New York’s office recovery shows improvement, but industry pros aren’t celebrating yet

Jeff Peck, vice chairman at the brokerage Savills in New York, knows he should feel good about helping to arrange three of the largest office leases in the city this year, with two involving top-dollar per-square-foot rents of over $100.

But the 25-year industry veteran said those transactions — spanning 110,000 to 300,000-plus square feet — only tell half the story about what’s going on in the largest U.S. office market.

“You’ll think the market is coming back, I should feel positive,” Peck said in an interview. The reality is, with the rise in hybrid and remote work, most companies need "much less space. These three tenants are part of the top 1% of companies that are looking for the top 1% of the Class-A-plus buildings," he added. But if you're a tenant who doesn't need to chase that limited supply of the highest-quality space, you have a big upper hand and, he said, "the world is your oyster."

More than four years since the COVID-19 pandemic rewrote the script of how Americans work, the recovery of the office market in New York, home to a "who’s who" list of corporate giants and a barometer for the rest of the country, remains uneven. Industry professionals are reluctant to celebrate yet.

On one hand, there have been growing signs of improvement as CBRE, the biggest global brokerage, pointed to New York as a driver of its U.S. office-leasing performance in the second quarter, which in turn led a “double-digit” increase in its global office activity. On the other hand, that momentum was driven by tenants seeking well-located, new or renovated properties with desirable amenities or getting lured to new space by proactive landlords and incentives, according to brokers and analysts, pointing to a glut of often lower quality or older unrevamped space that still presents challenges to the market.

“A number of indicators are indicating a recovery is emerging” in New York and other gateway markets, Jessica Morin, CBRE’s U.S. director of office research, told CoStar News. She adds that Sun Belt markets such as Austin, Texas, and Nashville, Tennessee, also have outperformed the U.S. average because of net migration gains, but it’s “too early to call a recovery yet."

She added that New York’s momentum "is a positive sign for the rest of the country. It was one of the hardest-hit markets" during the pandemic so she calls it a sign of optimism for the U.S. as a whole.

The top 8% of U.S. office space CBRE considers as prime, ranked by building quality and surroundings, had a second-quarter vacancy rate that was 3.6 percentage points below the U.S. average, Morin said, signaling a “divide in the market” and that the preference for properties with perks such as rooftop views and high-end gyms isn’t ending anytime soon.

She added that in New York, activity differs by neighborhood, with Midtown and Midtown South driving leasing while downtown Manhattan lags.

For Alfonso Munk, chief investment officer of the Americas at developer Hines, when it comes to offices, “one third ... is doing well in New York,” with more move-ins than move-outs and higher rents, he said in an interview. For another “third of stock that’s average, it’s about putting the right rent. There’s no capital now to renovate office. Over time those will be leased because they will compete on price" and are well-located.

As to the bottom third of offices that are often in downtown or in much lower-tier buildings around the city, Munk said, “they are going to significantly suffer to attract tenants.”

In a telling example of this large demand for high-end New York City office space, the roughly 1,400-foot-tall One Vanderbilt, in which Hines has a stake, has zero vacancy and commands top-dollar rents including a deal crossing $300 per square foot, in contrast to what CoStar data shows as the city’s still near-record high vacancy rate of about 14%.

Hines co-owns One Vanderbilt, opened in late 2020, with Manhattan’s largest office landlord, SL Green Realty, and the National Pension Service of Korea, according to CoStar data.

“Office buildings that have certain characteristics that attract people … that could be location, age, amenities such as having food and services, people want to go work in them,” Munk said. "One Vanderbilt is proof of the resurgence of Midtown and the quality of the office building."

He said that as interest rates fall, "ultimately there’ll be opportunities to develop offices in New York" because there isn't a lot of "trophy office space left."

In another sign of the impact of hybrid work, the average lease size in the second quarter fell 26% short of the pre-pandemic level, CBRE’s Morin said, adding the firm expects an up to 15% long-term reduction in office space per worker from before the pandemic.

Meanwhile, with interest rates and inflationary pressures leading to “high costs of moving and build-out,” renewals represented 45% of second-quarter U.S. office leasing, up from 30% pre-pandemic, she said. Last week, the Federal Reserve made a half-percentage-point cut to its benchmark interest rate, a long-awaited move that real estate investors hope will be a first meaningful step toward a recovery of property values, deal volume and development activity.

“I’m visiting 15 offices per week,” Savills’ Peck said of his work in New York. “These offices are basically empty Monday and Fridays. … Very few [employers] have gotten away with everybody back four and five days a week."

Those offices sitting empty at least certain days of the work week have increasingly become part of the budget calculation for tenants, some of whom don’t even wait until their leases expire as the old norm of one office worker per desk is increasingly becoming a thing of the past for many companies, according to Peck. Employers cutting back tend to make do with less space, he said.

As space needs for a number of companies have declined, landlords are more proactive than ever. For instance, Peck’s team has been working with a commodities trading firm seeking to relocate from 60,000 square feet to about 33,000 square feet in the neighborhood by Grand Central Terminal. The process led Peck to witness something he’s not seen before: Instead of going out to tour buildings and sending landlords offers, his team instead is getting offers from landlords unsolicited. The trading firm’s new landlord is also footing the bill for it to break its current lease in the form of free rent, Peck said.

“It’s a market share discussion” for landlords, Peck said. “Tenants like this across the board are saying, ‘We need 30% to 50% less space.’ … Most aggressive landlords are winning. … I had a conversation with a landlord. The landlord said, ‘Tell us where you need to be, and we’ll do it.’ They are willing to accommodate whatever we need.”

That's for a good reason: there’s still a mountain of space on the market.

Even though Manhattan’s office availability rate has dipped to about 17.5%, or 95 million square feet of available space, from a record high reached in February of 18.2%, or just over 98 million square feet, the market still has seen a net increase of more than 41 million square feet of available office space since March 2020, Frank Wallach, executive managing director of research and business development at brokerage firm Colliers, told CoStar News. Manhattan has a total of about 540 million square feet of office stock, he said.

“If you look at the results in the past six months, it’s very tempting to say that we’ve reached that inflection point” of market trajectory going "from decline to recovery," Michael Cohen, a 40-plus-year industry veteran who serves as both president of Colliers’ New York tristate region and managing principal of Manhattan office landlord Williams Equities, said in an interview.

Even so, “it’s not time to break out the champagne," he said. "The market has never in my lifetime [seen] this type of surplus.”

To compete for tenants, landlords are offering more incentives than ever. The average free rent on a new direct Manhattan office lease lasting at least five years rose to 15 months last year from less than 10 months in 2015 while tenant improvement allowances rose to about $140 per square foot from over $60 during the same time, Colliers data shows. Colliers’ Wallach said he’s seen tenant improvement allowances crossing even the $200 per-square-foot range.

“We have tenants that come to us making all kinds of requests if not demands,” Cohen said. “Keeping tenants happy and renewing them in place is still the best strategy. … The laws of supply and demand are still like the laws of gravity. … The leverage still favors the tenants.”

Williams Equities is now also furnishing and building out space for tenants, which Cohen said is “a new twist” to appeal to a certain segment of the market by “offering immediate gratification.”

“It’s yet another amenity landlords need to consider financing,” he said.

With tenants having an advantage in the market, a new trend has surfaced where they increasingly ask legal documents they sign with lenders and landlords to include language that would honor financial concessions in the event a building defaults on a loan, said Josh Winefsky, a partner at Kramer Levin, a real estate law firm.

Manhattan office landlord Sage Realty, with a portfolio including renovated properties on Third Avenue near Grand Central, is "just starting to see" a “significant uptick” in leases spanning 10,000 to 15,000 square feet as coveted spaces closer to the transportation hub and on Park Avenue have been filled, CEO Jonathan Kaufman Iger told CoStar News.

“A number of years ago, people sounded the death knell of Midtown Manhattan,” he said. But “Park Avenue still carries that name and address. … Over the last 12 to 18 months, what we are starting to see is this radial expansion of Grand Central. If you can’t be within four blocks, you can now be within six to eight blocks. … The market never turns on a dime. Market rebound happens gradually. Negotiations can take nine months. There’s a lag within our market. I wouldn’t say the market has turned. [But] the market is turning.”

In addition to amenities, what's nearby a building also factors into tenants' decisions.

For instance, Boston-based construction management firm CM&B during the pandemic relocated its New York office from the Penn Station area to across from Bryant Park, partly due to some safety concerns, Leah Blackman, CM&B's senior vice president, told CoStar News, adding it’s paying more at the new office for a similar-sized space.

“The team now sees the park as an amenity and a safer area,” she said. “We were able to trade up to a nicer neighborhood. ... It was a huge win for us.”

CM&B isn't alone. Tech giant IBM, in another example, recently opened its Manhattan flagship across from Madison Square Park, with views of the green space an important part of the office's design.

But parks and other neighborhood perks aside, easy access to transit options remains a top consideration. Commuters want to take just one train directly to the likes of Grand Central or Penn Station and walk to the office without having to transfer, Savills' Peck said, looking for that "one-seat commute."