New York City’s biggest corporate landlords have been doing well for years — benefiting from a booming economy in a city where companies scramble to set up offices and low interest rates that boost an industry built on debt.
Those days are over. Three years into the pandemic, floors of entire Manhattan office buildings have been emptied by tenants who have shrunk their footprints and employees working from home.
Now, there is another problem.
The rapid rise in interest rates has heightened concerns that New York City’s office market, the largest in the United States and the backbone of the city’s economy, could be at serious risk. Experts in the industry say this one-two shock could be worse than anything corporate landlords have experienced before, leading major banks and real estate analysts to warn in recent weeks of a housing slump and falling property values and borrowing costs. The rise could increase the likelihood of a national recession and a city budget crisis.
More than two-thirds of commercial real estate loans are held by small and medium-sized banks, raising concerns that regional lenders may not be able to withstand a wave of defaults if landlords cannot repay their loans. Some analysts predict a bleak outlook for urban centers, likening the crisis to the slow demise of many U.S. shopping malls.
in the latest SL Green Realty Corporation, the largest office landlord in New York City, a microcosm of the nation’s most important office market, revealed that more of its properties lost tenants in the first months of 2023. Across its 25 buildings, including some of the city’s premier office buildings, 90.2% of space is occupied, down from 95.5% in early 2020.
The ramifications extend far beyond the balance sheets of the city’s landlords, who borrowed billions of dollars at low interest rates in the years before the pandemic to build, buy and upgrade offices, and have attracted big names like Meta and Apple. Tenants to the city.
The city’s office workers make about 75% more annually than other private-sector workers, according to the state comptroller’s office, and they’re out of the office every day, costing many businesses spending.
The value of New York City office buildings could drop by $48.75 billion over the next few years, hampering a vital source of tax revenue for the city, according to a recent study by researchers at Columbia University and New York University.
Stijn Van Nieuwerburgh, a real estate professor at Columbia Business School, warned that New York City is facing an “urban doom loop” sparked by remote work. While the current downturn in commercial real estate has similarities to previous downturns, including in the early 1990s, after the September 11 attacks, and during the 2008 financial crisis, this downturn has a new twist: the drop in demand for office space appears to be is permanent, he said.
Dr Van Nieuwerburgh said: “Whether in the long run we need 10%, 20% or 30% less office space than before, we can debate, but everyone agrees the number is greater than zero“
Wall Street investors have been particularly bearish on the office sector throughout the pandemic, but their assessment of the sector has soured in recent months. Big banks such as JPMorgan Chase and Wells Fargo have increasingly warned that by the end of 2025, a large number of business loans will come due — totaling an estimated $1.5 trillion nationwide — and that the companies May be difficult to repay or refinance.
Shares of SL Green and the city’s two other publicly traded office owners, Vornado Realty Trust and Empire State Realty Trust, were trading near their lowest levels since the pandemic began.
Shares of SL Green have fallen 76% since the start of 2020. Vornado shares are at their lowest level since 1996. Shares of Empire State Realty, which owns the Empire State Building, are near all-time lows. Together, they have lost $17 billion in market value since the pandemic began.
“All three are centered around the office, and all three are centered around New York City,” Mr. Van Nieuwerburgh said. “Those stocks, office stocks, have been hammered. It’s amazing.”
Vornado and Empire State Realty will report their quarterly earnings in the coming weeks. Vornado’s buildings in New York City will end 2021 at 90.4% occupancy, down from 96.7% at the end of 2019; Empire State Realty’s buildings in Manhattan will have occupancy at 86%, down from 89.8%.
Private equity firm Blackstone, the world’s largest owner of commercial real estate, reported last week that its latest distributable earnings — which represent cash paid out to shareholders as dividends — were $1.25 billion in the first quarter, down 36% from a year earlier.
The company has significantly reduced its exposure to the office sector in its real estate portfolio, executives said on Friday, warning of looming challenges at those properties. Last year, Blackstone returned the keys to its Manhattan office building at 1740 Broadway to lenders.
In the most recent quarter, SL Green reported a roughly 28% drop in revenue from the same period in 2020, but still topped Wall Street expectations. On Thursday’s earnings call, the company’s chief executive, Mark Holliday, criticized what he said were alarmist forecasts for the industry.
“The commercial real estate sector seems to be grabbing most of the headlines these days, amplifying the message of doom and gloom, and creating what I believe is an excess of anxiety in the market that is felt most acutely in New York City,” Mr. Holliday said. “Overly negative voices overshadow some positive signs pointing 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 fears of an imminent collapse in the office sector.
However, recovery may not be possible for many landlords. While large landlords with still-supplied offices in Manhattan or holding properties elsewhere in the country may be better positioned to bounce back, many smaller firms with older, less desirable properties could be under intense pressure. According to analysts, about 80% of the office leases signed in the first months of the year were in buildings considered to be the top of the market, so-called Grade A offices.
In New York City’s office market, roughly 400 million square feet, nearly two-thirds of the buildings are facing obsolescence because they are decades old and largely unattractive to tenants, Mr. Goldfarb said. .
Tenants are looking for newer spaces that offer amenities and are close to transit stations, such as One Vanderbilt, SL Green’s newest building next to Grand Central Station, he said. The building has some of the highest rents in Manhattan, with some rents exceeding $200 per square foot.
“They’re going to keep winning share,” Mr Goldfarb said.
Executives at SL Green and Vornado, who dismissed the staying power of hybrid work at the start of the pandemic, now acknowledge that the workweek has changed for the foreseeable future.
Vornado, for example, is aiming to transform the Penn Station neighborhood into a large commercial district that could become the city’s priciest for rent, similar to Hudson Yards and around Grand Central Terminal neighbors. But executives at the company have decided in recent months to shelve the project, citing rising interest rates.
All three companies are scrambling to find new revenue streams. Empire State Realty has sold several suburban office buildings and expanded into the apartment market, buying three Manhattan buildings since late 2021.
But for office landlords, there is no quick fix. An attractive possibility – converting an underutilized office into a residence – is too expensive at today’s rates and often structurally challenging.
Vornado had considered bidding to open a casino near Penn Station in midtown Manhattan. In 2019, after the completion of luxury condominiums at 220 Central Park South, it also considered building more residential buildings, one of which sold for nearly $240 million, making it the most expensive home in the United States.
SL Green is also looking at gambling: It’s teaming up with Caesars Entertainment Corp. to propose a new casino in Times Square, competing with other groups for one of three casino licenses awarded in downstate New York.
Mr Holliday said in a conference call on Thursday the project would be “good for everyone”. “It’s going to be a huge catalyst for revitalizing and revitalizing New York, which I think is one of the most important tourist destinations in the world.”