The corporate world is facing a glaring issue: wasted office space. As leases expire and companies take a closer look at their real estate needs, they are finding empty desks staring back at them. So overwhelmingly, the solution for portfolios has been upgrading to fancier (albeit smaller) digs. And the new standard of economizing is enabling businesses to cut significant costs, but it’s having a disproportionate effect on the cities where these leases were.
The nation’s CBDs, where most of these leases were originally, are experiencing the worst of The Office Apocalypse.
Manhattan in particular, is facing a daunting challenge. The bustling heart of business is staring at a whopping 22% office vacancy rate, the highest since records began in 1984. It's like having over 40 skyscrapers the size of the Chrysler Building sitting empty.
For many, this is a catastrophic benchmark of New York City’s office market, the point of no return. A great deal of landlords won’t survive this shift and unprepared tenants will be caught in the crossfire. But, in the words of mega-landlord and corporate real estate magnate Scott Rechler of RXR, “Anyone (who) bets against New York evolving, they lose that bet.”
So let’s discuss Manhattan’s wasted space problem and what it means for the role of office space in its future.
Businesses are Making Cuts to Their Footprints
Long-term leases might provide stability for businesses, but they also create inertia. And as the days go by, companies are realizing that the leases they signed pre-pandemic no longer reflect their need for space.
Unfortunately for landlords, these leases are now coming due. The corporate world as a whole is deciding more and more to shake things up and find smarter ways to use the space they invest in. This means making sizable cuts on the large footprints of the past.
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All this culminates in the fact that downsizing has been the most notable approach to adapting corporate real estate portfolios. And the companies that haven’t yet are plotting more widespread footprint cuts in coming years. Half of the World's Largest Companies Are Planning to Right-size Their Space.
Because of this slowdown, NYC is on pace for the slowest year for CRE sales since 2009.
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“The Q1 2023 total of $2.2B in commercial real estate investment sales involving 108 properties in New York City is a 59% decline across the trailing four-quarter average and a 53% decrease from Q4 2022.” |
This represents a massive issue for the city because the office sector has historically been responsible for 21% of the property tax driven revenue.
NYC Hit Hard From Tech Leasing Slowdown
Rapid pullback in the tech leasing space is a significant driver behind the sheer amount of wasted space that has hit the market in the last year. In turn, some areas of Manhattan which acted as tech hubs for start-ups like the Garment District, have some of the highest percentages of vacant space.
Among the tech companies cutting their footprint in Manhattan are:
- Yelp
- Kickstarter
- Uber
- Meta
- Microsoft
One of the most recent names in tech to slash into its NYC footprint was Spotify. It recently announced that they would vacate four of the five floors they occupied at Manhattan’s 4 World Trade Center.
Spotify Chief Executive Officer Daniel Ek explained the move, “Our focus has shifted more towards optimizing our current portfolio and reviewing our real estate needs around the world as opposed to significant expansion of our presence in current markets.”
When companies don’t see the financial worth occupying a presence in The World Trade Center, this has huge symbolic significance to the severity of Manhattan’s commercial property devaluation.
New Office Tenants Demand More
The flight-to-quality is canonically changing the leasing landscape for tenants, investors, and landlords.
The rise of trophy class buildings (especially in standout locations like Manhattan) are the new standard for a corporate status symbol. Therefore, for some businesses, the extreme rent costs are worth the prestige.
After all, with the option to work from home, an office has to be pretty darn nice to encourage employees to get up and commute to their Manhattan jobs.
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Because of this shift, “undesirable” Class B (and under) offices have extremely devalued to the point of being labeled as “obsolete,” by RXR’s Rechler. And the New York Times estimated this to be a condemnation of “around 70 percent of New York City’s 1,381 office buildings.” |
And many won’t touch this building class with a ten-foot pole because upgrading these facilities requires huge sums of money (which is unlikely to offer a robust ROI with all-time-low office demand).
The properties that are in condition to be updated are still facing a long and expensive journey. Again take for instance Rechler, who “is in the midst of refinancing $2 billion in debt on four of his buildings, which will require a commitment of more than $700 million in new capital, part of which will go to renovations like the ones at 5 Times Square.”
This should emphasize just how massive landlords need to be to emerge from The Office Apocalypse.
Office Landlords Can't Keep Up
Because, in the fierce competition to attract tenants, landlords are pulling out all the stops.
From upgrading to premium facilities, covering build-out costs to offering months of free rent, it's cutting into their bottom line. As a result, the average net operating income of NYC landlords has taken a decisive blow.
Now there’s a tough balancing act for landlords trying to keep their properties occupied and tenants happy and many are falling off. This means that more landlords will join the ranks of major firms that have been forced to hand back the keys like Brookfield. And the current banking system isn’t built to withstand such a profound hit to the CRE industry.
All said and done this can have cataclysmic results for a lot of banks, specifically of smaller, regional denominations.
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“Rechler predicts that within two years, there will be “500 to 1,000 fewer regional banks” owing to failures and forced consolidations.” -The New York Times |
And this is because banks usually end up with the short end of the stick if a landlord defaults.
“For an office landlord, abandoning a building can be the best of bad options. Commercial mortgages on offices are usually structured as “nonrecourse” loans, which means that only the building is forfeited in a default. The bank may end up the biggest loser, taking over a property that is worth much less than its mortgage. It is becoming increasingly common to see office landlords — even the ones with billions in assets — walk away.”
And the issue is only set to be amplified by the $1.5 trillion in commercial-real-estate debt is scheduled to mature between now and 2025.
Are Conversions the Solution?
Confronted with a potential bank failure, the only other foreseeable alternative to the wasted space dilemma is converting the bones of empty office buildings into something Manhattan needs, housing.
And still that may not be worth it to salvage a vast majority of lower tier properties.
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“Some buildings might live on if they can be converted to other uses, like housing, but a significant number — not just the decrepit and old but ones that were considered Class A until recently — will probably be torn down.” Jeffrey Gural, quoted in Curbed |
Because of the sheer cost and massive job of converting offices into housing, it is unlikely to become the widespread solution to the wasted space problem. Because beyond zoning issue, there’s a myriad of complexities to confront in transforming office buildings to housing. Read more about Why Office Conversions are so Complicated.
Landlords will need to be of an enormous breadth to adapt to the evolving CRE landscape. But for tenants who want to keep their footprint or expand in NYC, this perfect storm affords a critical opportunity to take advantage of the record-low demand.
Tenants in the Manhattan Office Market
With plotted conversions suggested on the horizon, widespread renovations, and increasing landlord defaults, savvy tenants can optimize their portfolio like never before.
As the landscape evolves, landlords are competing fiercely to lure tenants, offering enticing concessions and with office vacancy rates at an all-time high, businesses can now leverage their bargaining power to secure affordable yet high-quality office spaces.
But of course, with landlords in a precarious position, there is significant risk assumed by tenants who can be negatively implicated by their property owner’s financials.
So, amid this challenging situation, the role of True Tenant Representatives™ becomes vital. They can assist tenants in navigating complex negotiations, protecting their interests, and finding the best-suited office space for their needs. With the market dynamics shifting rapidly, True Tenant Representatives™ can provide valuable insights and strategies to ensure tenants make informed decisions in this dynamic and evolving commercial real estate landscape.
As the demand for office space wanes and commercial properties face devaluation, it's crucial for both landlords and tenants to adapt to the changing market conditions. Proactive planning and careful consideration are essential for stakeholders to weather the challenges and uncertainties that lie ahead. Embracing flexibility and exploring alternative solutions beyond traditional office setups will be instrumental in shaping the future of corporate real estate. Whether it's embracing remote work, optimizing existing space, or exploring new possibilities, the path to success lies in adapting to the evolving realities of the office market.
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