New York city’s empty offices reveal a global property dilemma
The rise of remote work will hurt older buildings, leaving landlords in the lurch
In the heart of midtown Manhattan lies a multibillion-dollar problem for building owners, the city and thousands of workers.
Blocks of decades-old office towers sit partially empty, in an awkward position: too outdated to attract tenants seeking the latest amenities, too new to be demolished or converted for another purpose.
It's a situation playing out around the globe as employers adapt to flexible work after the Covid-19 pandemic and rethink how much space they need. Even as people are increasingly called back to offices for at least some of the week, vacancy rates have soared in cities from Hong Kong to London and Toronto.
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"There's no part of the world that is untouched by the growth of hybrid working," said Richard Barkham, global chief economist for commercial real estate firm CBRE Group Inc.
In some cases, companies are simply cutting back on space to reduce their real estate costs. Others are relocating to shiny new towers with top-of-the-line amenities to attract talent and employees who may be reluctant to leave the comforts of working from home. Left behind are older buildings outside of prime locations.
The US is likely to have a slower office-market recovery than Asia and Europe because it began the pandemic with a higher vacancy rate, and long-term demand is expected to drop around 10% or more, Barkham said. New York, America's biggest office real estate market, is at the center of the issue.
A study this year by professors at Columbia University and New York University estimated that lower tenant demand because of remote work may cut 28%, or $456 billion, off the value of offices across the US. About 10% of that would be in New York City alone.
The implications of obsolete buildings stretch across the local economy. Empty offices have led to a cascade of shuttered restaurants and other street-level businesses that depended on daytime worker traffic. And falling building values mean less property-tax revenue for city coffers.
A strip on Manhattan's Third Avenue, from 42nd to 59th streets, shows the problem of older properties in stark terms. While New York leasing demand has bounced back toward pre-pandemic levels, the corridor has 29% of office space available for tenants, nearly double the amount four years ago and above the city's overall rate of 19%, according to research from brokerage firm Savills.
The area is clustered with buildings from the 1950s to 1980s, many of which haven't been meaningfully upgraded in decades. The few that have been renovated struggle to compete with counterparts in tonier addresses on Park, Fifth and Madison avenues and new mega-developments on Manhattan's far west side.
The Third Avenue buildings have become "leave-behind space" rather than the types of offices that attract world-class tenants, said Nick Farmakis, vice chairman at Savills.
There's no easy fix for landlords, who rely on rental income to pay down debt. Some cities are exploring options to turn downtown offices to residential buildings: Calgary, for instance, has an incentive program for such redevelopments. While New York has had some conversions, the hefty costs and zoning and architectural restrictions make it a difficult proposition.
As cities try to recover from the pandemic, the towers along Third Avenue demonstrate the types of challenges faced by building owners in Manhattan and beyond.
Over the past few years, major finance, tech and law firms have been relocating to the west side of Manhattan, where a new crop of glassy skyscrapers has emerged to create a new business district.
KKR & Co. and BlackRock Inc. are shifting their headquarters to Related Cos. and Oxford Properties' Hudson Yards mega-development, while Wells Fargo & Co. relocated its New York corporate and investment banking business to the area. Brookfield Properties' Manhattan West project has drawn international law firm Clifford Chance and hedge fund titan D.E. Shaw & Co. from Midtown offices.
Debevoise & Plimpton LLP, an anchor tenant at SL Green Realty Corp.'s 919 Third Ave., signed a 20-year lease to relocate its headquarters to the Spiral, a new skyscraper by the Hudson Yards development, leaving behind more than 400,000 square feet. About half of that has been leased. (Bloomberg News parent Bloomberg LP, which already has offices in the building, took some of the law firm's space.)
The Spiral, owned by Tishman Speyer, is a 1,031-foot (314-meter) tower set to be completed this year. It will have 2.85 million square feet of offices and retail space, with cascading outdoor terraces, hanging gardens and sweeping views of the Hudson River. Amenities include a penthouse clubhouse with panoramic city views, a lounge and open-air terrace.
When Debevoise & Plimpton announced the move in 2020, Michael Blair, the law firm's presiding partner, touted the "truly modern, efficient and eco-friendly space," and said it will be "a highly functional workspace that will better foster the collaboration that is a hallmark of our firm's culture." The firm declined to comment further.
"In this environment, you can be in a lot better building in a better location at a similar rent," said Richard Litton, president of Harbor Group International, an owner of $19 billion in real estate. He said his firm would have "little, if any, interest in Third Avenue right now."
One large Manhattan landlord is betting that renovations will lure tenants to Third Avenue. The Durst Organization has put roughly $150 million into renovating 825 Third Ave., a 530,000-square-foot, 40-story building that was largely left empty when tenant Advance Publications departed after 25 years. When the lease expired in 2019, Durst explored a potential residential conversion but opted for a commercial upgrade.
The building, which reopens in October, will be the ultimate market tester for demand for upgraded Third Avenue space. Durst's renovations included new glass for upper floors, new heating and cooling systems, an updated lobby and an outdoor wraparound terrace. Smaller floor plates spanning 10,000 to 12,000 square feet in the upper part of the tower could draw interest from boutique firms seeking less space than vast, open layouts. Durst has signed three leases at the building, totaling 45,000 square feet.
The obvious solution to lower office demand in a city straining for affordable housing may seem to be converting the buildings into apartments. There's precedent: After the Sept. 11, 2001, attacks and the 2008 global financial crisis, many offices in lower Manhattan were turned into luxury condominiums or rental buildings.
But many of those downtown conversions took place in buildings from the late 19th to early 20th centuries, which had smaller floor plates and better light, making them more attractive for housing units. In contrast, the struggling towers across Midtown are largely 1950s to 1980s offices, with giant, dark floors that are far harder to convert.
Zoning changes and subsidies also gave developers incentives to build thousands of apartments downtown post-9/11. In Midtown, there are currently no financial incentives for developers to make the costly renovations, and many offices aren't eligible for residential zoning.
Bloomberg, working with architectural firm Gensler, examined two buildings, 655 Third Ave. and 767 Third Ave., to illustrate the opportunity – and complexity – in converting an office tower.
655 Third Ave.
This building, with a more than 40% availability rate, isn't ideal for conversion to residential use, according to Gensler.
While three sides of the building are unobstructed, the east façade is partially solid due to its configuration and an adjacent building, which could hamper sunlight for a large portion of units.
"The problem with Midtown is a lot of buildings need air and lights that the city requires, and you don't always get that," said Ran Eliasaf, founder and managing partner of investment firm Northwind Group, which is exploring residential conversions in the city. "Not every Class B building is an ideal target for conversion."
767 Third Ave.
This building is ranked as one of the best-suited for residential conversion on the Third Avenue strip, based on its smaller floor plates and good core-to-window depth, according to Gensler. Yet it too faces challenges.
Zoning laws in New York dictate that certain towers being converted to residential use are subject to residential floor area restrictions. While some older buildings can be fully converted, that generally applies to towers in certain areas built before 1962, and in lower Manhattan, 1977, according to Robert Fuller, studio director and principal at Gensler. 767 Third Ave. was built in the early 1980s.
The tower's owner, Sage Realty Corp., ran the numbers on a conversion years ago, but found it wouldn't make sense because zoning rules meant the company couldn't maximize its square footage, said Chief Executive Officer Jonathan Iger. The landlord would also have to buy out the leases of the remaining office tenants, a costly proposition.
"Unless we see the level of private/public partnership that we saw post-9/11 in downtown Manhattan to help spur office-to-residential conversion, it's not impossible, but it's much harder to pencil out," Iger said.
Another option for Third Avenue buildings would be luring tenants outside of the traditional finance, law and technology industries. Memorial Sloan Kettering Cancer Center recently agreed to buy a portion of 885 Third Ave., also known as the Lipstick Building, and plans to use it for academic and research offices.
But the longer-term shifts in work habits still loom, and it matters to more than just building owners. New York, like other cities, relies heavily on property taxes to fund schools, police and firefighters, as well as other services. Property taxes are the biggest source of revenue for the city, delivering about $1 out of every $3 taken in. And offices account for about a fifth of that.
Before the pandemic, the levies had climbed by about 6% a year on average, driven by rising property values. That helped finance new programs and services, as well as keep up with rising labor costs, said Ana Champeny, the vice president for research at the Citizens Budget Commission, a nonpartisan budget watchdog and research firm.
Manhattan's major office districts were no exception, generating steadily more revenue. But, in the fiscal year that ended June 30, the first to take into account the impact the pandemic had on real estate, tax levies from those areas declined by 11% to $5.24 billion.
The biggest drop was in a part of Midtown East north of Grand Central that the city's Department of Finance calls "Plaza," which contains some of the Third Avenue properties.
Tax bills for the current year suggest a slight rebound in revenue from office buildings citywide, but the recovery could take years to play out, especially if tenant demand remains depressed. New York also raises almost $1 billion annually from a tax on large commercial leases, which could fall if demand from big tenants like law and financial-services firms remains soft, said Champeny. Office use also has ripple effects on other important parts of the economy, from the transit system to retail and hotels.
"It's still early to tell what the structural change will be in both the economy and working and commuting," she said. "But clearly, the city is facing some short-term challenges."
Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.
