The odds are in favor of New Jersey’s commercial real estate market gradually pulling itself out of its recession and post-recession slump, with the office sector clearly trending upward and maybe turning a corner. That’s according to Kevin Thorpe, chief economist at national real estate services firm Cassidy Turley, who spoke at the firm’s New Jersey headquarters in Chatham late last month.
“The future is brightening without question in New Jersey and I’m not the only one saying this,” he said.
Thorpe said state-wide vacancies are down to just above 15 percent, reflecting the first improvement since vacancies hit their 21st century peak last year. The North and Central Jersey markets rank among the top 10 nationally in demand for office space. New Jersey’s need for office space has grown every month for more than a year, despite the fact that the nation’s overall demand has, according to Thorpe, been “subpar” over the course of the recovery.
The National Association of Realtors (NAR) predicts vacancy rates nationwide will decline between 0.2 percent and 0.6 percent in the office, industrial, and retail markets from now until August 2014.
Lawrence Yun, NAR chief economist, expanded on this in a statement released in late August, “Rising international trade is boosting demand for warehouse space.”
Why the optimism?
“The fundamentals of economy look very solid,” Thorpe said. “It’s getting easier to see how something more robust could be forming.”
Thorpe puts the odds on a continued U.S. economic recovery at 84 percent and credits job growth as a primary factor. Although New Jersey’s unemployment rate remains above the national average, almost all of the state’s designated metropolitan areas are adding jobs at a rate that outpaces the rest of the country. The state created 49,000 net jobs last year and looks on pace to create 76,000 new jobs this year.
Construction jobs are back on the rise, as are those in financial and professional business services -- two industries that create the strongest demand for office space statewide. But the state’s pharmaceutical industry is still shrinking (as demonstrated by Merck’s announcement yesterday). And a prolonged government shutdown and continued federal sequester could threaten New Jersey’s 50,000 federal employees.
Looking to specific markets, Moody’s is forecasting near-record job growth in the Newark and Edison metro markets in 2015-2016, with Newark metro already boasting one of the state’s hottest office markets, along with Princeton and Morristown. Thorpe said Newark and Edison metro are proving attractive to developers and CEOs because those who spent the recession investing exclusively in top-tier markets are now more comfortable seeking financing for projects in riskier locales.
“Now as we get closer to peak employment, it gets more attractive to build risk and reward into a portfolio,” Thorpe said.
Newark also makes perfect geographic sense for law firms and multinational companies because of its proximity to New York, a major international airport, and a federal court. Nevertheless, when Prudential employees move into new headquarters in the city, they’ll abandon 800,000 square feet of leased space in The Gateway Center.
On a smaller scale, other markets looking to boost their corporate appeal might learn a lesson from Morristown and nearby Summit, which Cassidy Turley Managing Principal Raymond Trevisan calls a “mini-Morristown” for Class A office space. Strategically located on a train line to Manhattan, both towns have spent the past decade increasing their allure to young, educated professionals by adding restaurants, bars, and retail -- all located within an easy walk of transit. And where young professionals want to live, high-prestige companies dealing in products like hedge funds and consulting services follow.
“When a new building goes up in Summit, it’s filled pretty quickly,” Trevisan said.
A city like Parsippany, on the other hand, is losing companies because it doesn’t have a downtown to modernize, and its overstock of older office space fails to provide enough reason for landlords to make the upgrades that could entice new tenants. According to Trevisan, Parsippany may take a long time to recover.
“Parsippany has a number of functionally obsolete buildings. Tenants in those older buildings have a lot of choices, and where landlords are not putting work into buildings, tenants look for better-quality office space,” he said.
Even in hot markets, law firms and other companies are choosing to forego the libraries and ornate boardrooms of yore in favor of more functional space and aren’t leasing as much office space as they used to. According to CoreNet Global, an association that represents corporate real estate executives, before the recession the average amount of useable space per American office worker was 225 square feet. Today, it’s approximately 170 square feet, and a survey of CEOs forecasts that number will shrink to 151 square feet in the next four years.
The physical downsizing adds to 39 million square feet of empty office space in North and Central Jersey, which Thorpe considers high.
“New Jersey has a ways to go [before it reaches capacity],” he said. Despite increasing demand, the amount of vacant office space is keeping the state’s rental rates relatively flat. NAR predicts nationwide office rental rates will rise between 2.5 percentage points this year and 2.8 percentage points next year.
But Thorpe predicts 2015 as the inflection point for rents in New Jersey, and Frank Recine, executive managing director of Newmark Grubb Knight Franks’ Rutherford office, also expects rents in Class A commercial office buildings to start climbing over the next 12 to 24 months.
“Rents are fairly static but concession packages are going up and tenant improvement dollars have increased over past year,” he said.
Put simply, savvy landlords are attracting new tenants with so-called concession packages that include free rent (currently, an average of half a month to a full month per year) and “tenant improvement dollars” -- essentially, promises to build out and upgrade space according to tenants’ specifications As these buildings modernize and fill up with new tenants, Recine says current tenants will extend their leases at higher rental rates, thereby perpetuating the cycle.
Perhaps the brightest spot for the state’s commercial real estate industry is the industrial sector. It’s the most active in the state, and Central Jersey ranks as the 15th in the United States for the amount of industrial space absorbed since 2010.
Cassidy Turley estimates that the expansion of the Panama Canal will increase business at New Jersey’s ports by at least 15 percent, which can lead to record-setting demand for industrial space. And e-commerce is proving itself a major driver: According to a 2013 real estate outlook published in Area Development magazine, approximately 35 percent of retail-related industrial demand is in the Northeast, with concentrations in Central Jersey and eastern Pennsylvania. The article notes that Central Jersey benefits from its population density, which is “a must” for these labor-intensive facilities whose customers expect next-day delivery.
The magazine noted that demand for specialized retail distribution centers will rise this year and into the future since e-commerce is expected to grow by more than 10 percent and mobile commerce projected for a nearly 50 percent increase.
And what of the overhaul to the state’s business incentives programs that Gov. Chris Christie signed last month? Will it jumpstart New Jersey’s commercial investment activity?
Though Trevisan says New Jersey will still have a hard time competing with places like South Carolina, where it costs significantly less to do business, he believes incentives will encourage development and eventual job growth,
And Thorpe expects the new law to help lure business from neighboring states that wouldn’t have otherwise come. Though he doesn’t expect the incentives to allow New Jersey to catch up to a state like Texas, which is experiencing faster growth than any other, he does commend New Jersey for having “a lot of the same DNA as faster-growing states”: a highly-educated workforce, a diverse economy, and a strong tech sector, among other things.
And, perhaps most importantly, he said, the new incentive programs help “send a message to the business community to think about New Jersey, and maybe that’s more powerful than anything else.”