Baltimore, Maryland

Overview
The Baltimore Metropolitan Area office market sagged under the weight of too much construction and too little absorption in 2007.  Coming off a three-year streak of absorbing over 2 million square feet, the market was only able to absorb 781,000 square feet, a 67% drop from a year ago.  The market added 1.8 million square feet of space, driving the vacancy rate from 14.2% to 15.2%.  Although performance dragged across the metropolitan area, there was encouraging development which demonstrated some of the market’s underlying strengths.

The financial services sector announced expansion plans both for Downtown and Owings Mills.  Legg Mason will lease 400,000 square feet of space in a new building to be completed in 2009 in Harbor East, where Morgan Stanley will lease 130,000 square feet at Thames Street Wharf in Harbor Point when it is completed in two years.  T. Rowe Price expanded at 100 E. Pratt Street and will add two new buildings to its Financial Center Campus in Owings Mills, totaling 400,000 square feet.  Elsewhere Downtown, Venable will relocate into 142,000 square feet at 750 E. Pratt Street. Catholic Relief Services completed its move into 117,000 square feet at 228 W. Lexington.  This positive news was offset by Bank of America and PNC Bank shedding space, the latter as a result of its acquisition of Mercantile Trust.

Howard County had the most absorption in the Baltimore metro market―317,000 square feet, which would have been higher except for a lack of velocity in Columbia Town Center and the collapse of residential mortgage tenants like Novastar and Fieldstone Mortgage.  Construction was completed for Johns Hopkins University’s Applied Physics Laboratory’s new 243,000-square-foot facility.   Other large leases to United HealthCare, Barton Cotton, Maxim, and the Corps of Engineers offset the vacancies left by Amerix, American Home Mortgage, and the previously cited mortgage firms.

Leasing activity slowed in the BWI Airport market to its lowest level in five years as 580,000 square feet of new space were added, but only 168,000 square feet was absorbed. The vacancy rate climbed into double digits for the first time in four years.  AT&T Wireless, the USGS, Sitor, US Bureau of Prisons, and T. Rowe Price accounted for some of the larger leases, but larger defense contractors, CSC, Booz Allen Hamilton, and Titan Corporation offered some of their space for sublease.

The Greater Annapolis market also had more construction than absorption as did Baltimore County’s Suburban West market. Suburban North was the only market to see its vacancy rate drop because absorption exceeded construction.

Despite the uncertainty surrounding the capital markets in the latter part of the year because of credit, pricing, and the displacement of debt players as viable buyers, 2007 had several notable sales in both the Downtown and in the suburban markets.   Arc Wheeler Corporation acquired the venerable B&O Building for $267 per square foot for conversion to mixed-use office and hotel use.  The recently completed 280,000-square-foot 500 E. Pratt Street building sold for $282 per square foot, and Washington Investment Capital paid $277 per square foot for the City Crescent Building.  In Howard County, Eaton Vance paid $263 per square foot for 7651 Montpelier Road, which was built for JHU’s Applied Physics Laboratory, while the Micros Systems Headquarters building was sold for $235 per square foot.  In Baltimore County, Greenebaum & Rose’s 73,000-square-foot 1829 Reisterstown Road building sold for $247 per square foot, the same price paid for its Woodholme Medical Office building.

Trends
Capital Markets

• The sub-prime residential mortgage meltdown has caused commercial lenders to tighten their underwriting standards.  Interest rates have risen as much as 120 basis points, interest only periods are less common, and both loan to value and debt coverage ratios are more conservative.
• Commercial lenders can no longer rely on a take-out or buyer for their loans and are pricing deals at rates that reflect their need to hold loans in-house indefinitely.
• Leveraged buyers have to bid based on higher cap rates to maintain the yields they were getting prior to the credit crisis.  While the all-cash buyer has not been directly affected, some are taking advantage of the changed environment.  The result is that cap rates on investment deals have risen up to 100 basis points, depending on the strength of the specific market (primary, secondary, tertiary), asset quality, occupancy, tenant credit, lease expirations, etc.
• While some Class A investment grade transactions will not have their values diminished by this changed environment, a return to fundamentals has occurred. Investors are focused today on replacement cost and in-place income versus projected income.  Rental rate increases are constrained and more conservative exit pricing is being used.
• Deals of substantial size, in excellent locations, with credit tenants, and little roll-over risk will command the lowest cap rate/highest market pricing as these will attract the institutional/all-cash buyer.  Smaller scale deals that attract the leveraged buyers, or have significant vacancy, or less attractive locations or credit risk will feel the effects of the market correction.

Construction Costs

• Construction costs continue to rise, although at a slower rate.  The Association of General Contractors (AGC) expects that these costs will increase in the 5-8% range.
• Although helped by the decline in residential construction and easing of US demand for materials such as lumber, plywood and gypsum, AGC reports the rise in costs for non-residential construction continues to outpace the Consumer Price Index.  There are few less expensive substitutes for materials used in construction.  There is still high demand for these materials in China, India, the Middle East, and other developing countries around the world.  Finally, the cost of construction materials is affected by the price of gasoline as everything has to be delivered to the construction site.
• The approximate costs for typical office build out (base building standard finishes), including general conditions, all materials, mechanical and plumbing, electrical, contingency, and soft costs (architect, MEP engineers, contractor overhead and profit) is $34.83 per square foot.

Outlook
The ambivalence about market prospects for 2008 stems from:

• The extent of the fall-out of the subprime mortgage mess.
• The cascade of vacant new space to be delivered in 2008 on top of the still available space delivered in 2007.
• The last gasp attempts to challenge the announced BRAC relocations into Central Maryland.
• A still surprisingly strong jobs picture in Baltimore.

Residential mortgage defaults are expected to continue through 2008.  The loss of the “wealth effect” and borrowing capacity from rising home values is likely to affect consumer confidence and spending.  How much may largely determine how strong our consumer driven economy will be.

The Baltimore area added 1.8 million square feet of office space this year, of which 830,000 square feet is still available. Another 2.6 million square feet is under construction, 2.1 million of which remains to be leased. 791,000 square feet of this is in the BWI market, which is expected to be a principal beneficiary of the BRAC relocations.  Any delays in the implementation of BRAC are likely to have a disproportionate effect on the BWI market.

In the face of this year’s slowdown in absorption, the metropolitan area still has a low unemployment rate and year-to-year growth in Professional Business Services, a key source of the office tenant base.

The net effect of all of this will be that real estate lenders, developers, landlords, and brokers will be on edge throughout much of 2008.

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 10,092 employees span the world in 267 offices in 57 countries. On a worldwide basis, Colliers manages 672,945,918 square feet, and has revenue of $US 1,620,958,349.

Contact Information

Jeff Samet
410.752.4285
jsamet@collierspinkard.com

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