Manhattan office market's tough outlook persists, leaving investors on sidelines

Jones Lang LaSalle Incorporated

12/07/2023 20:30

By Herbert Lash
       NEW YORK, July 12 (Reuters) - The end of the pandemic
has brought little relief to Manhattan's depressed market for
workspace, where empty floors remain the norm and by one
calculation the values of 45% of the city's office buildings are
below their last sale price. 
    The amount of space leased in the second quarter was down
almost 50% from a year ago and was a quarter less than the
five-year pre-pandemic average, according to brokerage data
provided to Reuters. 
    Even so, rental prices have held up and jumped for high-end
space. But a slump in office building sales paints a more dire
picture as capital remains reluctant to invest in a market
radically changed by remote work.
    "There's essentially almost no market for office buildings
right now because people don't know where the bottom is," said
Andrew Nelson, a real estate economist who runs Nelson Economics
in Washington. 
    Demand is strong for expensive space in trophy assets, but
everything else is "getting more and more vacant," he said.
"It's a slow-motion train wreck that's going to take years to
play out, but it's bad now and it's going to be getting worse." 
    Unlike in past economic cycles, the office market has yet to
correct after more than three years of a downturn, said Andrew
Lim, a research director at Jones Lang LaSalle Inc  JLL.N  in
New York.
    Opportunistic investors who could clear the market of
unneeded office space and help lift values are biding their
time, sitting on the sidelines, Lim said.
    "We know there's s a lot of capital around, whether it's
from domestic firms or sovereign wealth funds," he said. But
"buildings going back to the lenders or in foreclosure has not
been as widespread as some of the more pessimistic pundits have
predicted."
    The number of buildings in Manhattan with loan balances that
exceeded their market value rose in the second quarter to 112,
with 33.4 million square feet of space, from 73 with 15.1
million square feet of space the prior quarter, JLL said. 
    The difference in the current valuation of the 112 buildings
from their last, mostly pre-pandemic sale price, totaled $38.3
billion, JLL said. That's down from a valuation loss of $75.8
billion in the first quarter, the brokerage said.
    The biggest construction boom in New York in decades, and
building renovations that often cost $100 million or more, have
kept office supply high and favored tenants looking to lease.
    Year-to-date, negative net absorption – when an increase in
supply along with more space being vacated is greater than the
amount of space leased – is now 2.75 million square feet,
brokerage CBRE Group Inc  CBRE.N  said this week. 
    The increase in negative absorption comes despite the number
of office jobs in Manhattan now exceeds pre-pandemic levels.
    Leased square footage was down 46.7% from last year's second
quarter and was the lowest quarterly volume since the first
quarter of 2021, JLL said in a report.
    And Savills Plc  SVS.L  said direct available office space
in Manhattan now measures 70.4 million square feet, the highest
in history.
    "People talk about converting into residential, and that's
certainly possible for some, but it's way overstated what the
potential is," said Nelson, throwing cold water on hopes
large-scale conversion will right-size the market.
                
    CONCESSIONS SOAR AT HIGH END 
    Landlords have increased concessions to bolster asking rents
- a key metric in commercial real estate loans that lenders use
to judge the revenue a property can generate - that have held
steady during the pandemic.
    "Asking rents overall really haven't shifted since 2019,
which is an anomaly given what past cycles have been like," Lim
said. "We know that is not perhaps the real state of the
market."
    Net effective rents, which include concessions such as
allowances for tenants to improve an office, have doubled in
price to $106 per square foot this year from $53 in 2020 for
trophy buildings, Lim said.
    But the net effective rent for office space in older Class B
buildings barely rose during the pandemic, to $50 from $48, a
sign of the market's bifurcation between demand for the very
best and the lack for lesser quality.
    Mark Berry, managing director of REIT credit ratings at
Kroll Bond Rating Agency LLC in New York, said capital sees an 
opportunity but it's difficult to underwrite loans for office
buildings as sales are so few it's hard to judge true value.
    "I don't think values are yet at the point where those pools
of capital are ready to put the money to work."
   

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 (Reporting by Herbert Lash, Editing by Nick Zieminski)
 ((herb.lash@thomsonreuters.com; 1-646-223-6019; Reuters
Messaging: herb.lash.reuters.com@reuters.net))