Forecast: Bright Spots, Dark Clouds

There are both bright spots and dark clouds in the 2007 Forecast for New Jersey's markets. Like the state's economy, the office market will be impacted by what does or doesn't happen in Trenton this year to turn around the state's growing reputation as tax-laden and business unfriendly. A lot of New Jersey's growth in office jobs this year likely will depend on New York City maintaining its strong business growth. With office vacancy in Midtown down to 7% and class A asking rents twice the average of New Jersey's northern counties, the trip across the Hudson River becomes more attractive all the time.

Real estate professionals generally give Gov. Jon Corzine high grades for understanding the state's fiscal problems and not being afraid of the political consequences in taking an aggressive approach to address them. He let two business taxes expire in 2006, a move one economist says should leave an additional $300 million of revenue in the pockets of businesses that earn it in 2007. In December, he was working with the state legislature to cut property taxes for most New Jersey homeowners, although much of revenue to do that would come from the one percentage point increase in the state sales tax in 2006 and the businesses that have to pay it.

Now for the dark clouds. The Philadelphia Fed recently released a report that said economic growth in the Garden State has declined to its slowest rate in five years. In fact, New Jersey led the nation as the state with the greatest rate of growth in unemployment for the fiscal year ending last July 31.

Economist James Hughes, dean of the Bloustein School of Planning and Public Policy at Rutgers University, expects the New Jersey office markets to be flat this year, with the greatest potential for growth from business migrating across the Hudson, primarily to the Jersey City waterfront and Bergen County.

"The state economy hasn't been generating new jobs and it has slowed even further over the past five months. The national economy this year will under-perform 2006, although I don't think there is going to be a recession," Hughes says.

The industrial market, meanwhile, remains a bright spot for 2007. Driven by imports from China, the amount of goods moving through the Port of New York and New Jersey rose 10% in the first six months of 2006, according to Cushman & Wakefield. In Q3 2006, the central and northern industrial markets turned in 21 million sf of leasing activity, with 4.5 million sf of positive absorption in the first nine months of the year, even with three million sf of new space under construction.

"Demand always has been there, but in 2006 a lot of people were rethinking their requirements and looking at supply chain and logistical issues," says Rick Marchisio, managing director of Grubb & Ellis, Fairfield. "Many companies have hired consultants to re-evaluate how the use their warehouse space. In 2007, I think a lot of requirements are going to come out of the box."

In fact, he envisions Grubb & Ellis increasing its industrial group staff by up to 50% in the year ahead if the market continues to perform. But it will come down to jobs and how well the national economy performs.

Back in the office sector, meanwhile, the state took a couple of steps forward in changing its image as a place of high business taxes, as mentioned, when the current administration let the law prohibiting businesses from carrying losses forward expire. But the $300 million in taxes that the elimination of that rule coupled with the expiration of the alternative minimum assessment will save businesses is a mere one-third of the $1 billion in business tax increases put through during the McGreevy administration.

In terms of statistics, the 2.5 million sf of Northern and Central New Jersey office buildings that Jones Lang LaSalle tracks were expected to absorb about half as much space in 2006 as they did in 2005, and the company's executive vice president Paul Giannone, says that trend is likely to continue through this year.

"We're just not creating the jobs," he says. "Where we had earlier been creating 50,000 new jobs a year, in 2006 we created about 17,000, and only 5,000 to 6,000 were office jobs."

But even without job growth, he believes office rents should increase modestly this year due to the fact there has been so little new construction. Sublease space, which accounted for about 20% of vacancy a few years ago, now is down to about 5% of the 7.4 million sf of available office space. Concessions and work letter allowances also have come down to a month or two worth of free rent on a five-year lease instead of five or six months, according to Giannone.

Raymond Sohmer, senior managing director of CB Richard Ellis in Saddle Brook, says he is perplexed that the market didn't see greater absorption in 2006, although he says that class A vacancy is below the overall average.

"When you think about the high rents in Midtown and all of the people commuting into Manhattan from New Jersey, companies could put those people into a modern facility in New Jersey that cuts their commute," Sohmer says. "I expected to see this happen in 2006. I'm positive it's going to happen in 2007.

Gil Medina, executive managing director of Cushman & Wakefield of New Jersey, East Rutherford, sees a number of reasons why both the state's economy and its commercial real estate markets should turn in a positive performance in 2007. Two important drivers should be the Corzine administration's willingness to tackle tough fiscal problems without gimmicks such as non-recurring sources of revenues, and what some term as "the New York City effect."

"The New York economy is performing at an incredibly high level," Medina says. "Moody's Credit Rating Service is projecting white collar employment in New York City will grow 2% to 3% over the next few years. That is being reflected in vacancy rates. Take the sublease space out of the 7% vacancy at the end of the third quarter, and Midtown Manhattan has direct vacancy of 5.8%. Class A average asking rental rates are $60 per sf in Midtown, $41 per sf in Midtown South and $38 per sf Downtown."

But some of the taking rents have been even higher. Medina notes that 110 Midtown office deals done in the Q3 2006 were signed at $70 per sf or more.

"Another driver next year will be the Corzine administration's forthright approach to fiscal policy and, from a regulatory point of view, the DEP is taking a very balanced approach to regulation," he concludes. "The DEP still is aggressively protecting the environment, but it's taking into consideration the impact of the regulatory process on the economy."