The office vacancy rate and available sublet space in Manhattan, home of the largest U.S. concentration for this property type, both rose to new records as remote work, higher interest rates, layoffs and concerns about a possible recession wrought further damage to an already troubled New York market.

The first-quarter office vacancy rate in Manhattan reached 16% for the 470 million square feet of space tracked by JLL, the brokerage firm said, adding that leasing has continued a slowdown that began at the end of last year. Despite what it described as “resiliency at the top of the market,” reflecting the flight-to-quality pattern, JLL said first-quarter leasing volume is the smallest since the second quarter of 2021.

“We’re going to have a very significant distress cycle in the office sector” in the United States, Roger Morales, partner and head of commercial real estate acquisitions at private equity giant KKR, said at Goodwin and Columbia Business School’s 2023 Real Estate Capital Markets Conference in New York on Wednesday.

In another indication of market malaise, the city’s office leasing activity in the first quarter was driven by renewals as “discretionary deals” slow and tenants “exercise caution at a time of increasing economic uncertainty,” Savills said in its first-quarter Manhattan market report. Renewals made up 63.1% of first-quarter leases, “a major increase” from 44.6% just one quarter earlier, Savills said.

Meanwhile, companies putting spaces up for sublease reached an all-time high of 22.4 million square feet in the first quarter, accounting for 24.6% of all available office space in Manhattan, Savills said.

CoStar data also shows office vacancies both in New York and nationwide have reached new record highs.

“Landlords are under even more pressure to stay competitive, either by investing in new tenant amenities or by offering generous concessions,” JLL said. “But, with higher borrowing costs and tighter access to funding, capital-constrained landlords may find it hard to add amenities or offer competitive incentives.”

The latest market scorecard come as security firm Kastle Systems’ average return-to-office rates in both New York and other major cities still hovers around 50%, more than three years after the start of the pandemic. The metric in some markets including New York has never crossed the halfway mark during that time.

Heads of major office landlords, such as Boston Properties Chief Executive Owen Thomas, described the space as being “in a recession” while Vornado Realty Trust’s Steven Roth recently conceded “Friday is dead forever. Monday is touch and go,” as he said some corporate leaders have “no power” to get people back to the office.

“Coming out of the pandemic, human behaviors changed,” Brady Welch, founding partner at Slate Asset Management, said at the conference. “There’s a lack of leadership to get people back in the office. … [The impact isn’t] just about an office. It’s the whole ecosystem of the city.”

The low office use rate is compounded by the fact that higher interest rates and fears about an economic downturn have seized up financing and other market activity, with the issues further exacerbated by the recent fallout of regional banks such as New York’s Signature Bank that have been among major lenders to real estate projects.

Also, job cuts and a pause or change in expansion plans from tech giants including Google and Amazon, which have been key occupiers of top-tier office space in New York and other cities, threatened to create more supply in the marketplace at a time of uncertain demand.

For instance, while deals over $100 per square foot made up 22% of Manhattan’s first-quarter leasing volume, a large amount of trophy sublease space that came on the market in the second half of 2022 led to the steepest decline in trophy towers’ direct rents since the third quarter of 2021, JLL said.

Trophy direct rents dropped to $103.49 in the first quarter from $105.74 in the fourth quarter and from a peak of $113.10 in the second quarter of 2021, Andrew Lim, JLL’s research director, told CoStar News in an email, adding that 40% of Manhattan’s trophy tower vacancy at the end of 2022 was sublease space.

“This glut of sublease space, a lot of it in new construction with long sublease term lengths available, was arguably able to compete with the direct trophy space,” Lim told CoStar.

Manhattan’s average overall rents remained essentially unchanged at $76.96 per square foot in the first quarter as rising Class A direct rents offset declines in Class B and sublease space, JLL said.

Subleasing is just one element driving record New York vacancy. More than 1.5 million square feet of office inventory was added in the first quarter from the completion of 660 Fifth Ave.’s renovation, which increased the vacancy rate, according to JLL.

KKR’s Morales expects the return to “some equilibrium in supply versus demand” is “going to take a very long time,” and almost every office building had at least one or two lease terminations going back to 2020.

The various factors at play facing the market have led major office landlords including Brookfield Asset Management and Columbia Property Trust to default on office loans recently.

Columbia, which owns top-tier properties in gateway cities from New York to San Francisco, defaulted on a $1.72 billion floating-rate loan backed by seven of its towers in New York and other cities housing well-known tenants including WeWork, Twitter, BuzzFeed and Snapchat. Brookfield’s loan defaults are tied to a pair of Los Angeles buildings.

“It’s almost impossible to get a loan on a high-quality office building today,” Scott Rechler, chairman and chief executive of New York-based developer RXR Realty, told a packed room of nearly 500 at the conference. Every building has “been painted with the same brush. … No one wants to go to their credit committee or their investment committee and talk about an office building. … Where you’re seeing the cracks isn’t necessarily the quality of the buildings. It’s the capital structures that are on those buildings.”

Still, therein lies the opportunities, Rechler said. RXR is making $250 million in preferred equity investments in some office properties to “get a preferred return and a share of the upside in that area,” he said. “It’s an opportunity for those that want to look through the noise … and identify which are the ones that will be successful, and make those investments.”

About 20% of buildings in New York are “competitively obsolete,” Rechler said, with only some of them suited for conversion to multifamily and other uses.

“This is probably a 20-year painful process that’s going to create a significant amount of challenges to our city’s ecosystem,” he said, adding some 70% of the city’s revenue comes from real estate taxes. “This is really more of an existential threat to our city.”

And the problem is far from being exclusive to New York.

“It’s not in New York alone,” Rechler said. “I’d rather be in New York than San Francisco. San Francisco can be the Detroit of our generation [being] so focused on one industry. New York’s big asset is talent.  We have this incredibly deep diverse talent pool that nowhere else in North America or the world has. New York has the best and brightest talent across so many sectors. … There are lots of cities that don’t have that.”

RXR bought $2 billion of multifamily property during the period of the pandemic when “everyone was leaving” New York, Rechler said. The occupancy rate at the properties, however, has surged to 98% from the low 80% range at the time of purchase, Rechler said.