NYC Office Market Grapples with Old Buildings, New Work Styles

Tenancy Trends Shift as Aging Office Infrastructure Faces Hard Time Supporting the New Way of Working

Disruption, the longtime visitor to retail markets nationally, has washed ashore of the Manhattan office landscape.

There’s been a major shift in how tenants and companies are using space, according to David Pfeffer, partner at Tarter Krinsky & Drogin, which represents developers and owners of New York City office properties. He calls it the "shared working environment," exemplified by WeWork and its competitors.

Coworking users are gravitating to languishing space. With WeWork’s recently opened hub at 750 Lexington, the company now has 43 Manhattan locations. Competitor Knotel signed 11 new Midtown South leases in 2017 totaling about 200,000 square feet, and the company has been very active in that submarket for the 20,000- to 30,000-square-foot range, according to Mitti Liebersohn, president of Avison Young’s New York City office.

Leading Manhattan office experts say that the coworking trend has compounded the fundamental changes in workspace utilization already underway.

"Large companies are starting to embrace shared workspaces with more frequency for large numbers of employees. Younger professionals want dynamic environments. They don’t necessarily expect an office with a window, but they want other things like collaborative space, stocked pantries, etc.," says Pfeffer.

Tenants are demanding higher quality office space, with larger windows, a mix of both collaborative and enclosed areas and more efficient building systems. But the office infrastructure that ferries Manhattan business through the day is inherently unable to meet those demands as it currently stands.

"The city is going through a major change, which is both revolutionary and evolutionary. Revolutionary because the new buildings are state-of-of-the art and can compare favorably with the best and newest buildings around the globe. Evolutionary because this updating of New York City’s outmoded office building stock will go on for decades to come," says Mark Edelstein, chair of Morrison & Foerster's global real estate group.

About four years ago, Morrison & Foerster moved from its long-standing base at Rockefeller Center to Boston Properties’ 250 W. 55th St. as the anchor tenant.

"While we loved our old Rockefeller Center location, we felt we were living in a Class B+ building stock because the building was 55 years old. We felt we didn’t have enough light and air, the systems were old, the heating and AC were uneven, the convectors were noisy, the space design was outdated and we were limited in what we could do to redesign." said Edelstein. "Our new building has no HVAC convectors. We designed a beautiful and efficient space in a pillar-free environment. It is night and day. You can’t change light and air."

According to CoStar research, 3,149 Manhattan office properties spanning 309.23 million square feet of office space were built before 1960.

"With more than 15 million square feet of office space under construction in Manhattan, we are seeing tenants in older buildings flocking to new quality space," says Lauren Baker, an analyst with CoStar Market Analytics.

It will take years to rejuvenate Manhattan’s aging office stock. The process will involve both razing and rebuilding new office properties, and repositioning and renovating buildings that still have room to run.

"We are very far from meeting the needs of today’s office tenant," says Gavin Evans, partner at Normandy Real Estate Partners. Normandy is in the middle of a full modernization of the office space at 888 Broadway, but has opted to raze and redevelop at 799 Broadway.

"Basically all masonry buildings in '30s, '40s, '50s - It’s a real problem, these older buildings," Pfeffer says. On the East side, Pfeffer says, "Owners are talking about razing some buildings - those that are under 20 stories - to take advantage of the rezoning that was approved last year for Midtown East."

Some landlords, however, are opting to keep the buildings and invest in repositioning.

"Although they are masonry, in some cases older buildings can be re-skinned with glass pillars to look more like a new construction," Edelstein says, pointing to the Verizon building at 375 Pearl St.

390 Madison is being completely transformed, adds Liebersohn, and Midtown South has other examples, such as George Comfort’s repositioning of 63 Madison Ave.

Hudson Yards and World Trade Center buildings put pressure on landlords of older buildings to renovate and update in order to compete, "but we are still at the 10-yard line," according to Edelstein.

"Related did a great job striking a nerve with big corporate users," Evans says of Hudson Yards.

Nevertheless, when renovations are needed on older products, it could become opportunity for the city’s top developers. Renovation on these types of properties should be easier on landlords with deep pockets.

"The most powerful sponsors - Boston Properties, Durst, Silverstein, Related, Brookfield, Vornado, SL Green, etc. - will be able to get the financing to reposition or raze and redevelop older buildings," says Edelstein. "But what about second- and third-tier borrowers? Will they have the clout to get these construction loans in the current market? If you think about it, several of the top developers have had their new buildings financed on spec. It’s a testament to the power of certain developers."

Meanwhile large blocks of space, a trademark of the 2017 Manhattan office leasing cycle, are becoming harder to find.

Forecasted office preleasing figures are strong through 2022. Of 22.1 million square feet coming online by that year, 8.1 million square feet is already preleased, or about 38 percent, according to data from Cushman & Wakefield.

For large companies, the space they are looking for simply doesn’t exist, according to Pfeffer.

"If Amazon comes to New York, I don’t think they would take Manhattan," he says, adding that "50,000 workers to our city is not a big deal, but it is for a building to house them."

Large tenants who historically eschewed downtown now have few other choices, according to Edelstein, calling the shift an irony.

"Now, and in the past couple of years, a tenant seeking 350,000 square feet would have few options in Midtown and would need to look Downtown; that is where large supply remains," he says.

Downtown has become more diversified, with significant activity government entities and professional business services, explains Liebersohn, citing McKinsey at 3WTC.

"What we are seeing is that geography in many cases plays a less important role in the tenant decision making process - this is a relatively new trend - the NYC office market being more dynamic," he notes. "Larger tenants, when they are in the marketplace, will explore all geographies with an eye towards quality building and efficiency space."

Avison Young expects downtown office to continue to draw tenants and that FIRE tenancy will remain active through the year.

"FIRE tenants did one-third of the volume in 2017. In 2018, we see that continuing," concludes Liebersohn.

Diana Bell, New York City Market Reporter  CoStar Group