COVER STORY, JUNE/JULY 2011

CLIMBING OUT OF THE RECESSION
When will office property values and rents hit peaks seen before the downturn?
By Jaime Lackey

As the economy improves, office markets across the Northeast begin a new real estate cycle. They start and stop and lurch along. Sellers wonder when we will hit the peak values seen 4 years ago, and tenants look at the rents and wonder if this is the last window of opportunity for a good deal. Brokers in major Northeast markets say activity is beginning to increase, which will drive upticks in rents and values. However individual markets still have challenges. Northeast Real Estate Business talks with brokers in New York City, Boston and New Jersey to gauge the recovery in each of these markets.

New York City

Sales prices for land and office properties in Manhattan have increased rapidly this year, says Eric Anton, executive managing director of New York City-based Eastern Consolidated. He predicts that sales prices for office buildings in Manhattan could reach the highs we saw in 2006 and 2007 sometime next year.

“The volume of transactions is picking up as well,” Anton says. “More owners are willing to consider selling office properties as values increase.” Anecdotally, he notes that his company was working on three transactions valued at more than $50 million in late second quarter, whereas the company did not have any listings in that range during first quarter.

Leasing activity in New York City continues to improve as well. According to Paul Glickman, vice chairman with Jones Lang LaSalle, spaces that are in particularly high demand include those in trophy buildings, space that is offered in move-in condition, tower floors with good views, and larger blocks of space that allow companies to consolidate all of their operations into one space. “These types of listings are seeing an uptick in demand and increased asking rents,” Glickman adds.

For examples of large space consumption, one needs look no further than recent deals brokered by Jones Lang LaSalle. Glickman represented the landlord at 120 Park Avenue in its 400,0000-square-foot lease to Bloomberg in February. Mitchell Konsker, also of Jones Lang LaSalle, represented Hong Kong-based Li & Fung in its 500,000-square-foot lease at the Empire State Building in January.

To see how rents are holding or improving, Glickman points to asking rates in Midtown Manhattan. Average Class A asking rents in May were $66.39. At the low point of the recession, landlords were asking $65.15 in January 2010 and pre-recession levels reached a high of $96 at the end of 2007. Trophy properties are improving more quickly. Average asking rents at these buildings were $81.99 in May. The low point in March of 2010 was $71.51 and the watermark was established at $122 in late 2007.

Overall, Glickman says, New York City is extremely resilient. “We are a central point of commerce and an international city. We’ve recovered faster than most of the country,” he says. “I predict a sustained recovery in employment, which will support improvement in the office market into 2012. We will see steady growth in rental rates.”

White collar job growth is driving the leasing activity in Manhattan, Anton notes. Whereas law firms were the main driver for new leases a couple of years ago, media, advertising, technology and entertainment firms are actively moving today — especially in Park Avenue South, Hudson Square and SoHo.

“SoHo has been a really interesting market to watch,” Anton notes. “People love it. It has great subway access and it is good for workers. Vacancy is at 4 percent. Values are up big time.”

Boston

In June, Acme Packet signed a 10-year, 262,000-square-foot lease extensionand expansion at 100 Crosby Drive in Bedford, Massachusetts. Grubb & Ellis’ Brad Spencer and Tyler Ewing represented the company, a global provider of voice, data and unified communications services and applications.

The general tone of the Boston office market is improving, according to Mike Edward, executive vice president and managing director, and Tim Van Noord, a research analyst with Grubb & Ellis’ Boston office. “This is the first time in six quarters that we’ve seen upward trends in the market, so we’re experiencing some optimism. Things feel good again,” Edward says.

A number of companies are moving from Cambridge and the Route 128 area to Boston, says Van Noord. Vertex Pharmaceuticals will move into a new 1.1 million-square-foot property, which is being developed by The Fallon Company. Vertex has signed a 15-year lease for two towers. NaviNet has leased 65,000 square feet in Boston. And Communispace has moved from Watertown, Massachusetts, into 82,000 square feet at the Atlantic Wharf Building.

According to Van Noord, companies struggle with lack of available blocks of space and high rents in Cambridge. Besides, says Edward, “All roads lead to Boston. Smart companies are getting into better spaces before rental rates tick back up. Business profits are increasing while quality real estate still has depressed values. This is a good time to invest or sign a lease.”

Today, average asking rents for Class A buildings in Boston are  $50.17. (Back Bay spaces’ average listed rates are at $55.09). By comparison, the mid-2008 rates averaged $67.68. At the lowest point of the recession, average rates dropped to the high $48s, and they are still bumping along the bottom of the trough as the market tightens, Edward says.

“2010 rental rates were totally flat. We are just starting to see an upward trend this year. The activity level is increasing and that will drive rents back up,” he adds. He notes that technology companies are leading the leasing activity in Boston.

As for investment sales, generally the sales volume and pricing is off the peaks seen in 2007 and early 2008. However, when a trophy asset comes to market, institutional investors are offering competitive bids and local companies are getting shut out.

When it comes to sales of the Class A- and Class B properties, Edward says, “With the market bottoming out, we can now establish value. We will see more activity in these properties this year and next, especially as lenders foreclose or push borrowers to sell distressed properties. It can’t be avoided now that everyone can see the value of these buildings.”

End users are interested in purchasing now. “Many corporations hoarded cash through the recession and they want to invest in real estate for their own use now,” Edward explains.

Looking forward, Van Noord says, “We expect a slow climb out of the recession. It will take a few years to see stabilizing employment numbers and a full recovery but we are seeing early signs of improvement.”

Northern & Central New Jersey

In past recessions, we’ve been “cautiously optimistic” as we come out of the downturn, says Bob Martie, executive vice president of Colliers International’s New Jersey region. “This time, I think we are ‘cautiously guarded.’”

While there have been positive signs of an improving economy in late 2010 and early 2011 — including increases in consumer spending and slight decreases in unemployment — there are still reasons for concern, Martie says. In particular, the cost of oil, which is tied to geopolitical issues in Cairo and Libya. Also, he notes, the lack of job growth fuels a sense that the residential real estate market may continue to suffer.

However corporate profits are up and corporations’ cash positions continue to improve, he says. “We know we’ve hit bottom, but we have several quarters of climbing to do.”

Martie is concerned about New Jersey’s lack of job growth, though. “We must create jobs to solve the housing crisis and create confidence,” he says. “Also, the state must address its tax structure to make it more favorable to business, and it must address other issues, including legacy costs and unions.”

And the state is making progress in attracting and retaining businesses. New business incentives allowed the state to retain the Honeywell corporation, which plans to redevelop its corporate campus in Morris Township to meet LEED standards.

In Newark, Matrix and SJP Properties are developing a 400,000-square-foot tower with lead tenant Panasonic taking 250,000 square feet. “The Urban Transit Hub Tax Credit made financing viable,” Martie notes.

On the investment side, Martie says, “Class A and trophy buildings are trading at phenomenally high prices and phenomenally low cap rates. Investors are very hungry and there are not enough properties on the market to satisfy the appetite.”

Distressed office properties are seen as opportunities for adaptive reuse — and this will be the future of New Jersey development. “New Jersey is emerging as a redevelopment market,” Martie says. “We will never see development in the future like we saw in the past. There’s no land left inside the 287 loop. Now that we’ve figured out how to mitigate and insure environmental issues, the opportunities are in redeveloping obsolete buildings and environmentally challenged sites.”

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