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COVER STORY, OCTOBER/NOVEMBER 2009
OFFICE AND INDUSTRIAL MARKETS STYMIED BY CAUTION
By Stephanie Specht
The office and industrial sectors in the Northeast continue to struggle as companies deal with the changes in the economy. Overall, caution on the part of tenants has kept activity to a minimum. This month, Northeast Real Estate Business sat down with experts from the office and industrial sectors to find out what kind of activity they are seeing currently and what we may expect in the future.
Office
In New Jersey, Robert Rencarge, senior advisor of the Strategic Services Group at CresaPartners, says that demand for office space remains extremely low from a historic standpoint. Quarterly leasing activity hovers at or below 50 percent of the average over the past decade.
“Most of this activity results from existing tenants renewing or relocating, often into smaller spaces,” Rencarge explains. “To state the obvious, demand for office space is directly related to employment. It takes many months for job losses to translate into reduced demand for space, so even if employment levels off, demand [for space] is likely to continue a downward trend for some time to come.”
Due to this decline in activity, office vacancy rates in the Northern New Jersey market are sitting in the 18 percent range. However, Rencarge says that this figure can be somewhat deceiving since many tenants have a significant amount of space under lease that is not being utilized. “Including this so-called ‘shadow’ vacancy, the true rate is over 20 percent, and will likely approach 25 percent over the next year,” he notes.
Rental rates for Class A office space ranges from the low $20s to the high $30s per square foot, and Class B space can be obtained at rates starting around $15 per square foot. In addition, concessions are having a significant effect on rents as well. “Net effective rents, which take into account concessions such as free rent and construction funding, are even lower, and will continue to trend downward for the next year or more,” Rencarge says.
Despite the downtrend in leasing activity, brokers are still hard at work making deals happen in New Jersey. Many of the largest leases are in central New Jersey, especially in the Princeton area and along the I-78 corridor. Otsuka Pharmaceutical recently closed a notable transaction spanning 67,000 square feet at University Square in Princeton, and Verizon Wireless recently expanded its leasehold in Warren by 35,000 square feet, to a total of 75,000 square feet. Other leasing activity has been on the smaller end of the spectrum, however. The majority of most recent leases have been 25,000 square feet or less, and many of these are renewals.
While many are hopeful that a recovery is just around the corner, the office market in New Jersey may take more time to see an improvement. Rencarge notes that he is not seeing a rebound in the market at the present time, and he does not anticipate an improvement in demand for office space in the next several quarters. “Until the erosion in employment ends — and then reverses — there is no reason to expect that leasing activity in the office market will improve,” he explains.
The New York City office market is still sluggish as well, facing many of the same woes as its neighbor. According to Richard Persichetti, head of research for Grubb & Ellis New York, only 12.2 million square feet has been leased this year. “Leasing activity is down 37 percent through the month of August compared to the same time last year, with 40 percent of the activity in the form of tenants signing renewals for existing space,” explains Persichetti. “There was a slight uptick in activity during July and August, as 4.2 million square feet of office space was leased. The activity during the summer accounts for 35 percent of this year’s leasing volume.”
However, Persichetti notes that despite the recent jump in activity, the majority of the space leased was from tenants with pent-up demand, meaning tenants who have been in the market looking for space for more than 2 years. And now that it is a tenant’s market, they are finding the deals that they were hoping for. “Most of these tenants entered the market in 2007 when space was scarce and were looking at rents 30 percent to 40 percent higher than they ultimately signed for this summer,” Persichetti says.
Vacancy rates in Manhattan are still considered low by national standards, but Persichetti notes that the current 8.8 percent vacancy rate is a substantial increase from the 5.7 percent witnessed just 1 year ago. Persichetti also notes that the vacancy rate does not capture all of the available sublease space on the market. “With more than 16 million square feet of sublease space available, the Manhattan availability rate is much higher at 14.6 percent,” he explains.
Vacancy rates in Midtown Manhattan are sitting at 8.9 percent with an availability rate of 15.1 percent. In Midtown South, the vacancy rate is slightly lower at 8.2 percent and an availability rate of 14 percent. In Downtown Manhattan, the vacancy rate is 8 percent with an availability rate of 13.6 percent.
Rental rates have also been affected in New York City. The Manhattan Class A average asking rent is $73.66 per square foot, a figure that Persichetti says is down 20 percent from market peak in the second quarter 2008. “However, asking rental data does not tell the whole story,” Persichetti says. “Landlords increased concession packages, pushing net effective rents even lower. Class A net effective rents averaged $53.44 per square foot through August and reached levels not seen since 2005.”
In Midtown Manhattan, Class A rental rates are $78.22 per square foot and Class B rental rates are $59.30 per square foot. Class A rental rates in Manhattan’s Midtown South district are $66.52 per square foot with Class B rates sitting at $48 per square foot. In Downtown Manhattan, Class A rental rates are $53.78 per square foot and Class B rental rates are $38.63.
However, despite the sluggish market, some notable leases have closed recently. Gap took 265,083 square feet at 40 Worth Street, Claremont Prep School leased 203,000 square feet at 25 Broadway, Instinet closed on 107,611 square feet at 1095 Avenue of the Americas, and Federal Direct Deposit Insurance Corp. leased 102, 960 square feet at 350 Fifth Avenue. A handful of substantial renewals have also closed recently. Showtime signed a renewal for 202,495 square feet at 1633 Broadway, the National Basketball Association renewed 153,405 square feet at 645 Fifth Avenue, Merrill Lynch/Bank of America renewed 120,000 square feet at its 717 Fifth Avenue location, and Loeb & Loeb signed a renewal for 113,513 square feet at 345 Park Avenue. Sublease space is also being taken in the New York City marketplace. Orrick, Herrington & Sutcliffe LLP sublet 210,000 square feet at 51 West Second Street and Lehman Brothers Holding sublet 150,000 square feet at 1271 Sixth Avenue.
Despite recent activity, Persichetti explains that this does not necessarily denote a rebound in the New York City market. “There are many variables that will keep landlords cautious over the next 18 months. New York City employment is still projected to decline through 2010, and the market will likely continue to soften,” he says. “More space is projected to come on the market in the first half of 2010 as more firms consolidate and re-organize their space needs. It will be at least 18 to 24 months before firms begin to create new jobs and require additional space, making it difficult for the market to rebound before 2011. There are also trillions of dollars in commercial loans coming due between 2010 and 2013, which will impact the market as well.”
Industrial
The industrial market in the Northeast has slowed down in terms of leasing activity as well. John Root, senior vice president of asset management of Hackman Capital, a private real estate investment firm with several properties in the Western Massachusetts market, notes that although industrial activity has been slowing the past 12 to 18 months, he believes that we are nearing the bottom.
Overall, Root notes that the modest lack of demand has been most evident in the large block arena as few large tenants are seeking expansion opportunities right now — a direct result of the hit that many other sectors in the market have taken. “Distribution has always been particularly strong for Western Massachusetts, but the decline in retail has curbed that activity somewhat,” he says. “We are starting to see strong changes in customer attitude as consumer surveys are starting to become more positive, but it will take time for that to affect the retail and then distribution.”
At Hackman’s facilities in Westfield and Chicopee, Massachusetts, vacancy rates are staying in the low double digits and have been on an upswing in terms of negative absorption. In some sectors, companies are taking advantage of this tenant’s market to move up into higher class spaces for lower rent, but Root notes that this has not really been the case in the industrial market. “For industrial product, the gradation between pricing is not as dramatic between one product and another as much as it is in office and retail for instance, so we are not seeing a flight to lower priced assets by and large,” he says. “That said, those that are able to move are commanding aggressive rates, but overall landlords are being very aggressive to keep tenants where they are.”
As landlords get more aggressive to keep existing tenants in place and lure in new tenants, rental rates have dropped and concessions have increased; however, Root adds, rent is the main focus for tenants and landlords. “Concessions have been increasing but we are seeing more concessions on just rental rates,” he says. “Some submarkets are as high as one month free for each year of a lease.”
In terms of recent leasing activity, tenants are shying away from large blocks of space and the majority of the recent leasing activity has not been any larger than 60,000 square feet.
Overall, Root notes that despite the downtrend witnessed in the last year or two, he is gearing up for more activity next year. “At Hackman Capital we are optimistic for the coming year. On a national level we are hearing encouraging news on more activity at some of our other locations as many are reporting a more decisive attitude from tenants on future activities,” explains Root. “We are looking for an uptick next year.”
Root adds, “On a future note, Western Massachusetts has always been known as an excellent location for logistics and warehousing distribution and we are looking forward to an increase in equity next year.”
In New Jersey, the industrial market is still dealing with the fallout in the economy as tenants prefer to stay put and are looking to the future with great caution. Barry Cohorsky, vice president of NAI James E. Hanson in Parsippany, New Jersey, says, “It is still an anemic market. No question about it.”
During an economic slowdown, Cohorsky explains, tenants will typically look at other spaces, but they also try to use this to their advantage get a better deal at their existing space. “If the landlord will offer them a better deal, they will most likely stay where they are,” he says. “Aggressive owners will do what they have to do keep their tenants. If a tenant is willing to sign a 1-, 2- or 3-year renewal, the landlord will do it and just fight the battle down the road when market recovers.”
In terms of what landlords are offering tenants to keep them in place, it is really a mixed bag. Cohorsky explains that some landlords are offering anywhere from 2 to 6 months’ free rent, but it typically depends on the submarket and the credit worthiness of the tenant. “We are still seeing some major landlords not wanting to touch the base rent because they have to report to a lender,” he adds.
Rents in most major submarkets have taken a hit; however, the rental rates depend on the submarket, the location and the landlord. In Edison, rates are ranging from $5 to $5.25 per square foot, and in the Port area rents are slightly higher, ranging from $6 to $8 per square foot. Overall, rents depend greatly on how aggressive the landlord is willing to get.
Cohorsky remarks that the Exit 8A submarket, where rents are hovering around $2 to $3 per square foot, is suffering more so than its neighbors due to an over abundance of space, especially second- or third-generation space that is on the cusp of being obsolete. “If someone does not need high ceiling heights, they can get a killer deal,” Cohorsky adds.
While all industry types are feeling the pain and no submarket is immune either, there is a hint of optimism in the market, but the mood is still extremely cautious. “As of the last several weeks it seems like there has been an uptick, but it is slight and I don’t want to be too optimistic,” Cohorsky says. “It could just be that business is starting ramp back up a bit from the summer or it is just a very small bounce. Overall, I don’t think we will be out of this until second or third quarter of 2010.”
Despite the possibility of a slight uptick, Cohorsky notes that the majority of the leasing activity has been from renewals as tenants prefer to stay put and expansion is out of the question for many. “Tenants are having a difficult time because of the pressures on their businesses, so it is tough for them to forecast the state of their business 5 years down the road. They are thinking about surviving this year and also getting through next year and then they will see what they can do long term,” he explains.
Although most firms are being extremely cautious when it comes to future plans, Cohorsky notes that some are seeing the current market as an opportunity. Small- to mid-size tenants that have been in business for a long time and have a strong cash reserve set aside see the current market as an opportunity to buy facilities ranging from 20,000 to 40,000 square feet. “Many perceive that there is a great discount out there. For example, in Edison, buildings that were once selling for $85 per square foot can now be purchased for $40,” he says.
However, Cohorsky notes, many are finding it difficult to obtain financing because of stricter underwriting standards from lenders. He says that most lenders require a 40 percent down payment, a greater percentage than in previous years.
Overall, brokers, owners and tenants are facing challenging times in the office and industrial marketplace in the Northeast. Our experts agree that until activity picks up in other sectors and employment makes gains, both office and industrial tenants will continue to proceed with a great deal of caution.
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