Market Report

Summary

The pandemic's negative impact on the New York office market is still evident at the start of 2023q1. According to data from Kastle Systems, office utilization in New York remains well below prepandemic levels as most companies are now operating in either remote or hybrid settings.

The availability rate, currently at 16.1%, remains elevated compared to the prepandemic total of 11%. With some occupiers viewing remote work as a productive and cost-effective alternative, the amount of available sublet space continued to rise over the past 12 months. Conditions are unlikely to improve in the near term as tech companies, who have been among the most active lessors of New York office space, have laid off tens of thousands of workers across the U.S. over the past year.

Still, there are positives worth reporting. Annual leasing activity totals in 2022 showed a marked improvement compared to the year prior as companies are taking advantage of a more tenant-friendly leasing environment. Recent large office commitments in New York include Datadog (330,000-SF), Franklin Templeton (347,000-SF), and KPMG (455,000-SF). Demand continues to be driven by the desire of tenants to primarily occupy the highest quality office buildings which has resulted in increasing the time on market for spaces located in more vintage assets.

But with 13.6 million SF of office projects under construction, vacancy levels are projected to remain elevated over the life of the forecast. Despite the office sector's issues, several projects have broken ground in recent years in what will indeed lengthen the office sector's recovery. Still, developers believe that what new leasing activity does occur will likely take place in these more modern properties. Perhaps this leads to a situation where older, less competitive office buildings are converted to an alternative use like apartments.

With the availability rate still near an all-time high, year-over-year rental growth stands at 0.3%. In this more tenant-friendly environment, discounts to asking rents are easily applied and concessions, particularly free rent, are now higher than usual. With vacancies expected to remain elevated over the long term, rents are not projected to rise sharply in the coming years.

Similar to leasing activity, the investment market is predominantly driven by the transfer of trophy office buildings. Buyers view these buildings as less risky since these are assets that occupiers covet. Investors are mainly staying away from traditional value-add opportunities in Class B office buildings for the time being due to both the current surplus of available space in Class A buildings and the uncertainty surrounding how long it may take these more vintage properties to stabilize occupancy levels. If current conditions persist, the negative impacts on pricing and cap rates will be most apparent in trades of office assets with higher vacancy levels. But for now, there is not a large wave of distress among office buildings as rents are still being collected and owners are well-capitalized.

Leasing

The New York office market continues to feel the aftershocks brought on by the pandemic as office utilization in New York remains far below prepandemic levels according to data from Kastle Systems. Remote and hybrid work arrangements have become widely popular as major companies are making work-from-home permanent staples of their operations. With the dynamics regarding the need for office space shifting, the availability rate, currently at 16.1%, remains elevated compared to the prepandemic total of 11%.

Further, tech ?firms across the U.S. have laid off tens of thousands of workers over the past year which will negatively impact future demand levels and this financial strain has led some firms to cut costs by placing their office space on the market. As a result, absorption levels over the past 12 months remain in negative territory, while the amount of available sublet space continues to inch upward.

It should be noted, however, that leasing activity in 2022 has improved compared to the year prior as more companies are taking advantage of this more favorable leasing environment. Renewal activity, which was more popular due to widespread uncertainty in 2020, has slowed although renewals by News Corp (1-million-SF), Blackstone (652,000-SF), IPG (513,000-SF), and Fried Frank (400,000-SF) were some of the largest extensions in recent quarters.

Leasing demand has been driven by tenants looking to lease space in the highest quality of buildings. Recent examples include deals involving tech occupiers such as Roku, AlphaSights, Stripe, and Microsoft along with financial firms such as KKR, Chubb, Bloomberg, and Signature Bank. This "flight-to-quality" has resulted in the languishing of office spaces that are located in more vintage buildings, although it should be noted that some companies have chosen to considerably downsize their footprint upon relocating.

Despite the recent uptick in leasing activity, New York still has 13.6 million-SF in the construction pipeline. Other issues contributing to the supply-demand imbalance include firms looking to relocate to more tax-friendly markets or choosing to simply reduce their office footprint as they spread out their workforce. The base case forecast projects vacancies to remain elevated over the long term as a result of these factors.

Rent

For all office properties in the metro, rents stand at around $57/SF. This figure rises to around $75/SF for properties located within Manhattan.

The impressive rent gains witnessed early in the past cycle, which were fueled by the strong leasing demand from TAMI sector firms, are now a memory. Today, year-over-year rental growth in the New York metro remains below the national average. The poor rental performance can be linked to increased vacancies and weakened tenant demand. If more affordable sublet space were to continue flooding the market while leasing activity decelerates, some owners may continue to lower rents further.

Rental growth would be worse except landlords are typically hesitant to drop their asking rents, opting to instead offer generous concession packages to secure leases. With a notable amount of available space on the market, the competition for tenants is fierce and has resulted in concession packages notably rising since 2017. When signing a long-term lease, a midsized to large occupier can expect to obtain at least 12 months of free rent and more than $100/SF in tenant improvement allowance. An example of this surfaced when Facebook was able to secure better terms when finalizing their lease near Penn Station; achieving a reduced starting rent ($109/SF), more than 18 months of free rent, and the landlord contributing $146 million to build out the office space.

While concessions and greater lease flexibility, via shorter terms or opt-out clauses, are now part of the discussion, the prices for new Class A buildings are still lofty enough to rank among the highest in the nation. Asking rents at newly delivered projects at 1 Vanderbilt and Hudson Yards easily surpass $150/SF. The biggest question today is what happens to the asking rents of buildings that are not deemed the highest quality.

Construction

With 13.6 million SF under construction, oversupply now seems to be a concern. Despite the tenant demand for modern office buildings, vintage assets are now likely to sit vacant for quite some time as tenant demand has softened. This issue is magnified in secondary New York office markets like Brooklyn and Queens which have already experienced tepid leasing activity prior to 2020.

Premium office properties have consistently broken ground over the past decade, with developers investing in various project types, from modern skyscrapers to state-of-the-art boutique projects to repurposed industrial assets. The motivation for increased construction stems from the new demand profile which has tenants utilizing their modern office space as a recruitment tool. As a result, projects today are aiming to include not only a host of luxury amenities, but an abundance of natural light through the addition of outdoor terraces, floor-to-ceiling windows, and column-free floors.

Leading the Manhattan construction boom is the mega-development at Hudson Yards. With its focus on meeting the demands of companies looking for modern office spaces, the $25 billion mixed-use, multi-property project on the Far West Side of Midtown remains at the forefront of Manhattan's evolving office landscape. The area which opened in 2019, continues to grow, as a tower located at 66 Hudson Blvd. and dubbed the Spiral recently opened in 22Q4 and a separate tower at Two Manhattan West is set to open sometime in 2023. While attracting more demand than most buildings, the slowdown in leasing activity has even impacted Hudson Yards.

Recent deliveries also occurred outside of Manhattan with the completion of the Dime, a mixed-use building in Williamsburg that features a sizable amount of office space that has yet to lease to any tenants as office demand in Brooklyn remains sluggish. Though today's tenant values the product over the neighborhood, it seems that the idea of relocating outside Manhattan is a bridge too far.

Sales

With uncertainty surrounding the future of rental growth and office demand, investment activity has sharply declined compared to the long-term historical average. A rising interest rate environment and the complex process of underwriting for future occupancies have slowed down transactions as of late. Many potential buyers are either taking a wait-and-see approach or hunting for distressed assets, while many owners have had little interest in parting with their assets at far-reduced valuations.

Recent sales activity has been driven by the transfer of modern trophy buildings like 1 Manhattan West (at a $2.45 Billion Valuation), 441 9th Avenue ($1 Billion), and 100 Pearl Street ($850 million). Buyers view these assets as less risky due to their longer-term occupancies and premium build quality.

The weaknesses impacting the office sector have been evident in recent trades. The $445 million purchase of 450 Park Ave by SL Green was a marked discount to the previous purchase price of $545 million in 2014. A similar discount was applied during the $320 million sale of 1330 Avenue of the Americas by Empire Capital Holdings compared to the 2010 purchase price of $400 million. Despite these sales, investors are still largely staying away from mostly vacant value-add opportunities for the time being due to the current surplus of available space in Class A buildings.

Economy

At the start of 2020, New York City's economy was on solid footing. Tech, media, and finance firms were continuing to expand their presence, leading to near-record levels of employment and participation. As hiring increased, so has the population, with New York City's growing by 7.7% since 2010. Rising tourism contributed to an economic impact of $70 billion in 2019 which helped fuel the growth of both the retail and hospitality sectors.

Today, however, New York City's recovery continues to slightly lag other major metropolitan areas that have already exceeded their prepandemic employment levels. While nearly all of the private sector jobs have been regained, the seasonally adjusted unemployment rate of New York City, at 5.8%, is still elevated compared to the national average of 3.7%. The number of jobs supported by tourism spending surpassed 450,000 prepandemic and in order to reach prepandemic hiring levels, the leisure and hospitality sector in New York City still needs to regain more than 30,000 jobs.

New York City's retail, dining, and hospitality sectors have continued to witness improvements since the start of 2022. Hotel weekday occupancy has steadily improved throughout the year, which has resulted in operators revising their year-end outlooks. With foot traffic improving greatly over the past year, retailers have been more active in opening locations.

And although more New Yorkers continue to travel and enjoy leisure activities, most are still not utilizing the office. With many companies continuing to operate in remote or hybrid settings, office utilization in New York remains far below prepandemic levels according to data provided by Kastle Systems. This decline in usage continues to negatively impact the many small businesses located in predominantly office-centric neighborhoods that catered to this group.