COVER STORY, NOVEMBER 2011

JOBS ARE UP, JOBS ARE DOWN
Office markets have stabilized, but economic uncertainty and lack of job growth will prolong the recovery.
By Jaime Lackey

A sluggish job market does not bode well for office markets. While early 2011 showed promise for job growth, more recent numbers show stagnation. Questions about the European sovereign debt crisis and long-term U.S. debt issues may keep the economy in limbo, preventing significant improvement in office markets.

“The recovery is intact, but it is not as strong as it was,” says John Sikaitis, director of office research with Jones Lang LaSalle. “We are not seeing widespread job cuts or occupancy losses, but there is a decrease in demand levels. Interestingly, most companies are confident in their own prospects but not in the macroeconomics that surround them. In fact, companies have more cash on hand than they have had since the 1950s. And many are buying back their own stocks. This indicates they believe the stocks are undervalued and they do not want to invest in anything else, including real estate.”

He predicts, “In the coming year, the office markets across the Northeast will continue to tighten, though growth expectations are being revised down from early 2011 expectations. We do expect the recovery to continue, albeit slowly. Job gains will be isolated to industries like energy, technology and healthcare.”

Ross Moore, EVP of Research with Colliers International

Ross Moore, executive vice president of research with Colliers International, agrees: “The recovery is frustratingly slow. I would say that the Northeast is doing better than the rest of the country, but for every strong market, I could name a few underperforming markets.”

As for job creation, Colliers tracks 16 major metros in the Northeast. Not one Northeastern city was in the list of top 10 cities for job growth when the Bureau of Labor Statistics published August numbers. Boston and Pittsburgh were in the top 20 of 60 cities on the list. New York City was in the top 30, and Hartford, Connecticut, was in the top 40. In the bottom 10 were Edison, New Jersey; Nassau-Suffolk, New York; and Philadelphia. Newark and Camden, New Jersey, were in the bottom 20.

However, Moore notes, Camden now shows positive year-over-year job growth, though it is still 5.8 percent below the top-of-market numbers reached at the end of 2007. Edison is 7.5 percent below its 2007 watermark, and Newark is 7 percent below its 2007 highs.

Boston’s employment rate has increased 1.7 percent year over year, and it is less than 1 percent below the pre-recession numbers. New York City has improved its employment rate 1.2 percent since last year, and it is also less than 1 percent off its pre-recession numbers. Pittsburgh has grown its employment 1.5 percent over last year; another 0.3 percent growth will put it back at its pre-recession level.

Moore predicts that there will be no job growth on Wall Street and in the financial services sector. In fact, there is general concern about layoffs in this sector. Social media companies are growing, though this is largely a New York phenomenon. Business and professional services jobs have increased 2.3 percent over the last year in Northeast; nationally the growth in this sector has been less than 1 percent.

“This is a tough economy for the office market,” Moore says. “It is hard to see corporate revenues growing robustly over the next 12 months; instead, corporations will be watching costs. Commercial real estate costs will be scrutinized.”

But there are bright spots in the Northeast. Pittsburgh’s commercial real estate market has operated under the radar, Moore says. “At 8 percent, it has one of the lowest suburban vacancy rates in the region (and the country). The downtown vacancy rate is just 11.1 percent. Many cities would love to post these numbers.”

“In Pittsburgh, there has been an increased demand for office space from natural gas energy companies attracted by the Marcellus Shale. In fact, Pittsburgh is one of the markets leading the recovery in terms of jobs and demand for office space,” adds Sikaitis.

John Sikaitis, director of office research with Jones Lang LaSalle

Demand drivers in the Northeast include technology and energy. Technology companies are taking space in Boston, especially Cambridge, and in New York City, especially Midtown South, according to Sikaitis. “There has been some leasing activity from banking, finance, accounting and law firms across the Northeast. However, most of these companies are doing deals, but not growing.”Demand remains fairly strong in New York City, Moore adds. “Beyond New York, it is difficult to find standout office markets. Leasing is down a little in Boston and Philadelphia. I don’t see any source of optimism in New Jersey beyond the hope things will change as Governor Christy brings in some of his pro-growth initiatives. I am a little more optimistic about Connecticut. Hartford’s growth is sluggish and Stamford is losing tenants to New York at the moment, but long-term, I am optimistic about Stamford.”

Rents are up and transaction volumes are up in Manhattan and Albany, New York, says Ross Ford, president and CEO of TCN Worldwide. “Technology businesses are driving growth in these areas. But overall, markets across the Northeast face flat absorption in the next year. There just isn’t much company expansion. Companies are moving from space B to space A — especially in Manhattan, where real estate decisions are based on prestige and convenience, and moving just one block over can be a significant step up for a company.”

Fred Schmidt, president & COO of Coldwell Banker Commercial

“The Northeast is tricky to talk about generically because our metros are some of the largest in the world with major micro-markets within,” says Fred Schmidt, president and COO of Coldwell Banker Commercial. “We see a gradual decrease in supply with new construction at 40-year lows, and there is gradually increasing demand. We have a long way to go, but there are some signs of stabilization, which is subject to macroeconomics shifts and job creation.”

Schmidt points out that central business districts in the Philadelphia, New York and Boston metros have experienced fairly healthy absorption as compared to suburbs. “Major markets are driven by finance, insurance and real estate, with technology players having an increased role,” he says. “The suburbs in these markets have higher vacancy and somewhat lower demand. We obviously are concerned with the employment picture. Layoffs by major banks and talk of Wall Street layoffs will likely mitigate demand.”

Donald Noland Jr., director of research for the New England region with Cushman Wakefield, notes, “According to the Bureau of Labor Statistics, 48,000 jobs have been created in Boston alone since August 2010. The employment growth stats are beginning to affect office markets in a positive way. There has been an effect on net absorption registering positive 170,000 square feet to-date in the downtown Boston area, but it is still negative in the suburbs. In Hartford, the opposite is occurring: suburbs are registering positive growth while the downtown area is still negative.”

Massachusetts office markets are performing well, Noland adds. “However, a slow-down was witnessed during third quarter 2011 primarily due to consumer confidence declines and the psychological impact of a general slow-down in the economy over the summer months. While some of the growth is due to an increase in employment, much of it is due to the general ‘flight-to-quality’ in order to take advantage of the concessions being offered by landlords.”

In terms of investment in the central business districts, the major institutional players remain the big drivers, Schmidt says. “These include REITS, pension funds, and insurance companies. In the suburbs — depending on location and price points — the small investor has buying opportunity. Those with good cash positions can upgrade their portfolios at very discounted values.”

Ross Ford, president & CEO of TCN Worldwide

According to Ford, “There is a great deal of interest in commercial real estate from European buyers. There is a flight to safety. Compared to other parts of the world, New York is a safe bet.”

Buyers clamor over properties in Boston and New York, Sikaitis says. “As demand increases in these cities, prices increase and yields decrease. Therefore buyers are now looking at properties in Philadelphia, Pittsburgh and more suburban markets along the Northeast corridor.”

Some distressed properties are coming to market but not in the numbers expected. Investors pounce when these opportunities do come to market, and they are not having a substantial impact on the leasing or investment markets.

Schmidt notes that banks and other lending institutions have been willing to accept short sales on many of these properties rather than foreclose, thereby selling the asset at a lower price quicker and removing it from their balance sheets sooner. Investors are still looking for a reasonable percentage of occupancy while lenders are being conservative in writing loans.

Donald Noland Jr., director of research for Cushman & Wakefield's New England region

Over the next year, Noland expects that office markets will continue to improve in the Northeast, especially in greater Boston. With new construction limited to build-to-suit activity, vacancies should continue to decline. “While we expect this to be a long recovery period, all of the leasing fundamentals should continue to improve likely forcing upward pressure on asking and effective rents in 2012 and 2013,” he says.

Schmidt agrees: “According to REIS and Real Capital Analytics, we expect to see gradual decreases in supply with slight increases in occupancy. Of course this is subject to economic conditions. Key drivers are employment and stability. Those of us who will be successful in the coming months will work closely with those seeking unique opportunities on a market-by-market and case-by-case basis.”

Sikaitis says, “We’ve seen considerable change in the confidence of businesses over the past 4 months. At the end of 2010 and in early 2011, corporate profits were up and confidence levels were up. Many companies were investing in the future; they were investing in technology, research and development, and increased workforces. In late spring, when the U.S. did not offer a long-term solution to its debt issues, many companies shifted into wait-and-see mode. While we are seeing vacancy rates decline, the Northeast market is stagnant. We are seeing transaction levels down 25 percent compared to last year.”

He adds, “The situation in Europe is not clear, either. Most companies have a global reach and revenue is impacted by international events. They do not know how to deal with the possibility of governments going into default.”

Ford predicts 2012 will be more of what we are seeing today. “Job growth will be up, down and sideways,” he says. “There will be gradual improvement — moments of growth surrounded by periods of stagnation. 2012 is an election year, it follows that the economic outlook is neutral. The political system will be paralyzed. Everything positive — political or economic — will be followed by a negative.”

©2011 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.