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'The Vultures Are Starting To Gather': Boston's CRE Pain Could Be Opportunity For Some

With interest rates showing no signs of declining in the near future and lenders tightening their grip by the week, many real estate firms aren't able to finance new projects.

Layered with local government hurdles and high construction costs, real estate experts and government officials who spoke at Bisnow’s Boston State of the Market event last week said new developments seem to be impossible to make work. But they said there will be opportunities to come as more distressed properties come to the marketplace. 

Barings' Maureen Joyce, The Davis Cos.' Stephen Davis, The Mount Vernon Co.'s Bruce Percelay, M&T Bank's Colleen Foy and Nutter McClennen & Fish's Michael Scott.

“Land is really not that significant anymore compared to the construction costs and the interest costs,” Young Park, president at Berkeley Investments, said at the event, held at The Davis Cos.’ 66 Galen St. in Watertown.

“It makes no sense for a developer unless you have a distressed situation, and I think that’s what’s going to happen,” Park added. “I think deals will be stuck for developers that bought land at a great value, and they're waiting for interest rates to come down.”

Coming from ultra-low interest rates early in the pandemic, The Mount Vernon Co. founder Bruce Percelay said that as loans mature, borrowers are coming into a completely different environment, with rates double what they previously secured. For many, this realization will be costly when it comes time to refinance.

“We all got hooked on cheap money,” Percelay said at the event. “Cap rates were down because rates were down, and a lot of people are going to get caught because if you borrowed at 3%, your purchase price was predicated at 3%, and now you're paying 6.5% or 7% and your loan rolls over, you’ve got a problem.”

As interest rates remain high and costs persist, Percelay said an adjustment in the market will come either in the form of rates coming down or owners handing the keys to lenders. He said that the next two years will provide opportunities for cash buyers and that these deals are already starting to happen. 

“The vultures are starting to gather, and there will be significant pain. And the people with cash and funds will be in a position to purchase assets,” Percelay said. “For those people that have cash or funds that have not deployed, the next two years could provide real opportunity.” 

The Davis Cos.' Jonathan Davis

Earlier this month, private investment firm Kendall Capital acquired a 38K SF Class-B office building at 33-41 West St. for $4.1M, a 74% markdown from what Dedham-based Bay Management Corp. had bought it for in 2016. Kendall Capital President Mai Luo said the company bought the property on auction site Ten-X.

This summer, a 43% leased office building at 400 Crown Colony Drive in Quincy traded hands to a private investor for $5.5M, just a fraction of the $18M financial service giant UBS bought the 120K SF building for in 2005, the Boston Business Journal reported. The building was also auctioned off.

“It’s always miserable and a tough spot to get through, but unless this is different, this is a cyclical industry, and great growth and success always begin in markets like this,” The Davis Cos. founder Jonathan Davis said.

Colliers' Kendin Carr, Nuveen Green Capital's Mike Doty, Berkeley Investments' Young Park, Ecosave's Marcelo Rouco, Invesco's Yorick Starr and NFP's Brooks Finnegan.

Although some deals are happening, there is still a slowdown across the country. Real estate transactions were down from $424.5B in the first half of 2022 to $181.8B in the first six months of 2023 across major asset classes, the American City Business Journals reported. Across office, industrial, apartments and retail, transaction volume dropped 70% year-over-year.

“There aren’t going to be any deals,” said Kendin Carr, vice president at Colliers. “It’s a massacre out there. The only upside I can see is we are not San Francisco.”

As banks have faced more federal scrutiny and have tightened lending activity, developers said they have had to halt certain projects that haven't been able to secure financing. 

"We have three other deals that we’d like to get started, but we’re putting them on the shelf,” Berkeley's Park said. “The very far back shelf.”

The city of Boston's Mike Firestone and Sullivan & Worcester's Jennifer Schultz.

Lending from local and regional banks also continues to contract following the shutdowns of Silicon Valley Bank and Signature Bank six months ago. Due to the failure of these two banks, M&T Bank Executive Vice President Colleen Foy said that oversight from the federal government has restricted underwriting guidelines.

“Banks have narrowed our appetite to focus on our existing client base,” Foy said. “It’s very relationship-oriented, and we are sticking to the major asset classes that we feel confident and comfortable with, and we are obviously looking for a return.”

Maureen Joyce, head of U.S. real estate asset management for Barings, said the pain in the Boston area isn't a unique experience, with other markets having similar issues with costs and rates. Nationally, total construction starts were down 6% in September, with nonresidential and residential starts down 4% and 6%, respectively, according to Dodge Construction Network.

“From a national lens, we are pencils down because the numbers don’t work,” Joyce said. “It’s construction costs, it’s interest rates, but it’s also required return. Investors want a high return.”

CV Properties' Canan Safar, MassDevelopment's Dan Rivera, Trammell Crow Co.'s Sam Schaefer, Bozzuto Management Co.'s Kate Becker, Nordblom Co.'s Kris Galletta and Mintz's Jennifer Kiely.

On top of the macroeconomic pressures, developers say city regulations and policies are making the process even harder. In Boston, Mayor Michelle Wu’s increase in the city’s inclusionary development policy was approved by the city council last month. 

The policy increases the percentage of affordable units a developer is required to set aside in a new multifamily building from 13% to 17%. The city also lowered the size of projects that fall under the policy from 100K SF to 50K SF. Linkage fees, which are used to fund job training and affordable housing, also increased in February from​​ $15.39 to $30.78 for lab space and $23.09 for all other commercial developments.

Boston Chief of Policy and Strategic Planning Mike Firestone said the city is trying to become a better partner for developers, especially with the macroeconomic pressures persisting. He said the city approved 946 units in August through the Boston Planning & Development Agency's Article 80 process, but he said they are being delayed by the financing environment rather than the city's policies. 

“A lot of what’s going on right now is that it’s just very difficult to pencil projects,” Firestone said. “We are continuing to see approval, but we are not seeing as many starts. But I think the city is recognizing that it needs to be a partner in reducing regulatory uncertainty and reducing costs.”

Cushman & Wakefield's David Thomann, JLL's Robert Coughlin, Ginkgo Bioworks' Shaun Funn, Foundation Medicine's Jeff MacKay and The Davis Cos.' Duncan Gilkey.

The city has also officially launched its office-to-residential conversion program to incentivize landlords of older commercial buildings to help produce more housing for the city’s business district.

However, real estate developers at the event said that although the mayor’s efforts have been clear and are appreciated, the city doesn't fully understand the scope of the issue at hand.

“I know Mayor Wu is trying really hard to convince developers to build more units, and kudos to her, but I think city officials are typically a year behind as they deal with the neighborhood and the community,” Park said. “I think it’s going to be really hard for the city to fully understand what’s happening in the marketplace.”