U.S. Federal Reserve Beige Book: Boston District (Text)

The following is the text of the Federal Reserve Board’s First District-- Boston.

FIRST DISTRICT - BOSTON

Economic activity in the First District continues to expand. With the exception of real estate, business contacts are generally upbeat about recent results, reporting similar or better growth than in the last couple of reports. Commercial and residential real estate markets are not much changed, with respondents citing weak but not disastrous conditions. While staffing firms note increased demand for labor, contacts in retail and manufacturing say they are hiring only modestly and plan limited pay raises. With a few exceptions, price pressures appear to have abated.

Retail and Tourism

First District retailers responding in this round report that business conditions in early 2012 have continued the improvement seen in the fourth quarter. Contacts ending their fiscal year in late December or early January say that fiscal 2011 sales ranged from down 2 percent to up 5 percent compared to 2010. These results are generally better than they expected at the start of 2011 and reflect strong same-store sales in the last few months of 2011 as compared to earlier in the year; indeed, December 2011 same-store sales ranged from high single-digit increases year-over-year to mid-teen increases. The range of results was wider in January 2012: One retailer reports same-store sales were down 8 percent to 9 percent year-over-year, which he attributes to mild weather depressing demand for winter hardware items as compared to a particularly snowy January 2011. Another saw January comparable-store sales up 7 percent compared to a year ago, and a third respondent enjoyed a 17 percent jump, which he credits in part to the mild winter not keeping customers at home. All contacts note that store traffic is up.

Responding retailers report that furniture is selling very well, as is paint. As noted above, the mild winter has depressed sales of some seasonal items, and one retailer has steeply discounted winter clothing to get rid of inventory. Prices on furniture are generally flat, but retailers expect the cost of items made with copper or titanium oxide (paint) to reflect price increases in these commodities. Stores are doing light hiring for some full- time and part-time positions; they are budgeting 2012 merit pay increases between 2 and 3 percent. Retail respondents expect the U.S. economy to improve further in 2012. While remaining a bit cautious, they all note that economic conditions seem more favorable than last fall.

Manufacturing and Related Services

Manufacturing conditions in the First District appear to have improved since the end of last year. All respondents in this cycle report sales growth in the fourth quarter from a year earlier. Although many contacts express serious concerns about the situation in Europe, only two say that sales to Europe were actually down. In contrast to the last two rounds, this time few contacts mention weakness in Asia. Contacts among defense suppliers express concern about the budget. One had concluded that programs his firm worked on were largely insulated from cuts but said they are “having trouble convincing our investors of that.” Another said that budget issues are leading to delays but not to reductions in sales.

Raw material prices have stabilized overall but remain an issue. On the one hand, a plumbing manufacturer said that copper is “on the march again.” On the other hand, low natural gas prices have been a boon to U.S. industry. A contact in the industrial membrane industry reports that a multimillion dollar project to switch to natural gas has already led to millions of dollars in savings. A petrochemical contact points out that the equivalent price of natural gas in terms of oil is approximately $25 a barrel, making the U.S. a low cost producer of petrochemicals; as he put it, we are “exporting natural gas in the form of ethylene and polyethylene.”

All of our manufacturing contacts are increasing investment and none cites any issues finding financing. Remarkably, almost all of our contacts say they have acquired at least one company over the last six months. Almost all responding manufacturers report increased employment and there are fewer complaints about difficulties finding qualified workers than in the past; at the same time, an equipment manufacturer is spending significant sums on training expenses for new hires. A pharmaceutical firm closed a facility in Philadelphia and offered jobs in Massachusetts to 20 employees, but reports that only six accepted, suggesting confidence in the availability of employment.

Europe is a source of considerable concern but has not yet affected our contacts in a significant way. Two respondents report slower sales in Europe and one, a plumbing manufacturer, says Europe is “in a recession.” Another contact revised down their sales growth forecast for 2012 by 2 percentage points to 4 percent to 5 percent--with the subtraction attributed to weakness in Europe--but at the same time indicated the risks had shifted to the upside.

Software and Information Technology Services

First District software and information technology services contacts report that the upward trends of early 2011 continued through Q4 2011 and into Q1 2012. Year-over-year revenue increases in the fourth quarter, ranging from 10 percent to over 25 percent, were generally on par with those seen in the third quarter. Contacts report upticks in demand across a number of sectors and geographies, with a few noting that activity in Europe exceeds their expectations. Growing workloads have led most contacts to continue to add to their headcounts. Indeed, one contact is on track to expand its workforce by over 20 percent in 2012; another, by contrast, reports a modest decrease, with a number of management positions being eliminated in an ongoing realignment. Two contacts say they have increased capital and technology spending relative to a year ago in order to build office space in Massachusetts. Prices are holding steady, with contacts reporting little to no downward pressure. The outlook among software and IT contacts is not appreciably different from that of three months ago; most are cautiously optimistic and expect revenue growth in 2012 to be in the range of 10 percent to 20 percent.

Staffing Services

New England staffing firms generally experienced a better-than- usual holiday season in 2011, with business picking up steam in early 2012. However, year-over-year revenue changes in the fourth quarter varied widely, from flat to up more than 25 percent. Labor demand is higher than three months ago, although a few contacts report signs of slowing in the light industrial sector. The growth in demand for permanent and temporary-to- permanent hiring has accelerated in recent months, with one contact noting that “clients are definitely ready to hire permanent employees.” Notwithstanding stronger demand, the hiring cycle remains elongated, and high-end skill sets are still difficult to find. Bill rates and pay rates have gone largely unchanged since November but remain above their year- earlier levels. Looking forward, New England staffing contacts are generally more upbeat than they were three and six months ago, with many expecting their rate of growth to pick up through the end of 2012.

Commercial Real Estate

Commercial real estate contacts around New England describe leasing fundamentals as largely unchanged since the last report, although some note modest positive developments. One Boston contact reports that some tenants are increasingly willing to pay top dollar for prime office space in Boston’s Back Bay, but cautions that such instances do not necessarily reflect a broad- based increase in office demand in greater Boston. Another Boston contact describes the city’s office leasing market as mostly flat, but grants that rents may have increased marginally in recent months. A Providence contact is more upbeat, noting a healthy increase in deal volume and significant office absorption since the last report. By contrast, office leasing volume slowed somewhat in both Portland and Hartford relative to December. For retail space, Hartford’s vacancy rate held up better than expected despite weak holiday sales at some large chains, while in Portland some long-vacant retail properties have seen a rise in inquiries by potential tenants. Greater Hartford’s industrial market also saw a modest uptick in tenant inquiries in recent weeks, including signs of life in the area’s moribund warehousing and distribution sector.

Boston continues to experience a surge of multifamily construction activity, with several large projects under way and more in the planning stages. Financing for such projects is available on attractive terms, with interest rates dipping below 4 percent in some cases. While investors and lenders are bullish on the multifamily sector and apartment rents have risen significantly in Boston in the past year, some contacts see a risk of overbuilding. Boston’s science and technology sector is generating significant build to-suit construction of laboratory/office space. At the same time, speculative office construction remains non-existent across the area, and one contact estimates that office vacancy rates would have to fall below 4 percent in Boston to warrant the creation of new office structures. While office construction is limited, the investment sales market for prime Boston office properties remains robust amid a highly liquid financing environment. Echoing similar comments in recent reports, however, some contacts perceive that sales prices for prime Boston office properties are too high in relation to expected fundamentals.

The outlook among contacts is tilted toward optimism. One Boston contact continues to expect only very slow improvement in leasing fundamentals in 2012, while another sees greater upside potential. Another contact expects Boston’s multifamily construction boom to last another two to three years, but beyond that sees few prospects for any new construction activity. Our Providence contact expects solid improvement in fundamentals in 2012, barring risks to growth from local fiscal troubles and a possible spike in oil prices. The outlook in Hartford is moderately optimistic, but based more on sentiment than recent data. Portland’s commercial market is expected to improve slowly in 2012, although prime office properties may see more robust gains.

Residential Real Estate

Sales of single-family homes and condominiums increased in New England in January, with most reports indicating low to moderate growth in sales compared to a year ago. Contacts say recent sales growth reflects market activity more accurately than in previous reports, when year-over-year increases were distorted by the expiration of the tax credit in mid-2010. Meanwhile, the median sale price of homes in First District markets declined compared to a year ago, which contacts attribute to distressed property sales. Concerns surrounding the impact of labor market conditions on housing demand have abated slightly. Respondents note foreclosures and delinquencies continue to affect the housing market significantly, but say these factors play less of a role in New England than in other parts of the country. Contacts expect low mortgage rates and improving employment outlooks to help fuel buyer activity. In the Greater Boston area, rent pressures coupled with low interest rates may push more buyers into the home and condo market.

Contacts expect to see continued year-over-year growth in home sales in the region, but do not anticipate significant improvements in the near term, with prices remaining flat at best. Contacts also note that exceptionally mild winter weather may prompt spring sales activity to begin earlier than usual.

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