Many spectators have questioned the pricing levels in Boston’s Class A market this past year, suggesting the onset of a New Pricing Paradigm. This theory inspired us to review the investment sales activity over the 1992-2002 period. 

While 2002 seemed like an erratic year for investment sales in the Boston market, Spaulding & Slye’s Capital Markets Group ended on a high note by brokering the largest downtown office sale of the year – One Boston Place, a 41-story, 781,000 square foot, Class A tower. Although the asset was not formally on the market, the needs of seller and buyer were successfully matched creating the proverbial win-win.

Given all the bearish news in the press, 2002 felt like an anemic year in terms of tower sales. On the contrary it was marginally better than an average year. From 1992 to 2002 the average number of sales per year was 2.3 and the average volume was $507 million. For 2002 there were 3 tower transactions with a total volume of $587 million. In contrast to the record level activity in 2000, when tower transactions were nearly triple the average, 2002 was a more moderate, but  more typical, year. From records dating back to the mid to late 1980s, what resonates most is that only a handful of these assets trade a year. Of the 44 buildings identified on the Spaulding & Slye Skyline Review, nearly 40% are controlled by REITS (which completed most of their acquisitions in the mid 1990s). The Class A tower market is a privileged asset class and the pricing reflects this status.

Replacement cost is a part of any tower pricing discussion, new paradigm or old. In 1991 Spaulding & Slye Colliers completed 125 High Street, a twin-tower development totaling 1.5 million square feet. The approximate cost of the project at that time was $301 per square foot with land valued at approximately $70 per square foot. While pro forma rents were just above $50 per square foot, breakeven rents were $42 per square foot and operating expenses and real estate taxes were $12 per square foot. Replacement cost today for 125 High Street, based on historical CPI, would be approximately $400 per square foot, which is in line with the anticipated cost to deliver One Lincoln and 33 Arch Streets. One Boston Place and many of the other sales expected to close near term traded, and will trade, significantly below that replacement cost. 

Another critical piece of any pricing discussion is rents. Class A average asking rents for the fourth quarter of 2002 are approximately $45 per square foot. The average in-place rent for One Boston Place was $33 per square foot, 73% of market rents. Even looking ahead to 2005 when One Boston Place experiences its next significant roll, the expiring in-place rents are $36.50 per square foot. If the most bearish of pundits are right in their projections for further rent deterioration in the 10-15% range, achieved rents would need to decline even further to erode the building’s income at that time. While the consensus at Spaulding & Slye is that overall downward pressure on rents will continue in 2003, we are not currently projecting rent declines of such magnitude. Operating expenses and real estate taxes for the average Class A tower have increased considerably to approximately $17.50 per square foot. These costs are not expected to decline and will help to shore up rents. 

The last leg of the discussion is returns. From a Capital Markets perspective core real estate is enjoying its day in the sun relative to other investments. The average going-in cap rate for 2002 was approximately 7.3%. Surprisingly, the four-year average going-in cap rate was 7.6%. While going-in cap rates have not shown a dramatic change in the Boston Class A market, the tolerance for lower cap rates for longer periods has increased bringing down overall yields. Yield compression has also been fueled by low interests rates, lack of alternative investments and large amounts of capital chasing a limited supply. Consequently, the recent pricing for stabilized, core real estate in Boston has dropped 100-150 basis points over the past year.

Is there a New Pricing Paradigm?  For stabilized, core assets in Boston the short-term answer appears to be yes. The next and perhaps harder question is for how long?