Baltimore, Maryland

Introduction
Activity in the Baltimore Metropolitan area office market remained sluggish during the first half of 2008 with limited prospects for the balance of the year. Modest absorption (209,000 square feet) could not keep pace with a limited amount of new construction (513,000 square feet).  Approximately 90% of the space delivered in the new buildings remained vacant as of midyear.  This pushed the vacancy rate to 15.5%, slightly higher than January’s 15.2% rate, but above the metropolitan area’s long term average of 14.9%. More Class B office space was absorbed than Class A space during the first half. In those markets where absorption exceeded new construction (Downtown and Howard County), vacancy rates fell.  In the balance of the market, vacancy rates rose.  The silver lining is that despite weak economic growth nationally, the unemployment rate in the metropolitan area remained below 4% through April.

There still were significant lease announcements, as well as the completion of major moves announced last year.  Hogan & Hartson will relocate into 34,000 square feet in the new Legg Mason Tower due to deliver in 2009 in Harbor East.  Integral Systems will occupy COPT’s 131,000-square-foot building under construction at 6721 Columbia Gateway Drive in the Howard County market.  Opus' first 60,000-square-foot building, developed under the Enhanced Use Leasing program at Aberdeen Proving Ground, has been leased to CACI.  Venable, LLP completed its 142,000-square-foot relocation into 750 E. Pratt Street, and Merkle occupied its 120,000-square-foot build-to-suit at 7001 Columbia Gateway Drive.  CareFirst of Maryland took an additional 29,000 square feet at Canton Crossing Tower. 

Investment sales activity slowed as credit tightened, buyers’ and sellers’ expectations diverged, and the cost to build, improve or operate buildings increased.  Some notable transactions were:  Eaton Vance Corporation acquired the 390,000-square-foot CareFirst headquarters building from General Growth Properties in Owings Mills for $246 per square foot, and Gramercy Capital Corporation bought the 430,000-square-foot 100 S. Charles building for $114 per square foot.  Sun Life Assurance Company of Canada sold 200 Harry S. Truman Parkway for $12.8 million, or $246 per square foot.

The market appears to be in transition because of a wobbly economy, tighter underwriting in the capital markets, inflation, and an accelerated rate of new construction.  A look at some of the trends that will affect the Baltimore market are summarized, followed by an outlook for the balance of the year.

Capital Markets

1. The once dominant Wall Street conduit lenders known for providing high loan-to-value (LTV), long-term, non-recourse loans are essentially "out of the market".
2. Life companies, known as the "other aggressive" lenders, have tightened up their underwriting criteria tremendously and now offer lower LTVs to a very select, "cherry-picked" group of borrowers, with a preference towards shorter loan terms.
3. Commercial banks that had been trending towards providing long-term, non-recourse loan structures to compete with the conduits and life companies are now trending back to wanting personal guarantees while also "cherry-picking" transactions to pursue, on preferred shorter terms.  Commercial banks prefer existing clients and are typically requiring "new" borrowers to establish additional accounts with them.
4. Lenders, in general, require higher occupancy levels, less risky rollover scenarios, better credit tenants, shorter-term loans, lower LTVs, higher debt-service-coverage ratios and higher-quality, newer vintage assets for financing.
5. Speculative and low-occupancy (less than 75% or 80%) projects of all property types are essentially non-financeable in the current capital markets environment with, of course, the occasional exception.  Equity/JV partners and participating lenders are also steering clear of this transaction structure.

Equity Side Update

1. A large amount of equity capital, which has been raised over the last 12-24 months, remains in the marketplace looking for placement.
2. Pension funds and large institutional investors have not lowered their real estate allocations, but have slightly raised their yield thresholds.
3. A bid/ask spread exists as sellers struggle to adjust to the new environment, as buyers attempt to take advantage of more favorable conditions.
4. Due to the elimination of the commercial-mortgage-backed-security (CMBS) market for the time being, larger transactions are much less prominent than in years past.
5. Sellers continue to bring mostly stabilized assets to the market.  These offerings are still receiving multiple bids with source of funds now being a very crucial factor in choosing a buyer.
6. Pricing for value-add deals is now very hard to predict as investors struggle to value vacant space, especially with rising vacancy rates in certain submarkets.

Construction Costs
According to the Bureau of Labor Statistics as analyzed by R. S. Means and the Association of General Contractors, construction costs are on the rise, again.  From April to May, 2008, costs increased 2.6% and over the past 12 months we have seen an increase of 8.4%.

Major increases were in:

• Structural Steel – 10.7%
• Diesel Fuel – 9.1%
• Softwood Lumber – 7.1%
• Steel Pipe – 4%

There are several reasons for these increases:

1. There is still a steady demand for construction materials, although this is expected to reverse towards year-end due to the weakening economy.
2. Asian buyers are still the dominant players so materials in the world commodity markets, such as steel and concrete, are affected by worldwide construction activities
3. The cost of transportation is rising in proportion with the cost of oil.
4. The declining value of the dollar on international markets.

 
Outlook

• The short-term outlook is cautionary.  Overall private employment is down from year-end 2007, although there was modest growth in professional and business services.  Employment in educational, healthcare and social assistance grew even more (4,200 jobs v. 1,100 in professional and business services).  Not surprisingly, employment in “financial activities” has declined since January.
  
• While employment growth is weak, new construction is accelerating.  Approximately 2.9 million square feet of new space will deliver by 2009, 75% of which remains available.  The 524,860-square-foot Legg Mason Tower in the Downtown market is two-thirds leased, but 91% of the one million square feet of space in the BWI Airport is unleased, as is 85% of the 789,000 square feet being added in Howard County.  The BWI market is expanding in preparation for BRAC-related relocations in 2009-2011.  With a weak national economy, strapped federal budget deficit, and a new administration taking over the White House, a lot is riding on BRAC coming online in a timely way.
  
• Landlords, sensing the downturn, are increasing broker incentives and tenant improvement allowances. Seasoned owners are taking steps to retain tenants and aggressively courting new tenants they may not have chased 18 months ago.

View Statistical Overview 

Colliers Pinkard, an affiliate of Colliers International, is a leading commercial real estate firm in the mid-Atlantic region, with offices in Maryland and North Carolina.  The firm provides real estate solutions to its clients locally and globally. Areas of expertise include advisory services, corporate solutions, investment services and management services, as well as property and tenant representation

About Colliers International

Colliers International is a global affiliation of independently owned commercial real estate firms. The organization's 11,000 employees span the world in 293 offices in 61 countries. On a worldwide basis, Colliers manages 868 million square feet, and has revenue of $US 2 billion.

Contact Information

Jeff Samet
410.347.7535
jsamet@collierspinkard.com

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