Flight to quality, new concepts, repositioning and conversions

Investor demand for office properties in New York increased in the first six months of 2022 with trades of $4.7 billion, up 11% from 2H 2021 and 353% from 2H 2021. 1H 2021, Ariel Property Advisors Research shows.

Two first-half transactions stand out as distinct trends in the office market. These include Google
GOOG
$2.1 billion purchase of an office development, St. John’s Terminal in SoHo, which represented 45% of the dollar volume of this asset class, and the purchase by RFR of 475 Fifth Avenue in Midtown for $290 million, more than double the $143.9 million Nuveen paid in 2011.

Google: Build a home, not just an office

Google is a pioneer because the company is not just creating an office, but a home for its employees at the St. John’s terminal. Alphabet and CFO of Google
CFO
Ruth Porat wrote in a blog post that this “skyscraper” will include offices occupied by Google, a public food hall, community space, galleries, the largest public rooftop space in the city and educational and environmental programs managed by the Hudson River Park Trust.

Knowledge workers, especially at TAMI, are in high demand and a single, laid-out workspace like Google’s horizontal campus is one way to retain them. Therefore, other companies can be expected to build day houses for their employees. Another tech giant, Amazon
AMZN
is renovating the historic Lord & Taylor Building in an excellent Midtown location at 424 Fifth Avenue, which it acquired from WeWork for $978 million in March 2020 just before the Covid-19 shutdown.

Rather than buying buildings, other tech companies are renting office space and leaving landlords to make major upgrades. Meta (Facebook) signed a 730,000 square foot lease in August 2020 for the Farley Post Office building across from Penn Station where owner Vornado is investing $1.03 billion to redevelop it. In January 2022, Roku announced it was taking 240,000 square feet on the top eight floors of 5 Times Square, where owners RXR and David Warner launched a $126 million capital improvement project that will include 50,000 square feet of equipment, and Microsoft
MSFT
leased 150,000 square feet of space in October 2021 at 122 Fifth Avenue in Union Square, where Bromley Companies is undertaking a $100 million upgrade with private and communal patios.

Investor flight to quality: location and location

A few blocks north of the Amazon building, RFR purchased 475 Fifth Avenue in May 2022. This well-located Midtown asset with excellent rental is an example of quality and that starts with its location a few blocks away. of homes from Grand Central Terminal and across from the New York Public Library and Bryant Park, which are sort of natural amenities in the city. This transaction follows RFR’s acquisition of 522 Fifth Avenue for $350 million from Morgan Stanley.
MRS
in August 2020.

Similar recent sales with attractive tenants in desirable locations include Commonwealth Partners’ December 2021 $1.033 billion acquisition of Hudson Commons at 441 9th Avenue, which is 75% leased to Lyft and Peloton; Meadow Partners’ purchase for $288.23 million in June 2022 of 95 Morton Street in the West Village from RFR, whose tenants include PayPal, Venmo and Fanatics; and Macquarie Asset Management’s $130 million acquisition in January 2022 of 375 W Broadway in SoHo, where financial services payments technology company Block leases the top four floors.

Post Covid-19: back to basics with proactive management

Despite these high-profile deals, no asset class has been hit harder by Covid-19 than the office sector. The culture of “working from home” has reduced office occupancy rates to around 40% of their pre-pandemic level and the existing stock of office space available for rent at a staggering rate of 19.2%, significantly exceeding demand. As a result, we see a clear division between newer buildings, those with efficient managers, attractive amenities and locations, and “tired” high street products.

During the last years of our firm, Coffee & Cape prices event, panelist Andrea Himmel, Director, CIO and Head of Acquisitions for Long-Term Office Owner/Operator Himmel + Meringoff Properties, said she believes New York City remains an attractive office investment, noting that office buildings in his company’s portfolio were back to over 90% leased, although physical occupancy was even lower.

Himmel said his company is still bullish on the city’s office sector and is a buyer for some office buildings near public transit in emerging and/or temporarily run-down neighborhoods. “As long-term holders, we are patient and can arbitrate time because we don’t price assets based on current income,” she said.

“In our own portfolio, we’ve signed about 1 million square feet of leases over the past year, three or four of which were 100,000 square feet or more for 15 to 30 years,” Himmel said. “We just signed a 30-year agreement with Mount Sinai for 50,000 square feet at our property on 57th Street, a life sciences building, 100,000 square feet for NYPD and 70,000 square feet for NYU, between others.”

Success in today’s office market requires active management and a strong proactive approach that Himmel and his team have behind them. In fact, she sees an opportunity to replace owners who aren’t as committed to management and pay them off.

“I think landlords facing capital calls and then debt refinances over the next 12 months are going to be stuck,” she said. “They won’t be able to refinance their property because it’s now half empty and the LTV is too high. I think we’re going to start seeing transaction activity in those buildings where rental costs are compounded by CAPEX charges. »

Office owners embrace coworking

Many New York City landlords are adapting to the changing environment by offering flexible office space. Himmel + Meringoff’s 1460 Broadway, for example, is fully leased to WeWork and is one of the coworking entity’s highest-performing buildings. Owner Tishman Speyer has expanded the footprint of his coworking brand, Studio, to 350,000 square feet, most recently introducing the concept at 175 Varick Street and 11 West 42nd Street. NYC Office Suites now offers short-term furnished flexible office space in the Chanin Building at 122 East 42nd Street, and Industrious offers coworking spaces in office buildings in Manhattan and Brooklyn.

With 45 million Americans working as freelancers and many tenants uncertain about the future of their business and their space needs, Himmel said flexible coworking alternatives would remain desirable. In fact, occupancy rates for well-located WeWork buildings in New York City are 60-70%, well above the citywide average of 40%, she said.

Conversions of offices into residences

Finally, some policymakers and housing advocates see the decline in demand for some office buildings as an opportunity to encourage office-to-residential conversions. However, this is a tall order. Modification of building structure is in most cases prohibitively expensive, office floor plates are not easily converted to residential use, locations are not always attractive and such conversions require zoning changes . Therefore, the city rarely saw them with a few exceptions.

Macklowe Properties has spent the past eight years converting the former home of Irving Trust and later Bank of New York to A Wall Street in the financial district into a 566-unit condo building. Sales are underway at the iconic tower for residences ranging from $990,000 for a studio and $12.75 million for a four-bedroom. The project is expected to be completed by the end of 2022.

Additionally, Silverstein Properties and Metro Loft recently agreed to pay $180 million for a 30-story office building in 55 broad streetalso in the financial district, and to convert it into 571 apartments at market price in the next three or four years.

“Converting office to housing presents an attractive opportunity given the arbitrage created by a potential short-term office oversupply and an overheated residential sector,” says Himmel, who also noted that it really can only be done. in buildings in zone C with floor plates. of at least 15,000 square feet and whose land is less than $400 per square foot. “You have to factor in no wastage factor, so for a given office building, you can probably build about 30% less residential square footage.”

Demand drivers bring hope to the office sector

High availability and low office occupancy rates can be seen as disheartening for New York City’s office stock. But there are encouraging trends that we should not overlook. First, office footfall growth has been substantial and doubled from 2021 to 40% in 2022, according to data from Castle systems. Second, bridges and tunnels traffic rose to 948,711 daily vehicles in August, slightly above pre-pandemic levels, MTA figures show. Metro ridership has steadily increased to 60% of the 5.5 million pre-pandemic riders and is expected to reach 4 million by the end of 2023. And finally, the connection of the Long Island Railroad with Grand Central by the end of this year it is expected to increase the number of users in the city by 160,000 and increase the capacity of the LIRR by 40%. Therefore, these demand drivers are encouraging and coupled with the above observations, the New York office market could be heading for a major recovery in the next few years.

Jose C. Birney