What is the Outlook for NYC Commercial Real Estate?

Office attendance rates have flatlined, and remote work significantly weakened demand for office space. This could result in a drop in office property valuations by the City, reducing property tax revenues.

However, multifamily real estate is doing well and is one of the best-performing asset classes nationwide.

1. High-Interest Rates

Increasing interest rates are putting pressure on the NYC commercial real estate market in several ways. The higher borrowing costs make it more expensive for investors to buy existing properties and depress demand for new development. Those factors are likely to push cap rates, but the overall effect will probably not be as severe as in 2009 and 2021.

The higher interest rates are also causing some companies to reconsider their office space needs. As a result, many large tech firms (like Twitter and Meta) have recently announced layoffs, while other office users, such as Amazon, Lyft, and Yelp, are considering reducing their real estate footprints or moving to smaller offices. These changes could reduce demand for office space when leases come up for renewal, further contributing to the rising vacancy rate.

Another problem is that higher interest rates make it more expensive for owners to refinance their loans. That could hurt the commercial real estate market, but it could be especially problematic for apartment buildings and retail properties. The soaring interest rates are already beginning to cause a slowdown in leasing activity. So far this year, Manhattan has seen only 12.2 msf of leasing transactions, which is well below the average for 2000-2019 and the lowest watermark since 2009.

In addition, the higher interest rates are raising the risk of a recession, and that could further dampen office occupancy. This is likely to lower the number of people who go to work and may also lead to a drop in the valuations that the NYC Department of Finance assigns to office buildings. This could significantly lower the City’s property tax levy.

These trends should stress the commercial real estate industry, but it is essential to remember that the market is resilient and will recover from any downturn. The best way to protect your investments in this sector is to diversify your portfolio and maintain a solid business plan focusing on strong cash flow and growth.

2. Layoffs

As the first quarter of 2023 ended, it was clear that New York City’s office market had stalled. Brokers’ confidence plummeted to a record low, and occupancy levels dipped across all sectors. The reason? Layoffs, a slow lending environment, and high-interest rates.

A resurgence in the New York City commercial real estate market will likely require a combination of demand-side and supply-side factors to be successful. On the demand side, it will require an increase in the number of companies establishing or expanding their presence in NYC. On the supply side, it will require re-purposing existing space into offices or other uses.

In addition, the resurgence will also depend on tech giants like Amazon and Google re-expanding their footprints in NYC. However, in the face of lingering job uncertainty, some tech firms are rethinking their office spaces and slashing jobs. This has led to the re-leasing of a significant amount of sublease space by tenants that would otherwise be leasing new space in Manhattan, and it has led to the sharpest decline in trophy tower direct rents since the third quarter of 2021, according to JLL.

Meanwhile, aggressive interest-rate hikes by the Federal Reserve and a looming recession have caused a wave of layoffs in the CRE world. For example, mortgage brokerage firm Better’s Zoom cut its workforce in November of 2021, and commercial real estate software companies like Redfin and Side have scaled back their teams as the deal flow has slowed.

The impact of layoffs in the industry is a sobering reminder of how quickly and dramatically conditions can change. A year ago, brokers were gushing about the new business opportunities that had emerged during the COVID-19 pandemic and were confident about their ability to negotiate attractive client deals. But the reality is that a lot of new business has dried up, and many young professionals are leaving commercial brokerage altogether or scaling back their hours, as evidenced by recent departures from Avison Young, Marcus & Millichap, and CBRE.

This shift to remote work has been theatrical in the luxury office market. While the average direct office rent in Manhattan’s top-tier buildings is still above $200 per square foot, SL Green’s newest tower, One Vanderbilt, has seen its average vacancy rate fall to 14% after a strong leasing campaign in the second half of this year.

3. Inflation

Inflation can have a wide range of impacts on the real estate industry. It can make it difficult for potential buyers to enter the market or experience less favorably leveraged financing. It can also benefit landlords, as they may be able to increase rent prices more efficiently in line with inflation.

However, high inflation rates can also hurt the commercial real estate sector. For instance, it can make it more expensive for developers to borrow funds for new projects. This can lead to fewer new construction projects and a slower overall market. In addition, high-interest rates can discourage investors from purchasing commercial properties. This can reduce the supply of available properties and potentially push up prices.

Despite these challenges, many commercial property types will hold up relatively well during this period of elevated inflation. For example, office buildings can benefit from a return to business-as-usual trends as companies begin to operate again and increase their staff sizes. Other asset classes, like retail and industrial, may see demand rise due to businesses’ and consumers’ pent-up need for those spaces. Finally, hotel real estate may be able to take advantage of the growing number of travelers and rising airfares.

But other sectors, such as multifamily and self-storage, may experience a more moderate price increase. These sectors tend to have shorter lease durations than office and retail properties, allowing them to adjust rents in line with inflation more quickly. Additionally, many of these sectors have a more steady revenue stream than traditional retail and office spaces.

In these challenges, assessing a specific property’s value and current financial performance is essential before making significant investment decisions. In some cases, buying a distressed property may be more prudent to capitalize on a discounted price and take advantage of the low-interest rate environment.

According to StreetEasy, buyer activity has picked up in the first quarter of 2023 but is still below pre-pandemic levels. With affordability as a top concern, buyers are focused on finding homes within their budgets. As a result, well-positioned sellers can expect strong offers for their listings. However, buyers are taking more time considering properties and negotiating pricing with sellers more frequently.

4. Uncertainty

New York City’s biggest landlords had it great for years as tenants clambered to sign office leases in a booming economy buoyed by low-interest rates. Three years into the pandemic, many corporate landlords face a less-than-rosy future with a steep drop in demand for office space and the potential loss of significant rent revenue. Many landlords also face a permanent shift in how their buildings are used, with employees choosing to work from home or move to other cities. As a result, the number of vacant offices in Manhattan has swelled, and trophy office towers have seen their direct rents decline by double-digits in the first quarter of 2023, according to a report from JLL.

The lower office attendance trend may have long-lasting consequences for commercial real estate. It could lead to a sharp drop in property valuations by NYC’s Department of Finance (DOF), affecting companies when their leases come up for renewal. This could also adversely affect lenders who lend against the value of properties.

While the outlook for NYC commercial real estate remains challenging, there are positive signs. For example, apartment sales have improved since February, as prices rose slightly month-over-month and vacancy rates declined. In addition, StreetEasy search data indicates that the city continues to draw interest from renters relocating from other markets.

Nevertheless, investors and owners must be patient as the market adjusts to these new conditions. A reversal in interest rate trends, a return to normalized office attendance, and a stabilization of inflation are needed before the market can turn around. Until then, keeping a close eye on the news and staying flexible with financing options is best. In the meantime, multifamily and industrial remain substantial investment opportunities. If these sectors can hold up in the face of increasing uncertainty, it will help to soften the blow for other parts of the market. For investors, this is the time to think creatively about how their assets can be best utilized in a changing economic environment.