Will Manhattan’s Office Challenges Hit CMBS Assets?

Kroll Bond Rating Agency’s new report evaluates the exposure of $25.3 billion of Midtown Manhattan office assets to issues facing the submarket.

The Midtown Manhattan office market will have to contend with a few complications in the near future, but those won’t necessarily spill over on CMBS office collateral in the submarket, per a new report by Kroll Bond Rating Agency.

Manhattan continues to be one of the top office markets in the country, even as change comes to Midtown, where three challenges are afoot, according to KBRA’s report. But the Midtown office market and CMBS Midtown office collateral are not necessarily on parallel paths. “One of the most interesting findings of the report was that all three challenges may not present a near-to-intermediate cash flow issue to the CMBS Midtown office collateral that we identified,” Larry Kay, a senior director with Kroll Bond Rating Agency, told Commercial Property Executive,

The Trifecta

The issues facing the Midtown office sector include tenant relocations to the recently completed first phase of the 28-acre Hudson Yards mixed-use development on Manhattan’s far west side. KBRA cites statistics from JLL indicating that 92 percent of office occupants who plan to relocate to the $16 billion neighborhood or have already made the move hail from Midtown. Although some of the vacated space has been filled by local business moving into Midtown, the market could still end up saddled with sizeable vacancies. However, of the $25.3 billion of CMBS 2.0 Midtown office collateral that KBRA identified, 61 percent of the total square footage will not be subject to lease expiration until 2023 or later. The office collateral, which spans 85 properties, includes Tishman Speyer and Irvine Co.’s 3 million-square-foot MetLife Building at 200 Park Ave., where expirations on 76 percent of the leased space won’t occur until 2023 at the earliest. At the 1.7 million-square-foot property at 787 Seventh Ave., part of CalPERS’ portfolio, only 2 percent of the square footage is subject to lease expiration before 2023.

Another concern for the Midtown office market is the unknown pertaining to WeWork’s presence in the market. The shared workspace provider occupies roughly 5.3 million square feet of office space in Manhattan, making it the market’s largest private office tenant. Per the report, WeWork’s credit strength has yet to be tested in an undesirable economic climate, so negative change in the economy could spell trouble for Midtown. Such a reversal of fortune, however, would have less of an impact on Midtown’s CMBS office collateral, as only six of the 23 Midtown locations leased by WeWork serve as collateral. The principal value exposure to WeWork is less than 5 percent, the report shows.

The Midtown office market’s third challenge involved congestion pricing, which will subject commuters coming into Manhattan below 60th St. to fees beginning in 2021. The imposing of the surcharge will ultimately result in emptier parking garages in the impacted area; although, only 22 of the 85 CMBS Midtown office collateral assets have parking accommodations. “As parking revenue is typically a small contributor to a building’s total revenue, congestion pricing will likely not have a major impact on the identified collateral,” said Kay.

The What Ifs

While KBRA suggests in its report that CMBS Midtown office collateral is unlikely to be crippled by the three challenges facing the general Midtown office market, the firm concedes there’s no accounting for unknown factors. “One downside scenario could be if there are quite a few Midtown tenants that have lease termination clauses and exercise them, or that WeWork comes under financial stress and starts to default on its lease obligations,” Kay stated.

Alternatively, there could be a silver lining. He continued, “A positive scenario for CMBS Midtown office collateral would be that landlords take advantage of Midtown East rezoning and make their office buildings more competitive against the challenge of the West Side development.”