BOSTON—While conditions remained tenant-favorable during the third quarter of this year in Greater Boston, some feel a bottom has begun to form and tenants are in better position than ever to negotiate new lease agreements, according to a report from Jones Lang LaSalle. Here are the excerpts from the report:

Economy

The local economy stabilized during the third quarter and signs now point to Boston emerging as one of the first to recover from the recession. Office-using employment fell 6.0 percent from its peak in February 2008, but between May and August net office-using job growth has remained flat. The professional services and information sectors held up particularly well, however the financial services sector continued its decline. Job losses largely shifted from the private to the public sector during the quarter where a net loss of 2,875 state and local government jobs coincided with the new fiscal year which began in July. Demand for local products has also stabilized over the quarter. The Purchasing Management Association’s Boston Index rose from a low of 26.7 in March to 47.4 in September. A reading above 50.0 indicates expansion.

Market conditions

Third quarter net absorption was negative 410,931 square feet as the impact of job losses continued to translate into occupancy declines across a majority of Greater Boston’s submarkets. Downtown Boston gained its first new office tower in five years with the completion of Two Financial Center. KPMG will be the first tenant to occupy the building.

The deceleration in asking rents Downtown slowed over the quarter, but remained approximately 25.0 percent lower than the current cycle’s peak. In Cambridge the total vacancy rate ticked upward, mostly due to IBM's pending lease expiration at 1 Rogers Street. The submarket, has weathered this economic downtown relatively well compared to other submarkets in the region due to its industry mix, but has experienced softer market fundamentals in recent quarters. In the suburban market, conditions remained tenant-favorable as net absorption totaled negative 354,630 square feet in the third quarter pushing year-to-date net absorption over negative one million square feet. The Northwest submarket was the only suburban submarket to record occupancy growth.

Tenant perspective

While conditions remained tenant-favorable during the quarter, some feel a bottom has begun to form and tenants are in better position than ever to negotiate new lease agreements. Landlords continued to offer aggressive incentive packages to keep occupancy levels high. Tenants exploring relocation or renewal options now should be able to lock in an extremely low effective rent in virtually every submarket. With employment stabilizing in recent months, market conditions will slowly begin to improve eventually creating a market closer to equilibrium.

However, recovery is still far off and considering that vacancy will likely increase throughout 2010 market fundamentals will remain tenant favorable for the foreseeable future. The danger of highly leveraged landlords defaulting over the next few years as 2006 and 2007 vintage loans come due has led savvy tenants to seek out properties where landlords have significant capital backing and consequently a significantly lower risk of default.

Landlord perspective

Landlords welcomed improved economic conditions both locally and nationally during the quarter. The market unquestionably remained tenant-favorable, however the prospect of recovery in late 2010 has eased pressure albeit marginally on landlords. Market conditions continued to soften over the quarter and year-to-date net absorption of negative 2.9 million square feet was the highest total since 2002. The average asking rent in Greater Boston fell by one dollar over the quarter to $30.24 per square foot gross. The rate of decline has eased in the past two quarters after falling sharply by 14.1 percent between the third quarter of 2008 and first quarter of 2009. Tenants have become increasingly conscious of the financial health of owners. Landlords that remain financially sound relative to competitors will have a significant advantage in tenant recruitment and retention going forward.

Outlook

Stabilization in the local economy is a necessary prerequisite to renewed expansion, however stabilization and an eventual recovery in the commercial real estate market will continue to lag the overall economy. With a sense of where bottom lies, sharp rent declines will give way to more modest adjustments as the office market begins to stabilize in 2010. Tenants seeking to take advantage of favorable conditions will likely begin to pursue transactions more vigorously in the coming months.