Avison Young: Manhattan Office Market Poised for Vacancy Reduction, Increased Asking Rents
Continued improvement in employment levels coupled with minimal new office construction slated for completion in 2013 are expected to result in a reduction in Manhattan’s overall office market vacancy rate and an increase in asking rents in 2013, according to Avison Young’s 2013 Manhattan commercial real estate market forecast.
The firm’s outlook for an improved office leasing market in 2013 was among numerous predictions unveiled during the first annual Avison Young and Chandan Economics Crystal Ball forecast event at The Cornell Club in New York City. The event brought together Avison Young experts in the areas of leasing, investment sales, note sales and capital markets, who joined Dr. Sam Chandan, President and Chief Economist of Chandan Economics, for an interactive discussion on the trends and conditions that are expected to shape the New York City commercial real estate market in the coming year.
The employment picture in New York City remained mostly positive during 2012. According to the New York City Office of Management and Budget (OMB), through to late fall 2012 the city added more than 94,000 private sector jobs during the year ― with job gains occurring in most sectors, including major real estate-using sectors such as finance and business services, trade, and leisure and hospitality. The office-using sectors have added nearly 45,000 jobs since the end of 2011.
Manhattan Office Leasing
In the final quarter of 2012, the Manhattan office market dealt with added complexity amid the myriad uncertainties arising from the Presidential election, Hurricane Sandy and the looming fiscal cliff. As the year drew to a close, overall vacancy rates rose and absorption fell into negative territory, yet average asking rents moved modestly higher.
In Midtown, seven of the top 10 deals completed in 2012 were renewals, including Viacom’s renewal for 1.6 million square feet (msf) at 1515 Broadway, which was the largest lease of the year. The market inertia pushed vacancy rates higher as space returning to the market met quiet activity for new leases. Given the hesitation in leasing activity, coupled with space returning to market, absorption retreated into negative territory. According to Avison Young, Midtown class A absorption finished the year at negative 2.2 msf.
Downtown’s class A vacancy rate moved substantially higher during the fourth quarter of 2012, finishing at a historical high of 16%, and up sharply from 11.8% at the end of September. Similar to Midtown, an onslaught of space added to the market during the fourth quarter was the catalyst behind the significant jump, the majority of which was at the World Financial Center where space previously occupied by firms such as Bank of America, Deloitte and Nomura officially hit market statistics. According to Avison Young, Downtown absorption measured negative 2.7 msf for the year, with the largest Downtown lease for the year being Morgan Stanley’s renewal of 1.2 msf at One New York Plaza.
For much of the year, Midtown South distinguished itself as the preferred destination for tenants in the Manhattan office market, particularly among the technology and new media sectors. The addition of 130,000 sf at 330 Hudson Street contributed to an increase in the submarket’s vacancy to 8.4% at year-end 2012 from 7.9% in the third quarter. Contrary to both Midtown and Downtown, there were several significant new leases signed in 2012 in Midtown South ― the largest of which was Havas’ lease at 200 & 205 Hudson Street for 258,000 sf.
According to Avison Young Principal and New York City Vice-President of Research James Delmonte, encouraging employment forecasts at both the national and local levels ― specifically projections of accelerated hiring in the latter part of 2013 ― are expected to lead to positive absorption for the Manhattan office market this year. Avison Young predicts a decrease in the overall Manhattan office vacancy rate to as low as 10.4% by the close of 2013 from 11.8% at the close of 2012, as well as an increase in the overall volume of Manhattan office leasing activity to 35 msf in 2013 from 28.6 msf in 2012.
Delmonte notes that the close of 2012 saw average asking rents up across all Manhattan markets. In Midtown, class A rents finished the year at $71.50 per square foot (psf), up from $70.69 psf at the beginning of 2012. Downtown pricing for prime space moved to $48.96 in December from $41.78 psf in January 2012, due in large part to the return of prime quality space at World Financial Center, along with the arrival of premium newly constructed space at 4 World Trade Center. Similarly, in Midtown South, new construction at 51 Astor Place caused class A asking rents to climb to $68.41 psf in December from $58.47 psf in January 2012.
In 2013, Avison Young predicts an increase of up to 7% in overall average asking rents for the Manhattan office market from the 2012 average of $57.83 psf.
“With landlords beginning to feel more confident about the direction of the market and tightening concession packages accordingly, we expect to see an increase in early renewals for the coming year as tenants look to lock in current rates before a projected increase in rental rates takes effect, possibly as early as the summer,” states Avison Young Principal Michael Leff. “While we anticipate that the overall increase in rental rates in 2013 will be modest, looking further ahead we could see rent spikes beginning in mid-2014.”
According to Avison Young Principal Jon Epstein, 2012 was one of the best-performing years for the New York City investment sales market since 2007, with the impending expiration of the Bush-era tax rates applying some pressure to long-term owners seeking profit before the end of the year. The total volume of sales for 2012 rose 46% since 2010, and 87% since 2009.
Moving into 2013, the outlook for Manhattan’s investment sales market remains bright, with Epstein noting that eagerness for investors to deploy capital into New York City will continue to be strong, and that sellers committed to profiting from the current interest rate environment will be out in force.
Avison Young predicts that total volume of commercial real estate sales in Manhattan will edge up to as high as $35 billion in 2013 from $32 billion in 2012, and that the average price will also increase to $550 to $575 psf in 2013 from $545 in 2012. The firm anticipates modest cap rate compression in the coming year for select transactions and property types, with a possible decrease to as low as 4.5% in 2013 from 4.7% at the close of 2012.
“Interest rates will likely remain low throughout 2013 unless we see a change in the Federal Reserve System’s policies. The current low interest rate environment will continue to assist the deleveraging process, but lower loan-to-value ratios will apply pressure to recapitalization,” states Epstein. “Demand will continue to be strong as long as there are ample equity and debt sources to get deals done. However, with no income tax driver and pervasively low interest rates, which have led to lower returns on alternative investments for 1031 Exchange sales, there is no clear group that will be driving the supply side. Quality deals should have no difficulty attracting buyers and achieving market pricing.”
The low interest rate environment is continuing to help keep banks from being forced to sell loans, as evidenced by fewer-than-expected large loan sales transactions. According to Avison Young Principal Justin Piasecki, this ongoing trend has resulted in some investors moving into the preferred equity and mezzanine space, which presents a greater opportunity to hit required yields.
Piasecki adds that one notable trend in the loan sales market is the move by firms, such as Blackstone, to launch funds focused on the large-scale acquisition of residential REO homes to rent to tenants. Despite fixed and unexpected expenses relating to these investments, including transfer taxes, title/escrow insurance, selling costs/taxes over the holding period and internal and external management fees, buying single-family REO assets has the potential to produce outsized returns compared to other real estate investments, particularly if home values continue to increase.
“As a result of the limited supply of new construction in the market, we anticipate a decrease in the number of new-home sales in the coming year. However, we expect a slight increase in the number of sales of existing homes in 2013, as well as a continued increase in home prices, but at a lower rate than in 2012,” states Piasecki. “One of the inherent challenges with investing in single-family REO assets is identifying opportunities to purchase these assets at the required discount to current market value. We’ve seen pricing pushed into the high-80 to low-90 percents of retail value in certain markets.”
Debt and Equity
According to Avison Young Principal David Eyzenberg, the quest for higher yield is taking investors into secondary and tertiary markets where there is less competition from other institutional buyers. To avoid bidding wars for core assets, equity providers are turning to urban-infill and value-added opportunities where opportunistic value via embedded mark-to-market rent growth can be readily achieved through basic capital and operational improvements.
Eyzenberg notes that while there has been a return of mezzanine financing for construction projects, particularly in the hospitality and multifamily sectors, the overall state of construction financing remains strained as lenders continue to be hesitant to aggressively re-enter the market, especially as macro-economic fundamentals do not yet support significant increases in new office and retail product.
“Lenders are seeing a turnaround in the market for multi-family rental residential assets where projections show positive net absorption through 2014,” notes Eyzenberg. “As it pertains to recapitalization transactions, we have seen an increase, as owners with long-term hold strategies are taking advantage of the low interest rate environment to place new debt on their properties. Overall, alternative reinvestment opportunities on the stabilized side are not as plentiful, making recapitalizations more attractive by comparison.”