A bleak outlook for Manhattan office space could signal a bigger problem

A bleak outlook for Manhattan office space could signal a bigger problem

New York City’s largest corporate owners have had a great time for years benefiting from a booming economy in a city where companies clamored to open offices and low interest rates buoyed the economy of an industry built on debt.

Those days are over. Three years into the pandemic, the floors of office buildings across Manhattan have been emptied by tenants reducing their footprint and employees working from home.

Now, there’s another problem.

Rapidly rising interest rates have heightened concerns that New York City’s office market, the largest in the country and a mainstay of the city’s economy, could be at serious risk. That one-two punch could be worse than anything business owners have experienced before, industry experts say, leading major banks and real estate analysts in recent weeks to warn that properties are languishing alongside falling property values ​​and prices. higher borrowing costs could increase the likelihood of a national recession and budget crisis for the city.

More than two-thirds of all commercial home loans are held by small and medium-sized banks, prompting concerns that regional banks may not be able to withstand a wave of defaults if homeowners fail to repay the loans. Some analysts have predicted an uncertain future for inner cities, likening the crisis to the slow death of many American malls.

In the latest snapshot of the nation’s most significant office market, New York City’s largest office owner, SL Green Realty Corporation, revealed that many of its properties lost tenants during the first months of 2023. In its 25 buildings , including some of the city’s most important office buildings, 90.2% of the space is occupied, down from 95.5% in early 2020.

The fallout extends far beyond the budgets of city landlords, which borrowed billions at low rates in the years before the pandemic to build, buy and upgrade office space, and have attracted tenants like Meta and Apple to the city.

Office workers in the city earn about 75 percent more annual salaries than the rest of the private sector, according to the Office of the State Comptroller, and their absence from the office every day robs myriad businesses of their spending.

And the value of New York City’s office buildings could plummet by $48.75 billion over the next few years, according to a recent study by researchers at Columbia and New York Universities, hampering a vital source of the city’s tax revenue.

Stijn Van Nieuwerburgh, a professor of real estate at Columbia University’s business school, has warned that New York City faces an urban cycle of woe triggered by remote working. While the current commercial real estate downturn shares similarities with previous downturns, including periods in the early 1990s, after the 9/11 attacks, and during the 2008 financial crisis, this downturn has a new twist: lower demand for offices seems permanent, he said.

We can debate whether we need 10 percent or 20 percent or 30 percent less long-term tenure than we did before, Dr. Van Nieuwerburgh said, but everyone agrees the number is greater than zero..

Wall Street investors have had a particularly negative view of the office sector during the pandemic, but their assessment of the sector has worsened in recent months. Big banks like JPMorgan Chase and Wells Fargo have increasingly warned that heaps of commercial loans due by the end of 2025 total $1.5 trillion nationwide and that companies may struggle to repay or refinance them.

Shares of SL Green and two other publicly traded office owners in the city, Vornado Realty Trust and Empire State Realty Trust, are all trading near their lowest levels since the start of the pandemic.

Shares of SL Greens are down 76% since the start of 2020. Vornado is trading at its lowest level since 1996. Empire State Realty, which owns the Empire State Building, is near an all-time low. Overall, $17 billion of their market value has been wiped out since the start of the pandemic.

All three are office-centric, all three are New York City-centric, Van Nieuwerburgh said. Those are the stocks, the office stocks, that’s been affected. It’s astounding.

Vornado and Empire State Realty will report their quarterly earnings in the coming weeks. At the end of 2021, Vornados buildings in New York City were 90.4% occupied, down from 96.7% at the end of 2019; The Empire State Realty buildings in Manhattan were 86% occupied, down from 89.8%.

Private equity firm Blackstone, the world’s largest commercial real estate owner, reported last week that its latest distributable earnings, which represent money used for shareholder dividends, were $1.25 billion in first quarter, a 36% decline from a year ago.

Executives said on Friday that the firm had significantly reduced its exposure to the office sector in its real estate portfolio and warned of looming challenges for those properties. Last year, Blackstone returned the keys to a Manhattan office building, 1740 Broadway, to lenders.

In the recent quarter, SL Green reported revenues that were approximately 28% lower than the same period in 2020, but still above Wall Street’s expectations. During an earnings call on Thursday, the company’s CEO, Marc Holliday, criticized what he called alarmist forecasts for the sector.

The commercial real estate sector appears to be dominating much of the headlines these days, amplifying messages of doom and gloom and creating what I believe is excessive anxiety in the market that is most acutely felt in New York City, Mr. Holliday said. Excessively negative rumors are overshadowing some of the positive signs that point to a slow but steady recovery.

Alexander Goldfarb, managing director and senior research analyst at investment bank Piper Sandler, said SL Green’s better-than-expected earnings should ease some of the worries of a looming office sector collapse.

Yet many owners may never recover. While larger landlords owning offices in Manhattan that remain in high demand or own properties elsewhere in the country may be in a better position to bounce back, numerous smaller companies owning older, less desirable properties could face enormous strain. . About 80 percent of office leases signed in early this year were for buildings considered top-of-the-market, known as Class A, according to analysts.

In New York City’s office market, which encompasses about 400 million square feet, Goldfarb said, nearly two-thirds of its buildings are facing obsolescence because they’re decades old and largely unappealing to tenants.

Tenants are looking for newer space that offers amenities and proximity to transit stations, such as One Vanderbilt, SL Green’s new tower near Grand Central Terminal, he said. Leases on that building are among the highest in Manhattan, with some exceeding $200 per square foot.

They will continue to win the share, Goldfarb said.

After dismissing the staying power of hybrid work at the start of the pandemic, SL Green and Vornado executives now admit the workweek has changed for the foreseeable future.

Vornado, for example, had set his sights on transforming the Penn Station neighborhood into a major commercial district that could command some of the highest rents in the city, similar to its neighbors at Hudson Yards and around Grand Central Terminal. But company executives have decided in recent months to put the project on hold, citing higher interest rates.

All three companies have been scrambling to find new revenue streams. Empire State Realty has sold several suburban office buildings and has expanded into the apartment market, purchasing three Manhattan buildings since late 2021.

But there are no quick fixes for office owners. An enticing option to convert underutilized office space into residences is too expensive with today’s interest rates and is often structurally challenging.

Vornado considered an offer to locate a casino near Penn Station in Midtown Manhattan. He’s also looking into building more residential towers following the completion of his luxury condominiums at 220 Central Park South in 2019, where a residence sold for nearly $240 million, the most expensive home sold anywhere in the United States.

SL Green is also looking into gambling: It has partnered with Caesars Entertainment to propose a new casino in Times Square, competing with other groups for one of three casino licenses licensed for the state of New York.

The project would benefit everyone, Mr. Holliday said on Thursday’s call. It would be a huge catalyst to revitalize and reinvigorate what is New York and I would argue is the #1 top tourist destination in the world.

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