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Temporary Tenants?

After the destruction of the World Trade Center, a wave of office users moved across the Hudson. But how long will they stay?

By Maria Wood
Real Estate Forum

November 30, 2001

Once the twin towers of the World Trade Center crumbled after a terrorist attack, many businesses large and small were confronted with the question of where to set up operations. For some, the quickest answer was to relocate into neighboring New Jersey, specifically the Jersey City Waterfront, long home to back-office operations for several major financial firms.

Immediately following the attack, companies in need of large space requirements quickly snapped up sizable chunks of ready-to-occupy sublease space. According to an informal survey by REAL ESTATE FORUM's on-line affiliate, G1obeSt.com, some 3.4 million sf of prime Garden State office space was taken off the rolls after September 11. Some 1.2 million sf was absorbed in Jersey City alone.

Five well-known companies leased about two-thirds of that sum. Topping the list was American Express, which grabbed nearly 700,000 sf in Parsippany, Short Hills and Jersey City. Next up was Merrill Lynch, which took a total of 675,000 sf at three different sites in Franklin Township in Somerset County, in addition to a 30,000-sf block in Weehawken, a riverfront town just north of Jersey City.

Meanwhile, the Port Authority of New York and New Jersey leased about 330,000 sf in Jersey City and the Gateway Center in Downtown Newark. Lastly, both Dow Jones and Lehman Brothers moved into 300,000 sf in Jersey City. Specifically, Lehman Brothers subleased 150,000 sf' from Datek Online Holdings at 70 Hudson St.

But the question is: Will they remain? TenantWise, an on-line brokerage services firm, surveyed relocating tenants and found that a large number of them plan on returning to Manhattan once their former offices are repaired. However, “a closer inspection reveals that the largest of these tenants, accounting for 44% of the square footage of the damaged properties, have also made provisions to leave Lower Manhattan," write the TenantWise researchers.

While Lower Manhattan struggles to cope with the massive devastation, Jersey City-long considered the "sixth borough" of New York City-and Newark is seen as the two main destinations for New York City firms looking for replacement offices. "The World Trade Center tragedy has caused the New Jersey office market to do an about-face," contends Matt Dolly, director of research at Sitar Co.Oncor International in Iselin. "Headed for its sixth straight quarter of increased sublease space, the office market in Northern New Jersey now stands to benefit from the horrible events of September 11.

"Large leases signed or planned by New York City firms are helping bail out companies like AT&T and Lucent, which had large chunks of space on the market due to recent mass layoffs," Dolly continues. "Many New York City tenants are looking for a quick fix- short-term leases in New Jersey where they can set up shop and stay for several months. Some trading companies from Wall Street are even looking for warehouses along the Hudson Waterfront where they can set up a trading floor. At least in the short term, the office sector has vacancies in virtually every county to once again a place in very high demand.

Cranford-based Mack-Cali Realty Inc. has a number of projects either up or under way along the Hudson River Waterfront in Jersey City, including Harborside Financial Center. Before the attack, about a third of Harborside Plaza Five, a 34-story, million-sf project it is building there, was leased, according to CEO Mitchell Hersh. Since September 11 “there has been incredible demand,” he reports. Now, its two-thirds leased. “We have handshakes on a number of transactions that are in the final stages, but I am not able to identify any tenants at this time at their request.”

While quick to express sympathy for the victims, Hersh maintains that the event will further boost Jersey City’s attractiveness as an alternative to Lower Manhattan. Corporations, he suggests, will now seek to spread out locations within a geographic region, instead of centering their operations in a single site. “We will continue to see some demand on the part of companies in the financial and capital markets industries to locate in Jersey City because of the benefits that existed before this tragedy: the cost of occupancy, infrastructure, transportations systems, favorable utility costs, multiple power grids and the housing there and in Hoboken.

“Furthermore, companies will carefully evaluate dispersion,” continues Hersh, “and having disaster recovery facilities in a number of locations, not heavily concentrated in metropolitan areas like Lower Manhattan.”

“This disaster certainly will accelerate the leasing and future development of Jersey City and could potentially result in a spillover into Newark,” seconds Thomas Giannone, senior vice president and co-manager of the Julien J. Studley Co. branch in Edison. “The only difference between Downtown Manhattan and Jersey City is a bit further commute on the PATH train.”

If Jersey City is unable to accommodate those tenants, then Newark stands ready to welcome them, suggests Andre B. Zezas, senior managing director of Insignia/ESG of New Jersey in Saddle Brook. “Newark’s makeover in the past few years as a desirable business environment and its 1.95 million sf of available space at the start of September has made the city a serious and once again a hot spot for relocating expanding companies.”

Suburban locales further west of the city such as Parsipany, a popular corporate headquarters site in Morris County, may have a more difficult time gaining tenants as a result of the World Trade Center disaster. However, they may get their share, hints Richard Marchisio, executive vice president and managing director of Grubb & Ellis’ office in Fairfield. “The first obvious stop for most companies when they think about New Jersey is the waterfront,” he says. “From there, they move west into the Meadowlands and then further west.”

Hersh refutes any notion that New Jersey owners will take advantage of displaced WTC tenants. “There will be no price gouging,” he emphasizes. “It is business as usual in a very unfortunate time. The kinds of economics that were on the table on September 10 are on the table now. We are not making unreasonable demands on lease terms or anything else.”

David Schenkel, managing director of CB Richard Ellis’ Paramus office, reveals that some owners expressed a willingness to take in displaced WTC tenants on a short-term basis for no rent. “There was a universal thought that we would not be looking at this to raise rates,” he says. “In fact, there was intent to hold rates to what they were before the event.”

Yet after a flurry of major deals and numerous phone calls by NYC firms scouting the state for immediate office digs, the marketplace has cooled, say several brokers. While many executives are confident that New Jersey will snare a portion of tenants displaced from the more than 20 million sf rendered useless by the disaster, others point out that the state’s long-term picture remains clouded by a national economy that was thrown into even greater turmoil by the terrorist attacks. David Simson, president of GVA Williams of New Jersey in Parsippany, is fairly blunt in his assessment of the office sector. “While we have seen a short-term correction within the office market due to the tragedy that took place on September 11, the sector will not rebound based on the space allocation of New York companies, “ he says. “We, as real estate professionals, would be slightly naïve to disregard the economic status of our country, which included corporate downsizing through layoffs and mergers, as well as a freeze on growth by these organizations.”

Peter Yanotta, senior vice president of Equis Corp. in Edison, agrees with Simson. “What is happening is a short-term boom in the real estate market,” he says. “Space is going to be absorbed in Manhattan as well as New Jersey. But we don’t know what the employment picture is going to be over the next six to nine months. That is ultimately going to lead to whether we are successful, based on if these companies start hiring again. We thought this market was going to turn in the first quarter of next year. Now, we are not so sure.”

Vincint Marano, COO of National Business Parks in Princeton, concurs that former WTC occupants will be on the prowl for new office locations, but he is not sure that will offset a weakening economy in New Jersey. “There will also be space vacated by firms unable to survive the economy or from companies that are not as prosperous as they were 12 to 24 months ago and will be shrinking the size of their offices.”

Since the majority of their employees live in New York City and its boroughs, many former WTC occupants may not be in a hurry to move across the Hudson, says David Houston, president of Colliers Houston & Co. in Teaneck. “I have gotten calls,” he states, “and most of those firms have found space in Manhattan because when we sat down and talked to them, it didn’t make sense for them to come to New Jersey. All the space in Jersey City and Newark was leased very quickly. If you were in the World Trade Center, your employees can’t get to Parsippany. It didn’t make sense given the distribution of their people.”

Except for a rapid reduction in the amount of available office inventory by about 15%, or two million sf, Houston says he does not foresee any fundamental change in the sector. “The short-term impact has happened already,” he asserts. “Long term, there will be an impact, but it will based on the overall regional economy. New Jersey and New York are linked at the hip in terms of the health of their real estate markets. You can’t have a healthy market in New Jersey unless the economy of the region, and therefore New York City, is healthy.”

Moreover, many Garden State brokers predict New York City will put up a battle to retain its major tenants. “Certainly, the city and state of New York are going to be extremely aggressive with incentive packages,” reminds Mark Yeager, president of Gale & Wentworth LLC in Florham Park, one of the state’s largest owners and developers.

Any commercial real estate broker who may have thought the disaster presented golden opportunity is mistaken, declares David Schenkel of CB Richard Ellis. “There will be a long-term play, but it’s not going to be some huge panacea for the marketplace as it relates to office space,” he states. Most of the deals centered on companies’ snatching large portions of sublease space that they could easily and quickly occupy. “Some big blocks were sucked up by American Express, but they were in the market anyway,” Schenkel relates. “But there are other traditional office spaces, blocks of 25,000 sf, that haven’t yet been absorbed. Whereas in those first few days, we thought they might have gotten absorbed- that everything was going to disappear because of the sheer volume of calls- now it has slowed down.”

In its Q3 report on the Northern and Central New Jersey office market, CBRE reports that vacancies rose upward to 13.6% from 12.5% in the second quarter. Absorption did make a modest comeback, with the negative total gaining from 1.7 million in Q2 to 929,285 sf at the end of the third quarter.

Construction rose slightly in the third quarter, reveals CBRE’s calculations. Over the three-month period, the amount moved from 255,000 sf to a little over a million sf.

Others concur that leasing activity has slowed since the spike immediately following the terrorist attacks. However, some observers predict that companies may take a second look at the Garden State in months ahead. Several major firms formerly housed in the WTC, such as Aon and Morgan Stanely, are reportedly scouring the entire metropolitan area for permanent locations. “We got 50 calls inquiring about availabilities of space,” recalls Mark Yeager of Gale & Wentworth. “The majority of that was just a data-gathering, a market-reconnaissance type of effort to see what was out there.”

Yet after that initial survey, firms may now be evaluating their alternatives and that could bring them back into the state. “Over the next 30 to 60 days, there is going to be an ongoing assessment of options,” Yeager explains. “Then potentially, we could see another wave of activity.”

Will the state see a wave of new development, too? Not likely, say most observers, unless a developer is constructing a build-to-suit project, has substantial preleasing commitments or deep pockets. Lenders are still skittish when it comes to speculative construction.

“I do not think it will expedite any developments that are on the drawing board at this moment because the financial constraints are still such that borrowers have to come up with 30% to 35% of hard cash equity to build,” says Martin Klebanoff, senior vice president/regional manger of Legg Mason Real Estate Services in Parsippany. Yet he hedges that statement by adding that there is a need for new construction. “If there are partnerships that are well-heeled enough in terms of their financial wherewithal, then yes, I see an increased demand to build and certainly an increased demand for space in the suburbs based on the Wall Street tragedy.”

Most lenders want to see if tenants will fill those buildings before doling out the dollars. Robert Lipson, vice president of the GMAC Commercial Mortgage Corp. branch in Red Bank, says that money is readily available for acquisition and refinancing of existing properties. Speculative construction is backed only if the developer has a strong lead tenant in place.

“I don’t think a lot of lenders have been saying, ‘Go build a building and we will count on the tenants showing up,’” Lipson says. “Even along the Gold Coast, the area along the Hudson River from Jersey City to Ft. Lee, some of the big developers there have built one building at a time and when it is halfway done, it is leased up. The likelihood is they were speaking to people ahead of time and they knew they had a tenant and decided to get going. With some of the wealthier developers, their signature can get them construction loans.”

Yeager suggests that the disaster may spur some BTS opportunities, but not spec construction. Like most industries, real estate has become a capital market-driven business. Therefore, how much risk debt and equity providers are willing to shoulder in a faltering economy takes precedence over market fundamentals.

“Clearly, these events have thrown an already volatile general economy into a horrible situation,” Yeager explains. “What we don’t know is how the debt and equity markets are going to respond to this. You could tell a compelling story as to why you should build in New Jersey, but I don’t know if the debt and equity markets are going to view it that way. The country’s general economic welfare is very suspect right now. At the end of the day, those things will preclude rash of construction.”

Another factor blocking any boom in construction is the fact that firms need space almost immediately, Yeager notes. “People can’t wait two years for a build-to-suit. If you don’t have a building up and ready to go, it may be difficult to bridge the gap between when a tenant needs that space and when you can deliver it.”

Others, however, take a more optimistic view of the development picture in the Garden State. “Up until recently, we saw a significant reduction in construction activity,” says Giannone of Studley. “Now there might be quite a bit of money. If you can demonstrate that you can get a project up quickly and firms relocating from Downtown New York will absorb your space, you will be able to get some financing.”

Stephen Jenco, the research director at Grubb & Ellis in Fairfield, contends that development plans shelve due to the softening economy may get dusted off and put back in motion now. Companies taking temporary space are going to be looking at their future space options,” he says. “You are probably going to see developers looking to satisfy those types of tenants who are seeking a permanent home or headquarters facility.”

Prior to September 11, the New Jersey office market, like many others across the nation, was hobbling along with a surfeit of sublease space. Jenco reveals that between March and June his firm tallied “and extra one million sf of sublease space, which is a very large amount for New Jersey.”

He attributes the surge in sublease inventory to several factors: corporate consolidations across the state; a slowing economy that forced companies to reexamine their real estate holdings and ultimately decide to release space back on the market to cut costs; and the addition of some spec construction.

Despite the spurt of leasing immediately following the WTC disaster, the state was unable to overcome the extra 1.4 million sf of sublease space pushed on the market in the third quarter in Northern and Central New Jersey, according to local Grubb & Ellis researchers. As a result, the firm found that the vacancy rate moved up to a tad under 14% in Q3 from the 13.3% charted in the second quarter.

Grubb & Ellis also detected a slippage in rental rates for premium office properties in the northern and central portions of the state. The average asking price for class A space stood at $30.26 per sf, a reduction of 23 cents from the second quarter. That drop is “the first measurable decline in the class A average asking rental rate in more than five years,” reports Grubbs & Ellis. “In 2000, we were seeing rental rates for class A product increasing an average of about 60 cents for a quarter,” Jenco states.

However, not all submarkets are suffering. The Essex East/Newark CBD, Route 18/8A Middlesex and Somerset/I-78 all maintained class A rents in excess of $32 a foot.

Others say that the state’s leasing market is getting pricier or at least not dropping dramatically. CB Richard Ellis reports that average asking lease rate in the state stood at $24.59 per sf at the end of September. In the previous quarter, the price was $24.17 and last year it was $23.43.

Mark Yeager contends that office prices in the state are pretty much staying the same. Unlike the tech-driven markets of Boston, Northern Virginia and Northern California, where rents skyrocketed by nearly 30% a year, rates in the Garden State rose a more modest 8% to 14%. “Those markets are feeling a very dramatic fallout now,” he says, “because they had such a rapid run up. Our rents ticked along at a good, solid, justifiable, increase. So while those markets are in a freefall from a rent standpoint, ours are holding the line.”

Despite any softness in the office market caused by corporate consolidations and layoffs as well as the uncertain outlook for the national economy, most New Jersey office experts maintain that the state’s economy is relatively healthy due to a diverse tenant community that spans from financial services and consumer products companies to technology outfits. True, many telecommunication stalwarts have downsized, but pharmaceutical firms have gradually expanded

“Eleven years ago, if AT&T caught a cold, the whole market got the flu,” quips Peter Yanotta of Equis. “Now we are extremely diversified. In the top six counties, vacancy rates are still in the high single digits to 11% or 12%. The market is stable. No one is going to embark on new construction without having a significant prelease in place or unless demand starts heating up. That is going to put pressure on rents on existing buildings with tenants renewing.”

The three mainstays of the New Jersey office market remain pharmaceutical, financial services and telecom companies, says Mark Twentyman, principal of the New Jersey office of Cresa Partners in Morristown. “Currently, pharmaceutical is the sector holding strongest,” he relates, “but it has not produced enough demand to counter the surplus space coming onto the market. This year, overall, office markets have been sluggish, following the economy’s significant slowdown.

Nevertheless, David Houston says that this slump is different from other he has witnessed in the past. “In every other period as the market slowed, a huge glut of space came on stream,” he recalls. “The amount of space that has been built in the past two years in Northern and Central New Jersey is very small relative to the overall size of the market. The market is very healthy. Obviously, it’s gotten even tighter as a result of what’s happened. The rest is going to depend on the economy.” 

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