Amherst Capital commentary: Stabilized top–tier office most exposed to a potential slowdown in Manhattan
Manhattan and surrounding New York City metro employment is growing and office absorption has been positive — but at a weaker pace than a few years back, according to Amherst Capital’s October commentary report.
Employment in New York City has fully recovered following the 2008 recession, with the number of jobs in New York City reaching 4.5 million in June 2018, according to the Bureau of Labor Statistics. Most importantly, from a commercial real estate perspective, office-using employment has shown steady growth, with year-over-year office-using employment posting 2.5 percent growth in 2014 and 2015, higher than the national average. However, office-using job growth in New York City has slowed since 2015 with second quarter 2018 growth of just 1.2 percent year-over-year, as compared to 2 percent nationally.
While the job market has helped support steady demand, another factor impacting office demand in New York City is the rise of co-working spaces. Co-working companies such as market-leader WeWork provide shared space for multiple companies, with shared amenities and potentially without assigned space. Additionally, leases are short term, increasing flexibility for end-users of the space. According to Cushman Wakefield and CoStar as of August 2018, 11 million square feet of office space in Manhattan and 12 million square feet in New York City is leased to co-working companies. Co-working companies remain a small portion of the market size at 2 percent to 3 percent, but account for 10.5 percent of all leases signed during the first-half 2018 and represent 260 percent of the cumulative net absorption since 2013, according to Cushman Wakefield and CoStar data.
Many of the co-working companies are new and have not experienced a recession, and have long-term liability in their leases to office owners. This liability mismatch could lead to a faster increase in supply and exacerbate weakness in stressed office market conditions.
Even though most of the new supply has yet to arrive on the New York City market, rents are already showing signs of distress. Office rents have declined on a year-over-year basis –0.6 percent in the second quarter 2018 in Manhattan, after declining –0.8 percent in the year ending second quarter 2017. The slowdown was broad based across submarkets of Manhattan, with even the previously hot Midtown South and Downtown neighborhoods showing declining year-over-year rents through second quarter 2018 after posting double-digit rent growth in 2013–2015.
Another sign of rent pressure is the steady increase in concessions needed to sign tenants for new leases. Data from leasing broker Savills Studley indicate that tenant concessions in Midtown Manhattan reached $182 per square foot in 2017 compared to $152 per square foot in 2015 and $69 in 2007. Combined with lower gross rents, increasing concessions indicate more significant declines in effective asking rents. Rent pressure may continue as new supply comes online in the next few years, particularly if demand continues to exhibit slow growth.
Amherst concluded with the new development in the pipeline supply is expected to increase considerably in the coming years. Properties owned at lower bases and with necessary capital expenditures may continue to do well. However, for equity investors in stabilized assets, there might be reasons to be more cautious than before. And with co-working, the growing presence may result in greater pressure on landlords. Co-working companies’ short-term, flexible tenants are supported by long-term liabilities that may be harder to navigate than it seems during economic downturns. Amherst recommended to invest in structure strategies that focus on value-add rather than levered positions in stabilized assets facing re-leasing risk.
