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Reuse projects mask the pain in office market

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Adaptive reuse projects are helping to refresh the Garden State's aging stock of commercial real estate. But that positive momentum may masking the problems of an office market that still faces an uphill climb.

Leasing volume is on pace to fall short of pre-recession levels for the second straight year, and overall vacancy is higher than it was at the peak of the downturn.

One major culprit, experts said: shrinking tenant requirements, caused largely by corporate downsizing and a move toward more efficient uses of space. And that trend comes during a recovery that's been marked by tepid employment growth.

“The job market just hasn't come back the way it has in previous economic recoveries,” said Robert Donnelly, a vice chairman in Cushman & Wakefield's New Jersey offices.

Donnelly said other indicators, such as corporate earnings and stock prices, have “come back very strong, but a lot of that has to do with productivity, not necessarily new hires.”

The state has added some 119,500 jobs since November 2009 — about 70,000 short of the number lost during the recession, according to federal data.

Alongside that, lease sizes have shrunk in recent years, especially in North Jersey: In Bergen, Essex, Hudson, Morris and Passaic counties, average class A deal size has fallen nearly 27 percent since 2011, to 9,531 square feet, according to Cushman & Wakefield research.

The downturn left tenants with the upper hand, giving them the leverage to upgrade their space through renewals or relocations, said Robert Martie, of Colliers International. In many cases, that also meant taking less space.

Martie, executive vice president for Colliers' New Jersey region, said many firms now fit out space and buy furniture so that “you, as an employee, don't even have your own desk, per se.” Firms assign work areas to staffers on days they visit the office, “like scheduling a seat on the train.”

That means smaller footprints, he said.

And moves to upgrade or “right-size” may have had implications for current leasing activity, Martie said. From 2009 to 2011, he said, tenants and landlords often got an early jump on renewal options that otherwise would have occurred in 2012 or 2013.

“The buzzword of the day was the 'blend and extend,' ” Martie said. “Tenants were renewing early to take advantage of the lower pricing, and landlords were trying to preserve their assets and lock tenants down on a longer term.”

Still, brokers and developers are bullish on New Jersey's office market, pointing to a growing list of adaptive reuse projects that are rekindling obsolete sites around the region. Most recently, Bayer HealthCare moved into two redeveloped buildings at the defunct Alcatel-Lucent campus in Hanover. And in Bridgewater, Advance Realty is repositioning the 1.2 million-square-foot former Sanofi U.S. research campus.

But adaptive reuse is best suited for obsolete buildings, brokers said, which complicates things at class A properties with large availabilities. At 21.7 percent, class A vacancy is even higher than overall totals, and leasing activity has fluctuated since bottoming out in 2009 at 3.7 million square feet.

To stay competitive amid “denser” tenant requirements, class A landlords will have to be more focused on modern utilities, said Dudley Ryan, a senior vice president with CBRE.

Ryan represents 2 Gateway Center, in Newark, which is likely to lose Prudential Financial as a tenant next year, when the company consolidates its Gateway offices into a new downtown skyscraper. But he said the Gateway building will be in good position to find new tenants, having spent millions of dollars in recent years on electrical and mechanical upgrades.

“You're going to have a real demarcation of buildings with infrastructure and buildings that are handicapped in that way,” Ryan said. “And it's being driven by that more demanding tenant that's got a denser use.”

He pointed to law firms, whose vast libraries are now going digital, and said they're more focused “on the technological aspect of a building” than they were five or 10 years ago. Several law firms are now in the market for space in New Jersey, he said, and barring employment growth, they may end up with 15 to 20 percent less space.

Donnelly said the only way to fill large blocks of space is for the employment picture to improve.

“The real estate business is about people occupying buildings, and you need to get the job market going again,” Donnelly said. “When you see that happening, then you're going to see people taking more space.”

E-mail to: joshb@njbiz.com
On Twitter: @joshburdnj

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