We Lend CEO Ruben Izgelov examines the most essential medium-term factors shaping NYC commercial real estate in 2021 and beyond.

For those of us invested in New York City’s commercial real estate (CRE) — either financially or emotionally — getting through 2020 was like processing the five stages of grief: First came denial, followed by anger, then bargaining, onto depression and, finally, acceptance. 

After all, one in seven chain stores permanently closed in 2020, along with a slew of NYC institutions, including the Roosevelt Hotel and the Hilton Times Square. So, it’s little wonder that everyone from consumers to businesses and investors experienced a range of emotions as we adjusted to the new normal.

What’s more, it’s become increasingly clear that a return to normal simply will not happen. Working from home is here to stay, and hundreds of thousands of people have discovered the benefits of swapping city living for a backyard out in Hudson Valley or the Hamptons.   

Therefore, as we accept that NYC commercial real estate is transitioning toward a new normal, we have to understand the key forces that will shape this evolution. So let’s explore the five most important factors affecting CRE in 2021 and beyond.

Commercial-to-Residential Conversions

At the forefront of many minds right now is Governor Cuomo’s recent proposal to allow commercial-to-residential conversions in the city. As always, the devil is in the details. Commercial property classes that this would apply to are twofold: hotels with fewer than 150 rooms, and class B and C Office buildings.

Furthermore, this proposal only applies to buildings in certain areas. For example, hotels need to be situated between the Financial District and 110th Street or located in the outer boroughs. Similarly, offices need to be between Park and Ninth avenues and 14th and 60th streets, which is mostly Midtown.

The most glaring omission from this proposal is retail units, the property class that had been struggling long before the pandemic hit. However, the theory here is that the more residents this policy attracts to these areas, the more of a customer base local retailers and hospitality operators will have. The policy could also help reduce the current oversupply of office space in the city — which, at the end of 2020, had a vacancy rate of 15.1%, the highest in three decades.

While this may not go into effect until 2022, the effect could be felt sooner, with office landlords taking their vacant units off the rental market in anticipation of converting to residential. However, given other factors discussed below, it’s unlikely that this alone will fundamentally shift the imbalance of supply and demand for office space in the medium term.

Office Tenants Disposing of Unwanted Space via Subleasing

With many large office tenants committed to long leases with lots of floor space, plenty of businesses are beginning to dispose of excess space they no longer need in the hybrid work world. As a result, we’re already seeing a glut of unused office space enter the market via subleasing.

Specifically, as of January 2021, there was 12.2 million square feet of vacant sublet office space in NYC — up 91% from Q2 2019. Among those are flagship tenants trying to offload space, such as tech company Yelp with 270,000 square feet and PR firm Omnicorp with 147,000 square feet. This will likely continue to increase throughout 2021, as more businesses make strategic decisions on hybrid working becoming a permanent feature and then attempt to downsize their office space.

Consequently, this will then put further downward pressure on pricing, accelerating a market correction and slowing the recovery of office rents in the city. What’s more, landlords have very little by way of incentives they can offer existing tenants to stem the flow of downsizing and disposal via subleasing. Once a business has decided that new work patterns negate the need for existing floor space, the offer of a rent reduction isn’t going to change their mind. 

Rent Concessions Aiding Office Sector Recovery

So far, office landlords have been trying hard to avoid lowering face rents, instead offering longer rent-free periods and increased cash for tenant improvements. However, the realities of the subleasing market will inevitably start forcing their hands as the year progresses. In fact, as rents drop, we could begin to see similar levels of price discovery and activity that we’ve seen in the residential market. 

Yet, even in the new work-from-home/hybrid-working era, office buildings in Midtown and other parts of the city will still hold their allure. Plus, discounted floor space — coupled with the smaller space requirements of companies with hybrid workforces — may mean that many businesses that were previously priced out of one of the world’s most expensive commercial centers may suddenly discover that it is now within reach.

To that end, a look at the city’s residential rental market gives us some clues as to how market forces could start shaping office lease closings. For instance, residential lease signings have been surging throughout the last few months, with December 2020 seeing a 94% increase compared to the year before. Driving this growth has been the continued discounting offered by landlords, which stood at an average of 17% in December. And, while vacancy rates are still high, this growth in lease signings is the first step toward eventual price recovery.   

About

Ruben Izgelov is CEO of We Lend LLC, a New York-based hard-money lender focused on serving real estate investors by providing quick and low-cost capital.

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