Office Market Trending Towards a Hospitality Mindset
- Oct 03, 2019
Manhattan’s strong economy, dynamic business environment and sustained job growth have been paving the way for a robust office market. However, the trade tariffs tensions and the increase of expenses and taxes have brought clouds of uncertainty over the borough’s skyline.
“While rents have moved somewhat in New York City—most notably at the very high end (more than $100 per square foot) for new construction or an advanced, innovative project—expenses are through the roof and this is definitely a challenge. Taxes are at an all-time high,” said Jonathon Yormak, co-founder & managing principal of real estate investment firm East End Capital.
The company currently has an office portfolio in New York City and Florida totaling approximately one million square feet, including two assets in Manhattan: 695 Lexington Avenue, a 20-story, 110,000-square-foot office building in The Plaza District and 141 East Houston Street, a 65,000-square-foot mixed-use property that includes office and retail space. In an interview with Commercial Property Executive, Yormak speaks about the main trends and challenges when investing in the NYC office market, as well as his predictions going into 2020.
READ ALSO: Manhattan Office Report – Spring 2019
What can you tell us about the demand for office space in Manhattan? Is there room for more growth in the sector?
Yormak: The most interesting thing about the demand for office in Manhattan, in my opinion, is that it now exists in all neighborhoods. It used to be that Midtown and the Financial District dominated office demand for high-quality, growth tenants. Today, Midtown South, the Meatpacking District, SoHo, Chelsea, Flatiron and even the Lower East Side enter the discussion. More frequently than not, these areas actually attract and land the best tenants at the highest rents.
This demand is especially strong in newly constructed Class A buildings that are a bit more boutique in nature such as our firm’s project at 141 East Houston Street designed by Roger Ferris & Partners, Aurora’s Solar Curve project in the Meatpacking District and Related Group’s project at 300 Lafayette Street in SoHo—which has now been fully leased by Microsoft at rents exceeding $165 per square foot.
What are the main trends and challenges when it comes to investing in New York office assets?
Yormak: Tenant fit-out costs are at an all-time high and tenants of every credit quality expect installations that only blue-chip tenants received in the past. This has driven real yields down on most office investments. In my opinion, the investment cycle is now finally coming to this realization—meaning, sellers are starting to understand the buyer’s need to underwrite over $100 per square foot in fit out costs, therefore, their exit pricing is going to be lower. This, however, is not yet a market norm at all.
In terms of main trends, we’ve seen tenants migrate out of historically prime locations and into up-and-coming “cooler” areas with boutique office offerings. TAMI (technology, advertising, marketing and innovation) tenants have largely taken over the growth and demand story. Overall, office is trending towards a hospitality mindset. We need to think of our tenants the same way a hotel operator does, prioritizing service, design of the space and attractive common/shared areas.
The amenity war may be cooling a bit and it’s unclear if we need to pack every amenity into each building. The total ecosystem of “work” is most important and that boils down to the surrounding neighborhood more and more: What is the neighborhood vibe when you show up? Is the coffee shop energizing? How convenient is the midday errand run? Can you go to a great gym within a few blocks that has great buzz? Are there great restaurants and bars just outside the building when you leave? These are the things that really alter the total work/life experience.
There will also likely be an excess of large-block Class A product in the marketplace as we head into 2020-2022. Some examples are 2 Manhattan West, 2 Penn Plaza and 1 Madison Avenue.
What type of office assets are most in demand today?
Yormak: The most in demand assets are newly built, Class A boutique offices as well as interesting, historic buildings that have been restored with a fresh character but still contain the proper bones (e.g. high ceilings, big windows, excellent vertical transportation, self-controlled HVAC systems and green outdoor space).
Which areas in Manhattan are most attractive for office developers?
Yormak: Midtown South continues to dominate due to a large concentration of TAMI and other creative tenants. These tenants constitute the demand growth over the last decade, largely overtaking customary industries like finance, insurance and real estate.
Submarkets that are the most attractive have a great transportation system, amazing food/beverage/retail options, a concentration of like-minded companies creating a natural ecosystem in the area and buildings with character despite being somewhat older. Regarding the latter, some out-migration is occurring to the Class A, newly built product that is still located in popular areas like SoHo, such as Microsoft’s new offices at 300 Lafayette Street.
East End Capital’s portfolio includes assets in New York and Miami. What attracts you to these markets? Are you planning on expanding to other markets? Which ones?
Yormak: New York City is the greatest market in the world because it has the most demand, the most diverse set of high-quality tenants, the most intellectual capital and the most liquidity at any moment in time. In NYC, if you can pay your taxes and debt, anything you own should make money over an eight to 10-year hold.
South Florida continues to see a massive migration from the northeastern U.S. largely due to the high quality of life and an advantageous tax regime. The latter is expected to have an even more profound effect since the Trump tax changes were passed, which affected places like New York and New Jersey even harder. Over time, we’ve also seen companies pursue closer connectivity to South and Latin America.
We have no immediate plans of expanding to other markets, but we are always looking for new opportunities.
What are the similarities and differentiating factors between NYC’s office market and the Miami office market?
Yormak: For a city as dynamic and rich as Miami, it has a shockingly low number of Fortune 1000 companies that are headquartered there or even maintain a meaningful corporate footprint in the area.
In my opinion, too many well-educated youngsters from South Florida flock to other places for work. The City and State should consider subsidizing some major corporations and/or growth industries to start building the blocks around high-quality jobs that retain and draw more local knowledge workers over time. Eventually, those clever, intelligent employees will start their own companies and, hopefully, usher in a new era of large-scale corporate growth that has, to date, generally been absent in the Miami market.
NYC remains the coworking capital of the U.S., with more than 16 million square feet of non-traditional office space, according to a Property Shark report. How do you see demand for this type of workspaces going into 2020?
Yormak: Coworking is here to stay. We all became untethered from our desks over the past 10 years due to cell phones and laptops, which increases the benefit of this form of occupancy for traditional companies and the growing number of people engaged in the gig economy.
We definitely see a much slower growth in absorption of this type of space going forward and ultimately, many centers will fail and close, but the industry is here in a bigger and, more importantly, permanent way.
What are your predictions for the NYC office market going into 2020?
Yormak: Going into 2020, we expect moderate to no rent growth, stabilizing tenant improvement concessions (around $100 per square foot in NYC) and a slight increase in investment sales volume as institutional assets, acquired at the start of this cycle, are harvested to take advantage of low interest rates.