The overhaul of New York’s Penn Station, billed as the Western Hemisphere’s busiest transit hub, will proceed without relying on funding from office and other nearby commercial development — in the latest sign that uncertainty about workspace demand is reshaping development in the city.

Funding for the modernization of the train station that’s been described as an eyesore could instead come from government grants or other sources, New York Gov. Kathy Hochul said. Commercial projects led by Vornado Realty Trust were originally expected to be a key source of funding behind the station’s overhaul.

Contribution from some 18 million square feet of high-end offices, as well as retail, hotel, residential and other developments on eight sites was originally expected to be part of the sources of funding for Penn Station’s overhaul, estimated at $7 billion, and expansion, estimated to cost $13 billion, and for area transit and public-realm improvements, the state’s economy-promoting arm, Empire State Development, has said.

Vornado, which recently completed upgrading its Penn 1 tower and is revamping the Penn 2 tower above the station as part of its mega Penn District project, is pausing any new development in light of the economic uncertainty and higher borrowing costs that have seized market activity.

CEO Steven Roth, long a proponent of the benefit of employees working in the office, has also acknowledged that hybrid work patterns driven by the pandemic, higher interest rates and other economic concerns have led to a slower-than-expected return to the office.

“This has been a project that has had a few setbacks,” Hochul said at a news conference this week. “This has been a long talked about sometimes controversial initiative. … We are no longer tolerating the delay. [Penn Station is] crowded, congested. It’s unpleasant. We are decoupling this from the prior ... plan. It doesn’t mean we aren’t going to build office space at some point. While demand for office space is down right now, we believe this will be temporary.”

A Vornado spokesperson declined to comment to CoStar News.

The state’s change of plan comes as New York’s office vacancy rate has reached what CoStar data shows as another record high of over 13% with the amount of space for sublet also at a peak. Security firm Kastle Systems’ keycard swipe data shows New York’s office utilization rate still hovers just around 50%.

To lure tenants, even high-end offices benefiting from the so-called flight-to-quality workspace are giving away the equivalent of about a quarter of rent as concessions on average, a recent Avison Young study said. The lack of office workers also has curtailed area retail, restaurant, and other service businesses that depend on them, studies have found.

With 600,000 passengers coming through Penn Station daily before the pandemic, Hochul said, office development still makes sense for the commuters to “work in the same place where they commute to,” adding she also wants to build “more housing” in the area.

The state has estimated the plan to bring Metro-North Railroad service into Penn Station by 2027 will increase the number of daily passenger trips by about 15% from pre-pandemic levels over the next two decades, from 600,000 in 2019 to 678,000 in 2038.

New York state has already appropriated $1.3 billion for Penn Station reconstruction, which is “both separate and distinct from the future Penn Station expansion,” Hochul’s office said in a statement.

She added that more funding for the renovation is expected to come from state and federal grant programs and sources that make it possible to finance the overhaul “without immediate development proceeds.”

Hochul’s press event kicked off what she described as a design process. “We are open to any architect, design firm and engineering firm to compete for” the project, she said.

Penn Station “is something that’s an eyesore New Yorkers are ashamed of and scared about,” Metropolitan Transportation Authority CEO Janno Lieber said at the news conference, adding the renovation is set to make the new Penn Station train hall bigger than the combined size of the new Moynihan Train Hall, across from the existing Penn Station, and Grand Central Terminal.

He said a large Penn Station train hall will be possible by taking steps including removing some of the upper-level taxiway that originally allowed for cars to pull up to Madison Square Garden or Penn Station but hasn’t been used since the Sept. 11 terrorist attacks.

He said an overhaul also is possible without removing a smaller 5,600-seat theater within the famed sports and entertainment complex. Italian company ASTM has reportedly planned to buy the venue from MSG Entertainment, Madison Square Garden’s owner, and knock it down as part of its proposal to rebuild Penn Station.

Hochul’s office said in the statement it will begin talks with MSG to “seamlessly integrate the arena with the redesigned Penn Station.”

MSG has filed a special permit request seeking approval from the New York City Planning Commission to continue operating Madison Square Garden, home to the NBA’s Knicks and NHL’s Rangers, in its present location.

The filing came as MSG’s city arena permit, issued in 2013, is set to expire July 24.