Tim Thompson, Marcus & Millichap

In the fifth year of expansion, New England property markets are starting to diverge. Greater disparities between metros will be a powerful theme in 2016, with the uneven growth seen throughout the recovery becoming more pronounced and rewarding diligent investors for their ability to identify quality assets offered at reasonable prices.

Boston has experienced robust job growth and household formation, coupled with low retail vacancy and growing space demand. Last year, employers created approximately 56,000 jobs with the majority of new positions in the professional and business services sector, representing a 2.2% expansion. Employment gains supported the creation of 23,000 households in 2015, prompting increased residential development in the urban core.

In 2015, approximately 1.7 million s/f of retail space came online. Building was concentrated in the North Shore and Boston core, where 650,000 s/f was delivered over the past 12 months. An additional 2 million s/f of retail development is currently underway, with another 3 million s/f under consideration, including Seaport Square, which will consist of three residential towers spanning 1.1 million s/f, with 100,000 s/f of ground-floor retail.

Yet, even at the pace of retail development in 2015, deliveries did not satisfy demand due to strong pre-leasing. As a result, vacancy declined 40 basis points to 3.3% metro wide behind net absorption of 2.4 million s/f. Along with strength in demand, asking rents rose 2.2%. Rents for shopping centers vaulted 5.7% metrowide over the past four quarters. As rents increased last year, investor activity followed suit.

The upward trends in employment, household formation, and retailer space demand is inspiring investor confidence in the local economy, creating a competitive bidding environment. Limited listings have encouraged buyers to pay higher prices, with urban core cap rates sinking below the 5% range, which is 200 basis points below the metro average. Single-tenant asset pricing jumped 15% over the past year to $372 per s/f on average. In the coming year, buyers will continue to seek opportunities in Boston’s single-tenant segment, with competition continuing to apply upward pressure on prices. The core and areas surrounding new residential development, including South Boston, will remain popular targets. Multi-tenant buildings posted a price increase as well last year, rising to an average $308 per s/f. In the months ahead, as operations continue to improve, buyers should be less hesitant to consider neighborhood, community and strip centers over other investments options.

Meanwhile, in New Haven and Fairfield County, while local establishments will hire 10,500 workers this year, the total sits well below the cycle peak and may signal the onset of a slower-growth stretch in the market. In fact, over the past year, most sectors beyond manufacturing and natural resources are showing a loss of jobs further slowing economic activity in 2016.

Despite the potential softening in the local economy, developers will increase deliveries this year to 615,000 s/f, up from 440,000 s/f in 2015. Large projects in Fairfield County, including Market 32 and Milford Square, which measure nearly 200,000 s/f each, represent a large share of the new space on deck this year. Other scheduled deliveries consist of smaller single-tenant uses, limiting the impact on area operations. While a pickup in development would not be problematic by itself, the new stock arrives following negative net absorption in the market in 2015. Vacancy in many properties has already begun to rise and will likely continue to do so as new space is placed in service in the coming year.

Higher vacancy has limited rent growth to just above the rate of inflation over the past year. Various submarkets, however, including urban cores and retail concentrations near office complexes, have enjoyed tight vacancy and rising rents. Vacant space lingers in suburban assets, though, softening asking rents and tempering the pace of improvement in NOIs. Asking rents in the market are expected to rise 2% in 2016, reflecting the shifting balance of supply and demand.

In the metro, buyers are becoming more discerning. Closed sales jumped dramatically in stable areas such as Stamford and Bridgeport, but tumbled in fringe areas near the suburbs. Cap rates can also fluctuate greatly, with institutional-quality assets changing ownership in the 5% range. Private capital is likely to seek higher yields in value-add and repositioning strategies, where initial yields can begin in the mid-7% range.

Tim Thompson is sales manager at Marcus & Millichap, Boston, Mass.