LOOK AHEAD 2023: Office specialists take contrarian view of future lending, investment prospects   

The metrics from first three quarters of the year tell a different story than the past few weeks

Lenders, investors and brokers who specialize in the New York office market and beyond are offering a contrarian view of the beleaguered sector, urging a deeper analysis of an asset class that has been hit hard by the long-term fallout of the covid-19 pandemic.

The metrics from first three quarters of the year tell a different story than the past few weeks, according to several market participants on the investment, lending and advisory side who spoke with Real Estate Capital USA.

Ted Koltis, an executive vice-president at The Moinian Group, a New York-based investor and developer, said the story around the office sector is more nuanced than it may appear. Through the end of September, leasing in the Manhattan office market was up 50 percent year-on-year.

“But when the October report came out, leasing activity was down 40 percent when compared to the same period in 2021,” Koltis said. “I would say, however, that this is the sign of a recovering market and of a market finding its feet. You’ll have some swings like this, but overall, the market keeps trending better and people are finding a new standard for their office envelope.”

Office technology 

During the pandemic, tech companies like Facebook, Amazon, Google, Twitter and their peers were major consumers of office space both in New York and beyond. There have, however, been several high-profile headlines about layoffs in the sector.

“There are companies, especially on the tech side, which did the most leasing during the pandemic that are the ones now announcing the biggest cutbacks in space,” Koltis said, noting some tech companies that were considering leasing more space have put these deals on hold. “We may see a few more of these larger deals might have options exercised to give back some of that space but I think that is a right-sizing exercise.

“The term flight to quality has never been more exemplified than it has been over the past few years as it was seen in Manhattan, where you are seeing significant deals getting done in new projects like Manhattan West or Hudson Yards at pre-covid levels. You’re still seeing those rental rates being pushed. But there are big question markets on the larger, older assets,” Koltis said.

There are still several unknowns about the tech companies’ future intentions in the leasing market, said Michael Cohen, tri-state president at brokerage firm Colliers.

“I think the big unknown in the tech sector is whether we will see their Class A office space be put on the market for sublease as a result of these layoffs or whether it just means, as it has so far, a reduction in their rate of expansion,” Cohen said. “We’ve heard tech companies are not taking space anymore, but, with few exceptions, we haven’t heard of space that’s going back on the market. That shoe has not dropped, and it may not drop – are those layoffs here? Are they in Silicon Valley? Are they spread more or less equally? A job cut doesn’t necessarily mean a cut in space. The question will become how many of those jobs will be cut in New York and what will that mean for sublease inventory.”

Reading the tea leaves 

From January 1 through September 30, New York saw just under 25 million square feet of leasing activity and the market was on place to end the year with about 32 million square feet of leasing, if that velocity continued, according to data from Colliers.

Then, in October, the firm tracked a 40 percent drop off in leasing activity and demand was just over 1.5 million square feet, which was a significant slowdown, said Frank Wallach, an executive managing director at Colliers.

“Those numbers are markers because over the past 10 to 20 years, the typical yearly leasing volume was somewhere in the low 30 millions. Today, demand would have to surpass that and then some to create enough positive absorption to bring supply back down to normal because over the past two and a half years, Manhattan supply has increased by nearly two-thirds,” Wallach said.

There is another factor which could affect the supply of New York office – the pending conversion of office space into residential and demolition or redevelopment of existing, aging properties.

“We also have more buildings planning for their own demise. Both 250 Park and 300 Park are incorporating demolition provisions into their terms of new 10-year leases and 350 Park already part of a larger assemblage. These are examples of the alternative option to upgrading Class B buildings, which is tear them down and rebuild them bigger and better. On Midtown’s East Side, there is a virtually unlimited amount of air rights available thanks to the recent re-zoning,” Cohen said.

While the debt markets are on pause right now, there is a growing sense that there will be abundant capital for both equity and debt should a distressed environment emerge.

“Wall Street is very good at distress. They build it, they crush it, they buy it back for less,” Cohen said. “There will be very efficient vehicles to capitalize on distress. The debt markets are the traditional lenders are taking a breather and Wall Street is re-evaluating how to step into that breach and get a risk-adjusted return that is modest compared to their equity investments but more favorable compared to where they would have priced debt a year ago.”

Part of the potential distress could come from sponsors who are overleveraged or simply need to refinance.

“If you paid top dollar three to four years ago and leveraged it with a stack that included conventional debt, mezzanine debt and preferred equity, you could be struggling now,” Cohen said.

Submarket by submarket 

There is a future for older stock as well, with Koltis pointing to the years-long transformation of the monolith office buildings along Sixth Avenue.

“I feel like Sixth Avenue has done a good job of taking older stock and really putting a new face on it – almost every major asset up and down Sixth Avenue has had some kind of renovation done in the last five years, which initially was a response to what was happening with the development of Hudson Yards but has served that submarket well today,” Koltis added.

Midtown South has a smaller stock of boutique buildings that lend themselves to mid-tier tenants. “You are not going to land a 100,000-square-foot tenant in most of the properties in Midtown South due to their size. But in our buildings, we are working with mid-tier tenants, who are still doing deals – this is one of the most active parts of the market, for tenants with 10,000-to-30,000-square-foot deals,” Koltis said.

ESG has become a top-of-mind issue for tenants over the past six months, Koltis said. “But I think at this stage it is mostly the public firms and the larger tenants who are requiring that reporting but I feel that landlords are going to have to address it and that is easier to do on a newer project.”

Brad Tisdahl, a managing principal at advisory Tenant Risk Assessment, is still seeing a divergence between markets and asset class.

“If you’re looking at New York, people are more concerned about the recovery of Lower Manhattan than Hudson Yards or Midtown. For the first part of the year, the city was seeing a decent recovery in the office leasing market and our clients were feeling a bit better about how things were going relative to the first two years of the pandemic,” Tisdahl said. “But for office, there continues to be a divergence between brand new, Class A properties with strong amenities which are in a very strong position to attract tenants, even when leasing volumes are lower.”

Still, there continues to be some anxiety about how companies will be using space going forward. “I think one of the prevailing sentiments is that if there is a recession or if the employment markets get considerably weaker than they were during most of the pandemic, by virtue of the fact that folks would want to come back into the office to be seen by their employers to help avoid any potential terminations or layoffs,” Tisdahl added.