The commercial real estate industry is deep into a second year of pandemic adjustments. While office buildings are experiencing vacancies and downsizing as employees continue to work remotely, the demand for warehouse space has never been higher. Hear from Walter Sierotko, executive vice president and chief lending officer at Provident Bank, about the current state of the commercial real estate market in New Jersey.
Learn more about Provident Bank at https://provident.bank or on Twitter @ProvidentBank.
Don Meyer: Hi, I'm Don Meyer, chief marketing officer at the New Jersey Society of CPAs, and welcome to the Issues Watch Podcast. A recent NJ.com article described a time when “owning commercial office buildings in New Jersey was a license to print money.” Then the coronavirus changed how we work, shop and socialize — and, of course, where we do those things. Today, the commercial real estate industry is deep into a second year of pandemic adjustments. On the flip side, ‘insatiable demand’ for warehouse space continues in New Jersey. Rents surged and vacancies dropped to a record low for warehouses and other industrial buildings in north and central New Jersey from June to September, as demand from e-commerce continued to fuel the state’s red-hot market for logistics space. Here with us to discuss the current state of the commercial real estate market is Walter Sierotko, executive vice president and chief lending officer at Provident Bank.
Walter Sierotko: Thank you, Don, pleasure to be here.
Commercial Office Space
Don Meyer: Let's start with commercial office space. How are owners of commercial office buildings responding to the new hybrid work dynamic?
Walter Sierotko: Basically, the owners, the good owners, the strong owners are always adapting to the ever-changing environment in real estate, especially offices. Right now, we have a huge push for work from home, spot working, flexible work arrangements, and then just mass confusion over what do we need to do at all? I think one of the things you'll see in New Jersey is that a lot of it hit New York because, in addition to just the work environment or the office building, there's mass transit. People don't want to be on buses, trains, going in and out of the city or the various urban areas. So suburban offices picked up a little bit actually, because firms still need office space. I think gone are the ping-pong tables and pool tables and rec areas, but you will see more flexible units because people need a place to come into and touch down. There's still going to be meetings. You still have to have to maintain and build a corporate culture. And you really can't do that unless people are together as they used to be, more in the office.
And also you have the mentoring effect of younger employees. How are younger employees going to get a full mentorship, learn the business and everything else if they're remote? So I think the office market, the big change has been probably a little less urban and a little more suburban for now, because, as you saw, home prices in the suburban areas skyrocketed in the past year and a half. Sales were going at a record clip. So people would prefer to be closer to that environment than, like I said, they don't want to get on buses, trains or anything else. And some of the firms in New York also found that their space in New Jersey was quite valuable.
Don Meyer: Okay. You kind of alluded to my next question. You said that suburban office parks are actually doing better than the urban ones. And that was my next question. Are you seeing, because there's more mass transit or because the people at work and say like Hoboken, Jersey city and New Brunswick, are those places doing better? But you're saying that actually the suburban office parks are doing better than those urban ones.
Walter Sierotko: Sure. Office parks like Metro Park are pretty well leased. Florham Park, Short Hills, Morristown area very well leased for now. And I think it was just a little pullout. It's also a little less expensive than the urban areas or the waterfront.
Don Meyer: Now are tenants, whether it's suburban or urban, are they requesting lease adjustments? Are they taking more of a wait-and-see approach?
Walter Sierotko: In 2020, at the height of the pandemic, there were a lot of tenants that were pushing for a lease adjustment. But savvy owners, you've got a five or a 10-year lease, they weren't about to let people really mess with their livelihood. So many, many leases were not renegotiated. Those that came up matured, certainly saw a benefit of renegotiating a lease and it could even downsize a little bit. But, for the most part, most landlords aren't letting people out of their leases or a discount to the leases currently. More of that happened in retail, but not at the larger spaces. It was more the mom-and-pop retail in order to keep them in and keep them afloat, they were offered breaks during the pandemic.
Don Meyer: Are any tenants, commercial tenants, looking for reduced space? They had a certain amount of space pre-pandemic, and they still want to maintain that office space, but perhaps they want 75 percent of what they had or 50 percent, because people will kind of be in and out, maybe shared offices, things like that. Are you seeing any of that?
Walter Sierotko: Exactly where they can pick up the shared office space dynamic, and a lot of places have a three-two mentality where one person’s in for three days this week, the other person's in for two. And then in the following week at flip-flops. So that basically you have one office or cube space for two people. Now you can't go to an exact two-for-one measurement because you may have days where you need more of the staff in, so you'd still have to keep a buffer. But yes, you, you can get away with 75 percent of the space you had prior.
Don Meyer: So that's kind of the current, maybe even the short-term outlook. What are we looking at long term? Do you think things will go back to normal? I know everyone keeps saying, not just in office space, but across the board — oh, there's no going back. We're not going back to the way the things used to be. But do you see this continue to evolve or do you see some maybe regression to the mean, back to the way things were back in 2019 — after all of the medical and the health emergency issues are work through?
Walter Sierotko: Well, certainly, as we're doing right here, we're on Zoom. Who heard of Zoom two years ago? Right now, with Zoom, I've got to say it's very interesting. I don't want to do a phone conference call anymore. Why? Because people step over each other and everything else. But on Zoom, you can see one another, you light up on the border. If you're speaking, if somebody's trying to speak, so you can see all that. Well, that's a tremendous efficiency and technology makes us more efficient all the time. So when you can take your laptop home, have a Zoom call, you have, you can have Zoom phones that come into both your computer and your own cell phone. So your office phone is with you at all times. It'll be interesting. So I don't think we're ever going back completely to the way it was, but I think there'll be more people in the office. You notice a lot of parking lots are empty today. We will be back in the office, just perhaps not as much as we were in the past, and that just makes sense with what I see in technological increases in efficiency. If something else should change, who knows, but if people can work from home, find more work life balance, they're going to push for it and employees are pushing for it now.
Don Meyer: And there are some pretty significant companies that are allowing their employees to work from home as often as possible. There was a big announcement a couple weeks ago when PwC — one of the Big Four — when they announced that they were going to allow people to work from home, as much as they wanted to. That was, I think, for the accounting profession, that was, that was revolutionary. Because it's, I think, thought of as a profession where people need to be in the office and they need to see clients and so forth. So I guess, we're all going to follow lead to some of those larger companies, not just PwC, but your Googles and your other large companies.
Walter Sierotko: It'll be interesting to see. It all has to do with productive. If the people can be as or more productive working from home, companies will tolerate it and encourage it. Who doesn't want more productivity? Because if you're working from home and I have two people sharing one desk and maybe I need a 20 percent fluff factor, I just shrunk my cost of occupancy. And that's a saving to the bottom line. I no longer need 100,000 square feet. Maybe I only need 80,000. And that would be big.
Don Meyer: No, absolutely, huge savings.
Don Meyer: So, let's talk about retail space. You mentioned it a few minutes ago. How is, is retail space doing with just so many more people shopping online? You know, Amazon's exploding. It just seems like everything we get delivered to our house now. And not that people don't want to go out and shop retail, but it's just not as frequent as it used to be. So, how's retail space doing?
Walter Sierotko: It's interesting. I don't know if I buy that because we, at my household, get our fair share of brown smiley boxes. That's what happened. But if you drive around and look at some of the retail centers, the parking lots are full, the gyms are full again, people are going in and out of the stores, the grocery stores remain full. What you're not seeing maybe is as much traffic at a big, large interior mall. I think there's maybe a little less of that, but I've also seen in those bigger malls, I see people shrinking their space, where it's almost a showroom for them because everything can be delivered the next day. If you don't have to have it that night, because you need to wear it, you can get it the next day. And it's easy enough. I mean, it'll change. It depends on clothes if they need to be altered or not. But for the most part you can go into a place — I think Lululemon was the first one that really had the model. You went in there, you didn't have a tremendous amount of goods in the store, but by the next day you had whatever you wanted. What I've seen is the stockroom shrink in the stores, the mix of tenants in a strip center, perhaps, you love to see the grocery store and while you can still get groceries online, I think people still like going to their grocery store or getting it from their local grocery store. It just seems, I don't know, it's food, it's more personal. And then the pizza, the bagel store, the various little restaurants, the nail salons — you can't Amazon that. You can't get that delivered.
Don Meyer: I'm actually happy to hear you say that stores are cutting down on the inventory they have in the store. My wife loves to shop at Banana Republic, but she's been lamenting for probably the last three or four months that they never have anything in the stores, at least anything that she wants to buy. So I guess that actually is a conscious decision on the part of Banana Republic is to kind of shrink down what they have. So they're carrying less inventory.
Walter Sierotko: Sure, and it goes with part of the boom in an industrial space. Typically, retail space is more expensive. Industrial space was single digits — no longer in New Jersey, double digit rents for industrial space in New Jersey now approaching $20-plus in Bergen County in the Meadowlands area for industrial space. But what has happened is, well, guess what, I don't need to pay $40 in a retail center and carry a big storeroom. I can put that in a warehouse at $20 shrink my space that I'm paying $40 on, and it makes sense. I can get it delivered anywhere I want within a day. So it kind of makes sense that industrial has seen in this boom. In addition, our port has expanded, and by bringing in more containers — it is incredibly expensive to leave a container at the port. You have to get it out as soon as possible because the charges you get, the surcharges, are very high on a per-square-foot basis — in the hundreds of dollars a square foot for that container. So you've got to get it out of there. The closer you are to the port, the more efficient it is for you to get it out. But we have a wonderful road network of 95 and 78 that we can get east-west — can't go much further east — or north-south to I believe it's 40 percent of the population of the country. So that's big. In a day, within a day's travel. So it's very easy that way. And if you can do that, it makes sense. And, and Port Newark Elizabeth is, I believe, the third largest port in the country in terms of bringing goods in. So, we're a very important logistical location for the country and as such, our rising industrial rents make perfect sense.
Don Meyer: As a novice to this topic, I can't do a podcast about real estate without saying something about location. So, I'm just wondering, in terms of mall space, you'd mentioned mall space a couple minutes ago. I live in Morris County. I go to the Short Hills Mall and it's packed. I go to the Rockaway Mall and it's, as somebody in my generation – I grew up on malls.And so I'm just wondering, is location still as big or as important as it used to be? Can some of the struggles of whether it's a mall or a strip mall, is it attributable to location or do you think it's maybe just like a mix of stores and things like that?
Walter Sierotko: It's both. Certainly it's location because it's a convenient location for Short Hills. You're right off 287, 24, 78 and the Parkway. You can get everywhere from there. Garden State Plaza is, the same way. It's well located on 4 and 17, very busy. Also, the majority of the population in New Jersey is north of 195. So, the further north you get, the denser our population is. Like you said, you go further out into Rockaway, they don't have the same mix of stores that a Short Hills or Garden State Plaza has either. And soon American Dream will be fully open with its shop space that contains many of the higher-end shops. So those I expect will still have a draw. The entertainment aspect of American Dream will probably bring it in as well. But other than that, I don't see many people going — I see a lot of the older interior malls being repositioned and whether it's repositioned as apartments or industrial. Apartments and industrial continue to be the two hottest property types in our market, probably right now, industrial the hottest, apartments the second hottest. As we spoke about, office has certainly fallen off. Retail is okay, it's remained relatively stable and hotels are all going to depend on travel. We just opened up the borders to international travel, but business travel isn't really happening. Most companies aren't sending their people into the different cities or spaces for regular business travel. And that's where a lot of hotels make their money. It's the business week.
Don Meyer: So moving on to industrial space or warehouse space, what's driving the demand in logistics space — which is a term I hadn't heard before? What's driving that demand in logistics space?
Walter Sierotko: Well, there's two aspects. As I mentioned before, getting the inventory or goods out of the port. And then you have to put them somewhere and then the logistics professionals get together on “how do we get that in most of efficiently moving to the areas of population?” Secondly, you have the last-mile stuff, which is when a smaller building is utilized as a drop point for the various Amazons, UPS, FedEx — getting stuff in and around to local to us, the consumer. So it's a key game. And as I mentioned, our road network is 95 going from Maine down to Florida, 78 goes clear across east-west. So you can get all the out probably within 10 hours, you're in Ohio, maybe a little beyond and certainly 10 hours you’re as far south as South Carolina. That's getting a lot of goods to a lot of places in a relatively short period of time, which the logistics of it is key. Right. Hopefully, the infrastructure build improves our roads and bridges. So that makes it even easier. But that remains to be seen.
Don Meyer: With the infrastructure New Jersey has, which, let's face it, probably gets a D rating at best with, with all that warehouse space and transportation going through the state, you can only imagine what we could do if the infrastructure was in better shape. Are you seeing, you kind of ranked the other types of properties earlier, you talked about commercial and retail and apartments. Are you seeing any commercial properties that have gone vacant — are you seeing those converted to warehouse space to meet the growing demand?
Walter Sierotko: We have seen some office buildings, because a suburban office building was generally well located and became apartments. It made sense, and it made sense for the towns, too. So bringing an apartment building in will create a tax rateable for the town while not overtaxing the systems. So it was actually not as negative impact as once thought. Now, warehouses are great because they create jobs. You have jobs in your town, in your local community, from those working in the warehouse. Yhey don't tend to add a tremendous amount of traffic, because it's one spot. But it'll be interesting because I also think some of the retail that really fell off should come back a little bit as well. People just have to get used to it again.
Don Meyer: How long do you think the demand for warehouse space will continue? I mean, do you think we'll still see this upward slope for a period of time? Or do you think it'll level off at some point?
Walter Sierotko: So I never like anything that really has that hockey stick approach to it that, that steep, upward sloping to the right. But I think warehouses is here to stay. And its value is tremendous because we are going to get more and more of our goods delivered rather than picked up by us. And in order to do that, you have to have a place to put them; you have to be able to deliver quickly. If it took you two weeks to get any delivery you wanted, we would stop, we'd go to the store and pick it up. So, the whole appeal is that they can get it almost as quick as you're going to pick it up. Next day, which is fantastic. They have to have it in the warehouse. So they have to have the goods, they have to have the warehouse space. It makes a lot of sense. So I think maybe we're hitting a bit of an inflection point. I mean, rents can't continue to go up forever. If, if they do, something will happen there. The goods will get more expensive somehow and then maybe going back to a store to pick them up and they cut out the transportation cost and everything else. Makes sense.
Don Meyer: Now we have roughly, I think it's 550 municipalities in the state of New Jersey. Has there been, and they all seem to kind of want different things. They want things their own way. Has there been any pushback to the development of all of this warehouse space, kind of the "Not in my backyard" type of attitude. Have you seen any of that?
Walter Sierotko: Not really. Because most of the stuff is going to be as close to highways and everything as possible. You're not dropping big warehouses in a residential neighborhood, so that makes sense. Even converting an office building into apartments or warehouse space, the office building wasn't in the middle of a residential neighborhood, generally always highway intersection and everything else. So I don't think there's much of a problem that way, but the towns do, if you've followed any of the political action in the state, taxes are always a big concern. So commercial rateables from commercial real estate go a long way to help a town and ease the tax burden on the homeowners in the town. So they're going to have to balance it now. You wonder why they haven't done it before? Because every planning board meeting I've ever gone to, everybody has an opinion and nobody wants — it is a NIMBY effect — and at the same time, a lot of towns try to see what they can get out of allowing this development. Whereas they don't realize the development itself helps the town in many ways. All of a sudden, now you have redevelopment agreements and that's how towns getting things done. They do a whole overlay of an area for what they want put there, whether it be shops, small office, apartments type of thing.
Don Meyer: Well, this has been very interesting. I wanted to say how grateful we at the NJCPA are for Provident Bank’s longtime support. And, in closing, is there anything you'd like to share with our listeners and viewers about the services that Provident provides to CPAs, their companies and their clients?
Walter Sierotko: We love the CPA group. Provident's been around for 180 years and we pride ourselves on a commitment you can count on. So we like partnering with the CPAs. Various CPAs are a great source of business for us because they have a customer base and we feel if they're going to put their recommendation to a bank to a client, by their recommending us, it's an honor. Because they're going to only recommend to someone that they feel comfortable with because they're putting their reputation on the line with their customer. I mean, I'd hate to think that they referred it to someone like us and, and we did a bad job that, that can ruin a relationship with their own customer. So we really appreciate the many CPAs we do business with that continue to support the bank and refer us really good customers. So thank you.
Don Meyer: All right. Great. Well that about wraps it up. Thanks again for joining us today. Walt. We really appreciate it.
Walter Sierotko: It's been a pleasure. Have a good week.
Don Meyer: Thank you all for listening and watching a big thank you once again, to Provident Bank for all the support over the years, you can learn more at provident.bank. And we're excited to announce that the biweekly A&A episodes of the IssuesWatch Podcast now qualify for nano CPE credit. Each episode is 0.2 credits, and you can also purchase a five pack of episodes for one CPE credit. Learn more at njcpa.org/nano.