Interest Rates, Oversupply Have New York Office Giants Looking To 'Prune The Portfolio'

Office leasing in Manhattan has picked up so far in 2022, and the nation's largest office market's record availability appears to have stabilized, but even amid signs of improvement, the city’s biggest landlords are eyeing storm clouds that could dent their recovery.

Manhattan office tenants leased roughly 2.6M SF last month, an almost 12% drop from March, according to Colliers, but up from 2.1M SF a year ago. The previously soaring availability rate appears to have stabilized, sitting at 17.3%, the same rate as March, according to Colliers, which found demand more than doubled year-over-year.

“The demand that we've seen during the first four months of the year is definitely a key element pointing towards a sign of recovery, but the overall market has not recovered,” Colliers Executive Managing Director Franklin Wallach said. “Demand is still trying to catch up to supply, and in many pockets of the market supply is still outpacing demand. And there are still future blocks scheduled to come on the market over the next several quarters that keeps the pressure on the demand to continue to increase.”

The office return in New York City remains muted — Kastle Systems' occupancy tracker registered 37.4% of pre-pandemic levels in New York last week, compared to 43.4% nationally — and while office owners have an upbeat view on the long-term viability of high-quality offices, rising interest rates, questionable depth of tenant demand and global unrest are coloring their view of their portfolio. 

“The economy is now in the hands of the Federal Reserve and their role as an inflation fighter, and appropriately so,” Vornado Chairman and CEO Steven Roth said during the firm’s earning call this week.

On Wednesday, the Fed announced it would increase rates by half a percentage point, the largest jump in more than two decades.

“We had initially expected to deliver double-digit percentage [funds from operation per share] growth in 2022," Vornado President and Chief Financial Officer Michael Franco said. "But we now expect the impact of projected interest rate hikes by the Fed and our variable rate debt to be a greater headwind to this year’s growth than we originally anticipated.”

While Vornado executives expressed confidence in pushing forward their massive redevelopment of the area around Penn Station, they are also looking to shed properties that could be vulnerable to remote work shifts.

“We’re going to prune the portfolio,” Franco said on the call. "We’re going to continue to upgrade, make sure we own assets that we do believe are going to reflect what tenants want or we can push rents, most importantly."

The company reached a deal to sell its Center Building office property in Long Island City, leased largely to government tenants for $173M. Franco said the firm plans to bring 40 Fulton, a 249K SF office tower between Pearl and Cliff streets in Lower Manhattan, to market soon, as it is a “fine” asset but doesn’t fit into what the company wants to own five or 10 years from now. 

Empire State Realty Trust elected to return its property at 383 Main Ave. in Norwalk, Connecticut, back to its lender last month, it disclosed in its quarterly earnings report — another example of a major owner giving up on a building rather than try to resuscitate it.

ESRT CEO Anthony Malkin said during an earnings call last week that his company is still looking for acquisitions, though the current environment makes things more complicated.

“We have a very interesting world on the transaction side with regard to the economic uncertainty, war in Ukraine, and increase in interest rates,” he said. “That has caused, I think, what will probably be more complicated opportunities to come about. We get to look at those with great relish because we are good at complicated things.”

SL Green CEO Marc Holliday said in April the company is watching interest rate movement less over the next month or two, but in the next 12 to 18 months.

“I think at a time of rising interest rates, we're going to put more emphasis, if you will, just on a relative basis on debt repayment,” he said. “Debt repayment becomes more accretive relative to what it looked like three to four months ago.”

The firm bought 450 Park Ave. from Oxford Properties and Crown Acquisition for $445M in a deal set to close this quarter, the REIT's first Manhattan office acquisition since 2018. Holliday said the deal is “indicative of where our heads are” going forward.

“We used to do, I think, like a couple of billion dollars a year of acquisitions and that was kind of routine for us,” he said. "This is a unique opportunity.

Holliday said in his company's earnings call last month that physical occupancy levels in SL Green's portfolio were between 40% and 50%, while ESRT’s building utilization is at mid-40% for Manhattan when compared to 2019, and at the high 60% range in the greater New York region. 

“We have a ways to go, but I think we're heading in the right direction,” Holliday said.

JLL Vice President Kristen Morgan said occupancy of buildings is something prospective tenants ask about during tours, as indecision and uncertainty around what the office will mean to employees over the next few years continues to be the biggest thing affecting the office market right now.

“It points to people wanting to be part of a community when they come back and want to feel the buzz,” Morgan wrote in an email. “As occupancy creeps up and companies watch their competitors return, they will want to return and take more space which we're seeing across the board.”

She said leasing velocity today is being driven by financial services and technology companies, many of which are seeking “exciting and collaborative space” workers will be motivated to return to and will act as a recruiting tool for new talent.

Blackstone’s 326K SF renewal and expansion at 601 Lexington Ave. was the largest deal of the month, followed by Tiffany's 287K SF downsized renewal, Perella Weinberg Partners' renewal and expansion at 767 Fifth Ave. for 125K SF and Phaidon International's new lease at 711 Third Ave.

While availability has stabilized in Manhattan, overall availability has still gone up 73.2% since the pandemic started in March 2020 to hit 93.2M SF. There is now just shy of 20M SF sublease inventory, an increase of 65.9% since March 2020.

Even the most desirable properties aren't immune to changes in office demands: A tenant at 30 Hudson Yards listed a 453K SF block on the sublease market in April, per Colliers.

While average asking rent is up on last month, at $72.68 per SF it is still nearly 5% down from March 2020's average. But Wallach said the increase in demand, as well as a number of sizable deals, gives tenants in the market confidence. This week, HSBC signed a 265K SF lease with Tishman Speyer for its new U.S. headquarters at 66 Hudson Blvd., which Wallach pointed to as a bright spot for the market. 

“There is this little bit of pent-up demand because tenants might have not signed transactions in ‘20 or ‘21,” he said. “Being able to see that light at the end of the tunnel … for some tenants is giving them the confidence to sign these longer-term or new deals. But it is still not yet at the point where the demand has increased to a point where it's yet able to quickly absorb ... about 40M SF total that’s come onto the market in the last two years.”