Manhattan Office Owners Pay to Keep Tenants as Demand Falls

  • New towers, weaker leasing heighten competition by landlords
  • Effective rents dropped 7% in fourth quarter, brokerage says

Manhattan office landlords are facing falling rents and heightened competition, spurring unprecedented spending to accommodate tenants.

Effective rents, the amount paid after concessions, slid 7 percent in the fourth quarter from the previous three months to an average of $57.18 a square foot, according to brokerage Savills Studley. Leasing has slumped and tenants are putting more excess space on the market for subletting -- often a sign of weakness to come.

With brand-new skyscrapers opening and companies seeking to pack more workers into less space, New York landlords are having to work harder to lure and keep tenants. Building owners are spending aggressively to make traditional partitioned offices more collaborative while adding amenities such as food areas and open-air terraces.

“The market has demanded more in concessions from landlords, particularly for building out space,” said Scott Rechler, chief executive officer of RXR Realty, the biggest buyer of Manhattan offices in 2016.

Tenant-improvement allowances -- agreements in a lease to cover the cost of converting raw space into finished offices -- soared 12 percent last year to almost $76 a square foot, according to Savills Studley. While owners and tenants usually agree to share the expense, the portion paid by landlords reached a record in the fourth quarter.

Rising construction costs contributed to the increase, but the gain also indicates that office owners are competing to keep tenants, especially with new skyscrapers rising in the Hudson Yards district, as well as in Midtown and in lower Manhattan’s World Trade Center, said Keith DeCoster, Savills Studley’s director of U.S. real estate analytics.

Keeping tenants in place has become critical for landlords at a time when many companies are being cautious and are trying to make offices more dense, DeCoster said.

“If it takes refreshing their space or restacking their building or renegotiating the lease, not all landlords, but more landlords, are doing that,” he said. “If they want to be able to compete in this market, they really have to bite the bullet.”

Less Power

Rechler characterized the market as in equilibrium, where leasing is strong but new supply is putting a cap on how much landlords can raise rents.

“In a state of market equilibrium, you don’t have as much pricing power, so tenants can demand,” he said. In addition, “the need to bring space up for the 21st century character requires more work.”

Rechler paid $1.65 billion for 1285 Avenue of the Americas in May, and he said re-signing UBS Group AG as the anchor of the 1.8 million-square-foot (167,000-square-meter) tower was instrumental to completing the deal’s financing.

The 15-year renewal for 891,000 square feet included a “work letter” -- an agreement by the landlord to cover part of the cost of renovating the space -- of just over $100 a square foot, according to CompStak Inc., a provider of commercial real estate data to brokers. The deal was a renegotiation of an earlier lease written five years earlier that set a tenant-improvement allowance of slightly more than $20 a square foot, CompStak research shows.

Rechler declined to confirm the costs, but said a comparison is “apples to oranges” because the new lease is at a much higher rent and runs for 15 years, much longer than the five-year extension it replaces.

Leasing Drop

The UBS agreement at the Midtown tower was the second-largest in 2016, when Manhattan leasing overall dropped to 28.1 million square feet, its lowest in seven years and a 30 percent decline from a recent high in 2013, according to a report last week from Jones Lang LaSalle Inc., a Savills Studley competitor. The vacancy rate rose to 10.4 percent from 9.6 percent in 2015.

Subletting, or tenants putting space on the market, increased by 2 million square feet from July to December to 10.4 million square feet, Savills Studley reported.

Tristan Ashby, director of New York research for JLL, said leasing may improve in the first quarter, based on deals he’s heard are in the works. With the presidential election over, tenants may have more confidence to make moves, and there’s hope that financial-services firms will become more active if Donald Trump’s administration eases regulations, he said. Banks have played a relatively small part in the New York office market’s rebound from the financial crisis, with leasing instead driven by technology and media companies.

“If we had some growth, any growth, from the banks, that would be a positive for the market,” Ashby said. “It’s clearly too early to really tell, but that’s the model we’re looking at.”

New York job growth, which surged in the years after the financial crisis, slowed in 2016, Kenneth McCarthy, principal economist at brokerage Cushman & Wakefield Inc., said at a market briefing for reporters Wednesday.

Cushman has “measured optimism” that the Trump administration, through deregulation, may “stimulate more employment growth in the financial-services sector, which is a critical sector to New York City,” McCarthy said.

Durst Upgrades

Douglas Durst’s Durst Organization signed two leases in the last two weeks of December at 4 Times Square, one of his signature properties. The landlord spent more than $100 million to upgrade the tower, built in the late 1990s, after magazine publisher Conde Nast moved downtown to 1 World Trade Center, leaving behind about 817,000 square feet.

The renovation included new elevators, an updated lobby, heating and air-conditioning systems, and an “amenity” floor where tenants can enjoy new conference space, an outdoor terrace, a cafeteria and coffee bar.

The December leases were with SS&C Technologies Holdings Inc., a provider of financial-services software, for 135,600 square feet, and RSM US LLP, an audit and consulting firm, for 95,000 square feet, said Thomas Bow, Durst’s vice president for leasing. About half of the Conde Nast space is now accounted for.

Durst declined to say what rents the new tenants are paying, though he said he was seeking about $80 a square foot for the base of the building, to $90 for the middle floors. While his tenant-improvement costs have climbed about 10 to 15 percent from a decade ago, rents are up too, so he said he doesn’t view it as an outrageous expense.

Landlords may have awhile before they regain the upper hand. Effective rents peaked sometime last year, said DeCoster of Savills Studley.

“A year from now, landlords might look back wistfully on 2016,” he said.

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