled to expire until year end. At that point, roughly 25 percent of International Place’s rentable space will be empty.
That would seem to bode ill for the property’s ownership and financial stability, especially given International Place’s $400 million debt load. But Oatis waved off such concerns during an interview this week, noting the property’s sizeable mortgage is easily supported by its existing tenant rolls — and that’s even when accounting for Ropes & Gray’s exodus to its new home at the Prudential Tower.
Oatis said The Chiofaro Co. and prospective tenants were wrapping up negotiations on some 80,000 square feet of space at the two towers and proposals for another 450,000 square feet of potential leases are under review. The real concern is overshooting the market and leasing up too much space before the pendulum inevitably swings back in favor of property owners, he said. “Every landlord in town is thinking the same thing.”
At a time when a dizzying number of commercial property owners are losing their shirts amid crushing debt loads and soaring vacancy rates, a select group of landlords are sticking to their guns, namely their pricing discipline, in hopes of timing the market for fatter margins down the road. The bravado is grounded in two beliefs, namely that the economy’s recovery will soon force companies to lock up extra space for expansion, and that the supply of available Class A space will remain stagnant for years due to the time and cost required to build comparable space in Boston.
To even the most amateur of economic forecasters, rising demand and inelastic supply can only mean one thing: higher prices.
As an advisor to landlords on leasing and tenant negotiations, Duncan Gratton cautioned that Greater Boston is likely years from any serious pricing inflation, although property owners are certainly flexing some muscle in several “micro markets.” He said rents at quality properties in Cambridge have seen a 15 percent-to-20 percent increase this year, while demand for high-rise spaces in the downtown and Back Bay also remains frothy.
Rents at those and other prime locations — generally in the high $40s and low $50s per square foot in Cambridge and the $50s in Boston — will continue to rise as the economy rebounds, a trend that should prompt surrounding landlords to follow suit and “draft” off of that pricing momentum, said Gratton, a partner in the asset advisory group at FHO Partners in Boston. He said a similar scenario unfolded in 2007 after Blackstone Group aggressively raised rents after acquiring Equity Office Properties and its portfolio of local trophy assets. “It raises the question: Do you rent today or wait another six months for that pricing to ripple through?”
Regardless, he said only a sliver of the local landlord population has the luxury to be patient in such a battered market. Most are still desperate to populate empty floorplans. “You’ve got to have deep pockets, a long-term view and a quality asset.”
International Place appears to fit that bill. In a recent Moody’s Investor Service report, the ratings agency said International Place is expected to have a solid financial cushion even under the most challenging of scenarios. The property’s mortgage has been split and spliced into separate pools of commercial mortgage-backed securities, half of which are included in a $1.2 billion portfolio arranged by Wachovia Bank in 2005.
While Moody’s recently downgraded nine classes of the Wachovia CMBS portfolio, it said the International Place loan continues to perform amid solid operating income in excess of its monthly debt-service payment of $1.19 billion. The report pegged International Place’s market value at about $500 million, well below the $700 million appraised value the towers received when they were last refinanced in 2005.
The Chiofaro Co.’s Oatis contends that International Place has held its value since 2005, adding that the property’s pricing is a moot point since its mortgage doesn’t mature until 2015. He said that five-year window gives Chiofaro Co. ample time to pursue major tenants at leasing rates that far exceed today’s levels.
“In a market of this size, we can compete effectively,” Oatis said. “There’s still not much space out there. We’re not going to have some sort of death duel with other property owners.”
Read more: Chiofaro eyes rent rebound as International Place vacancy looms | Boston Business Journal