Balancing act

Editor’s note: The following is a year-end survey of the commercial and industrial real estate markets, written by three brokers from CB Richard Ellis-New England. For the overview, they tracked both the office and industrial sectors of the commercial real estate market, composed of approximately 80 million square feet of space in the Interstate 93/Route 3 and Seacoast/Interstate 95 corridors.

By Kent White, Margaret O’Brien
and Michael Harrington

The story of this year’s I-93/Route 3 corridor office market is a tale of two cities — Manchester and Nashua. Nashua’s vacancy rate increased from 14.8 percent in 2004 to 19.8 percent in 2005. But Manchester experienced a decrease in vacancy for the third consecutive year, starting at 17.5 percent in 2003, to 12.8 percent in 2004 and down to 9.8 percent in 2005.

The decrease in vacancy in Manchester can be attributed to recent improvements in infrastructure and cultural attractions in the downtown business district, including the expansion of Manchester Airport, the widening of Granite Street to include a north and southbound connector to I-293, and the building of the Verizon Wireless Arena and the New Hampshire Fisher Cats Ballpark. These changes have led businesses in other towns, like Bedford, to relocate to downtown Manchester.

Nashua’s increase in vacancy can be attributed to overbuilding of office space in the late 1990s, as well as corporate downsizing and relocation. Similar reasons explain the vacancy rates currently in Bedford and the other markets surveyed.

The Seacoast office market is reporting an increase in office vacancy rates. This is due to the downsizing of such large office tenants as Tyco, Enterasys and MBNA.

That said, the vacancy rate for the remainder of the Seacoast office market would have remained virtually unchanged, with tenants “trading spaces” within the market throughout 2005.

Unlike the leasing market, any office product — especially in the Portsmouth area — that is made available for sale has attracted tremendous demand. Savvy office building owners are taking advantage of this demand by converting their existing product to condominiums or building new office condo units for sale.

This trend was seen with the sale of 15 units totaling roughly 41,000 square feet of new office space at Griffin Road in Portsmouth as well as the successful conversion into 21 condo units of roughly 63,000 square feet at 36 Industrial Way in Rochester. The low-interest environment has fueled demand, though we expect to see a slowdown throughout 2006 as interest rates continue to rise.

Office leasing rates

Average asking lease rates in the I-93/Route 3 corridor increased slightly in 2005. This increase is primarily attributable to the Manchester market, where average asking lease rates increased by 50 cents per square-foot to $12.50, due to the recent absorption of downtown office space.

We forecast that this trend will continue through 2006 as the market slowly improves in favor of landlords. The remaining office markets are experiencing a decrease in average asking lease rates as the markets begin to stabilize and landlords readjust rent prices to coincide with demand.

The I-93/Route 3 corridor office market will likely continue to stabilize in 2006, as asking rates are readjusted and vacancy begins to decrease.

On the Seacoast, overall asking lease rates continued to show a slight increase – the third year in a row that the average asking lease rates have risen.

Portsmouth remains the strongest market, commanding an average asking lease rate of $15 per square-foot. Downtown Portsmouth and Pease International Tradeport space continues to drive the market, and with minimal new office development scheduled for 2006, and Class A space in short supply, we anticipate lease rates to increase marginally in the Class A markets and remain stable in the Class B markets.

Construction activity

In the I-93/Route 3 corridor, construction of speculative office space continues to be virtually nonexistent. New construction consists primarily of medical office projects, build-to-suit headquarters and conversions from industrial space.

The lack of supply of contiguous office space for users requiring 50,000 or more square feet has caused users to opt for building new.

Recent examples include Brookstone Corp.’s newly constructed 110,000-square-foot corporate headquarters in Merrimack and Fidelity Investments’ commitment to lease and renovate 100,000 square feet of flex/R&D space in Merrimack.

Other large tenants are expected to adopt a similar strategy when entering the I-93/Route 3 office market.

On the Seacoast, new construction consisted of approximately 290,000 square feet in 2005. The largest project was the 90,000-square-foot Measured Progress facility in Dover. The Pease Tradeport continued to see new construction, with the 62,000-square-foot office building at 100 International Drive and the 41,000-square-foot office/retail building at 14 Manchester Square.

A 41,000-square-foot building at 200 Griffin Rd. was completed as well, with all 15 office condominiums selling prior to occupancy. All new construction was built primarily on speculation, except for the Measured Progress build-to-suit in Dover.

Industrial market

The industrial market remained sluggish throughout the I-93/Route 3 corridor, showing only a minor year-over-year decrease in vacancy.

The weakest part of the market continues to be the lack of demand for manufacturing space, as the I-93/Route 3 corridor has yet to recover from the out-migration of manufacturing companies through corporate consolidation and relocation caused by less expensive offshore labor.

Despite soft statistics in 2005, activity within the warehouse/distribution sector, coupled with demand for small industrial companies, managed to keep the industrial market feeling healthy.

In the warehouse distribution sector, buildings with clear heights exceeding 20 feet continue to experience high occupancy rates, as building supply companies fuel demand.

Smaller users, ranging from 1,500 to 5,000 square feet drove the industrial condo market by capitalizing on low interest rates.

We are cautiously optimistic that there will be continued demand for warehouse/distribution facilities and small industrial condos in 2006.

In the R&D and manufacturing sectors, developers and owners continue to evaluate and reposition these types of properties for alternate uses. Functionally obsolete manufacturing buildings in the path of progress are being purchased for their land value and converted to higher and better uses, such as big box retail centers, grocery store anchor centers and other commercial facilities. This trend is expected to continue through 2006.

On the Seacoast, the industrial market shows a slight improvement in 2005. Vacancy rates dipped from 14.3 percent at the end of 2004 to 13.8 percent at the end of 2005.

Demand remains strong for smaller units, ranging in size from 2,000 to 10,000 square feet.

Large manufacturing availabilities, such as the former Celestica and Flextronics buildings at Pease make up the largest component of the vacancy rates. We anticipate continued strong demand for smaller product, but minimal demand for large manufacturing (50,000-plus square feet) buildings in the Seacoast during 2006.

Industrial lease rates

For the third year in a row, overall asking lease rates for the I-93/Route 3 corridor industrial market remained consistent with the previous two years and have leveled off at approximately $6 per square-foot. Lack of demand for industrial/R&D space, due to corporate downsizing, continues to create an oversupply of industrial space.

Overall asking lease rates on the Seacoast improved slightly. This increase was primarily driven by strong demand for 2,000-to-20,000-square-foot availabilities. The margin between asking vs. attained lease rates continues to narrow, except for larger manufacturing buildings that continue to see minimal demand driving down the attained lease rates.

We expect average asking lease rates to remain constant throughout the year, possibly increasing toward the third quarter, as we see slight positive absorption throughout the year.

Construction activity

In the I-93/Route 3 corridor, new construction falls into two general categories — industrial condo development and owner/user warehouse/distribution facilities. Due to a lack of available warehouse/distribution space, owners/users have been forced to purchase land and build new.

Tenants requiring 100,000 square feet of high-bay warehouse space have no choices in Manchester and only a few locations to consider in the Nashua market. This may change by the end of 2006, as two warehouse/distribution and cold storage facilities totaling over 500,000 square feet become available in the Manchester market.

On the Seacoast, there was minimal new industrial construction. The largest project was for Measured Progress in Dover. In addition to the firm’s new office space, an additional 70,000 square feet was built for warehousing and distribution needs. Various other smaller developments in Dover, Exeter and Seabrook round out the new construction on the Seacoast. New projects for 2006 include the 280 Heritage Ave. condominiums in Portsmouth and the 100,000-square-foot build-to-suit warehouse/distribution facility for a national pharmaceutical distribution company on Marin Way in Stratham.

All told, we expect to see a slow continued recovery in the office market throughout 2006. Rents are expected to gradually appreciate, and landlords will continue to pull back on concessions such as free rent and low annual escalations as the market continues to tighten.

It is anticipated that the industrial market will continue to strengthen, as demand for larger square-foot availabilities of warehouse/distribution space seem to be increasing. Large manufacturing buildings will continue to see low demand in the market.