New York City’s biggest business owners have done it well for years – benefiting from a booming economy in a city where businesses clamored to set up offices and low interest rates that supported the economy of a debt-based industry.
Those days are over. Three years into the pandemic, the floors of Manhattan office buildings have been emptied by tenants shrinking their footprints and employees working from home.
Now there is another problem.
Rapidly rising interest rates have heightened concerns that New York’s office market, the nation’s largest and a mainstay of the city’s economy, could be in serious jeopardy. That punch could be worse than anything business owners have experienced before, industry experts say, leading major banks and property analysts in recent weeks to warn that languishing properties as well as falling property values and rising borrowing costs could increase the chances of a national recession and a fiscal crisis for the city.
More than two-thirds of all commercial property loans are held by small and medium-sized banks, raising concerns that regional banks may not be able to weather a wave of defaults if homeowners cannot repay the loans . Some analysts have predicted a bleak future for downtowns, likening the crisis to the slow death of many US malls.
In the latest snapshot of the nation’s largest office market, New York’s largest office landlord, SL Green Realty Corporation, revealed that more of its properties had lost tenants in the first few months of 2023. In its 25 buildings, including some of the city’s first office buildings, 90.2% of the space is occupied, up from 95.5% at the start of 2020.
The consequences extend far beyond the balance sheets of the city’s landlords, who borrowed billions at low rates in the years before the pandemic to build, buy and modernize offices and attracted big-name tenants like Meta and Apple in the city.
City office workers earn about 75% more in annual salaries than the rest of the private sector, according to the State Comptroller’s Office, and their daily absence from the office robs many businesses of their expenses.
And the value of New York’s office buildings could drop by $48.75 billion in the coming years, according to a recent study by researchers at Columbia and New York universities, hampering a vital source of tax revenue from the city.
Stijn Van Nieuwerburgh, professor of real estate at Columbia University’s business school, warned that New York City is facing an “urban disaster loop” triggered by remote working. While the current downturn in commercial real estate shares similarities with previous declines, including periods in the early 1990s, after the September 11 attacks and during the 2008 financial crisis, this decline has a new twist: the Declining demand for office space appears permanent, he said.
“We can debate whether we need 10%, 20% or 30% less office space in the long term than before,” said Dr Van Nieuwerburgh, “but everyone agrees that the number is greater than zero..”
Wall Street investors have had a particularly gloomy view of the office sector throughout the pandemic, but their assessment of the sector has deteriorated in recent months. Big banks like JPMorgan Chase and Wells Fargo have increasingly warned that a slew of commercial loans will come due by the end of 2025 – estimated at $1.5 trillion nationwide – and that businesses may find it difficult to repay or refinance them.
Shares of SL Green and two other publicly traded office owners in the city, Vornado Realty Trust and Empire State Realty Trust, are all trading near their lowest level since the pandemic began.
Shares of SL Green have fallen 76% since the start of 2020. Vornado is trading at its lowest territory since 1996. Empire State Realty, which owns the Empire State Building, is near its all-time low. Collectively, $17 billion of their market value has been wiped out since the pandemic began.
“All three are office-centric, all three New York City-centric,” Van Nieuwerburgh said. “It is the stocks, the stocks of offices, which have been ransacked. It’s breathtaking.
Vornado and Empire State Realty will release their quarterly results in the coming weeks. At the end of 2021, Vornado buildings in New York were 90.4% occupied, compared to 96.7% at the end of 2019; Empire State Realty buildings in Manhattan were 86% occupied, down from 89.8%.
Private equity firm Blackstone, the world’s largest commercial property owner, announced last week that its latest distributable profits, which represent cash used for shareholder dividends, were $1.25 billion. dollars in the first quarter, down 36% year-on-year. There is.
Executives said on Friday the company had significantly reduced exposure to the office sector in its real estate portfolio and warned of looming challenges for those properties. Last year, Blackstone returned the keys to a Manhattan office building, 1740 Broadway, to lenders.
Last quarter, SL Green reported revenue about 28% lower than the same period in 2020, but still above Wall Street expectations. In an earnings call on Thursday, the company’s chief executive, Marc Holliday, criticized what he said were alarmist predictions about the industry.
“The commercial real estate industry seems to be dominating much of the headlines these days, amplifying the messages of doom and gloom and creating what I believe is the excessive market anxiety that is most felt in New York,” Mr. Holliday said. said. “Overly negative voices overshadow some of the positive signs that point to a slow but steady recovery.”
Alexander Goldfarb, managing director and senior research analyst at investment bank Piper Sandler, said SL Green’s better-than-expected earnings should ease some concerns about an impending collapse in the office sector.
Still, many owners might not get over it. While large landlords who own offices in Manhattan that remain in high demand or who own properties elsewhere in the country may be in a better position to bounce back, many smaller businesses who own older, less desirable properties could face pressure. enormous. According to analysts, around 80% of office leases signed in the first months of this year were in buildings considered to be at the top of the market, known as Class A.
In New York’s office market, which comprises about 400 million square feet, Goldfarb said, nearly two-thirds of its buildings are facing obsolescence because they are decades old and largely unattractive to tenants. tenants.
Tenants are looking for newer space that offers amenities and proximity to transit stations, like One Vanderbilt, SL Green’s newest tower next to Grand Central Terminal, he said. Leases for this building are among the highest in Manhattan, with some exceeding $200 per square foot.
“They’re going to continue to win the share,” Mr. Goldfarb said.
After dismissing the endurance of hybrid work at the start of the pandemic, executives at SL Green and Vornado are now admitting that the workweek has changed for the foreseeable future.
Vornado, for example, aimed to transform the Penn Station neighborhood into a major commercial district that could command some of the highest rents in the city, similar to its neighbors in Hudson Yards and around Grand Central Terminal. But company executives decided in recent months to put the project on hold, citing higher interest rates.
All three companies rushed to find new revenue streams. Empire State Realty has sold several suburban office buildings and expanded into the apartment market, buying three properties in Manhattan since late 2021.
But there is no silver bullet for office owners. One attractive possibility – converting underutilized offices into residences – is too expensive with today’s interest rates, and it’s often structurally difficult.
Vornado considered bidding to place a casino near Penn Station in midtown Manhattan. It also plans to build more residential towers following the completion of its luxury condominiums at 220 Central Park South in 2019, where a residence sold for nearly $240 million, the most expensive home sold in the United States. United.
SL Green is also looking into gambling: it has partnered with Caesars Entertainment to offer a new casino in Times Square, competing with other groups for one of three casino licenses allowed in northern New York State.
The project would be “in everyone’s interest”, Mr Holliday said during Thursday’s call. “It would be a huge catalyst to revitalize and invigorate what’s in New York and I would say it’s the most important tourist destination in the world.”