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Report: Leasing activity at less-desirable buildings driving office rebound

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While negative net absorption continued to drive up vacancy in New Jersey's class A office properties in the first quarter of 2012, increased leasing activity in less-desirable buildings may become the foundation for the real estate industry's recovery, according to a new report by Cresa LLC, a tenant representation firm.

"Usually in a downturn, companies would look to upgrade to class A, because they could get class A for the same price as class B," said Tom Giannone, co-managing partner of the firm's New Jersey division. "We haven't seen that trend, though. People are just using (the downturn) as an opportunity to save money. It seems everyone is in a stay-put scenario."

According to Jeffrey Otteau, president of East Brunswick-based Otteau Valuation Group Inc., that cost containment stems from companies focusing on their bottom lines more than ever before, which has led them to factor in rising rents for upgraded space.

"They stick with class B, rather than upgrading their space for the same cost, so they can stay where they are … and take advantage of low operating costs in the future," Otteau said.

According to Giannone, in past recoveries, companies would lock in long-term leases for office space one year after a recession, because they could foresee returning to business as usual within a few years. But now that business owners are not feeling confident that the economy will turn around, they are signing two- to three-year lease renewals without committing long-term to a space — and that sublet space availability is starting to dwindle, he said.

"Sublease was significant in the past several quarters, and it's still a factor. A lot of companies want a two- to three-year commitment sublet with furniture," Giannone said. "But since larger companies are staying put, they're not as willing to discount their sublet space as they did before. Possibly companies are saying, 'Maybe I will have a need for the space in the future, so maybe I shouldn't give it away."

One factor that attributed to the unchanged vacancy rate and decreased marketed space in the class B office market in the first quarter of 2012 was that more companies have been offered concession packages by landlords willing to drop rents for businesses that are willing to stay put, Giannone said. But Giannone noted that the real estate market is driven by job growth, so if the economy starts to improve, those concession packages will disappear, and businesses may have to consider locking in leases for longer terms.

"Most of these transactions are renewals. Cheap space is always the competition, and it's getting off the market," Giannone said. "Our recommendation to our clients is that they may not have to do something today, but when the market turns, it could turn very quickly, and that space could be gone fast."

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