'It Just Shouldn't Be This Hard': Much Of NYC CRE Stuck In Limbo

Buying and building in New York City has always been expensive, but rising interest rates and inflation, combined with a lack of government incentives, have brought the commercial real estate sector in the nation's largest city to a crawl, some of the industry’s biggest names said at Bisnow's New York State of the Market event this month.

“Long story short, there's a puzzle and there's a real opportunity, and it's probably not a tomorrow solution,” Jeffrey Mandel, senior managing director at Tishman Speyer and co-head of the firm’s acquisitions team, said at the event. “It's a lot of different factors that have to come to work together, and it'll take some time.”

Despite apartment rents at all-time highs, development has slowed dramatically, with developers at the event blaming the paralysis on the lack of government action and incentives. 

But that freeze is nothing compared to the city's office market, which is facing a particularly painful year. Of the $75B to $150B of office debt coming due in the next three years, Hines Senior Managing Director and Head of New York Jason Alderman said “all of it is going to be underwater.”

“From an office perspective, I was doing some simple math,” he said onstage at the 51W52 office building in Midtown, also known as Black Rock. “It’s depressing, and it's kind of hard to talk about.”

The combination of economic uncertainty and an unenthusiastic return to the office has tenants seeking shorter and smaller leases. Loans originated before the pandemic were likely underwritten with the understanding that landlords would have been able to increase rents over the past few years, Alderman said.

Deals were done four years ago with the expectation of rent growth and a positive spread, which has entirely disappeared, he said.

“A [4% cap rate] on $1 of income that you thought was going to become $2 within 10 years — the values are probably down 50% just on that one bit of math,” he said.  

A slow office transaction market means there are few indicators of how dramatically the pandemic has transformed office values, which will add to the challenges faced by owners looking to sell or refinance.

“In the office market, I would say they've marked down their values, but it's not far enough yet,” Alderman said. “I think the appraisal industry has been lagging big time — not for any fault of theirs, but just given the lack of transactions.”

The capital markets and leasing environment has led to a pullback from some of NYC’s most tenured office owners, Wolf Construction President Greg Wolf said. While new projects like Manhattan West, Hudson Yards and One Vanderbilt have been able to raise rents and sign deals, the majority of office buildings in the city need further investment to be competitive, and it is unclear when or how that will happen.

“You know when you see the older families from the real estate side are holding back, that they’re concerned,” he said. “To just get started with projects without knowing where their next tenant’s going to come from is concerning, especially with all the newer buildings that are filling up.”

One way that Silverstein Properties has tried to maneuver the inertia is to look at conversion, the firm’s senior vice president of acquisitions, David Marks, said onstage. Silverstein partnered with Metro Loft Management last year to turn Financial District office tower 55 Broad St. into the largest office-to-residential conversion in city history, making the leap on the basis that the 421-a tax abatement wasn't coming back, Marks said. 

Silverstein is planning more conversions but is also applying caution due to the capital markets environment, Marks said. Office values will have to endure a dramatic plunge to counteract the high cost of capital to make any conversion worthwhile, he added.

When Silverstein was closing on 55 Broad St., its investment thesis was looking to buy an office building for between $300 and $350 per SF — but almost 18 months later, the price today needs to be in the $200-to-$250-per-SF range, Marks said. In the second quarter, NYC office buildings sold for an average of $588 per SF, according to Avison Young data.

But even with a huge discount, the capital markets make it hard to complete a deal.

“In this environment, it's easier to find the deals, it's harder to capitalize them,” Marks said. “Institutional investors are really hands-off at the moment. They're mostly in sell mode, or they're in sail — as in sailing — mode.”

An absence of government policy or incentives for office-to-residential conversions is adding to paralysis for owners and lenders. Mayor Eric Adams' August initiative to rezone parts of Midtown South for conversions has been met with little reception from developers and owners who are still facing high costs.

“There is no office building in New York City that will be able to be converted to residential housing, period,” Slate Property Group principal Martin Nussbaum said. “Even if you gave it to me basically for free, the math would not make sense to convert it to residential housing without an abatement.”

The cost of capital has left multifamily developers with two options, Ariel Property Advisors President and founder Shimon Shkury said: luxury condos, which aren't in high demand, or subsidized affordable housing, which is hard to get approved and funded. Without 421-a and a lack of replacement from Albany during this year’s legislative session, the industry is facing a standstill, developers said.

“It just shouldn’t be this hard,” Asland Capital Partners Managing Partner and CEO James Simmons said. “For those of us who are toiling away, trying to do the right thing, trying to produce and preserve, it shouldn't be hard for us to do that. It should be really easy.”

Hesitation about the next moves for both the office sector and the multifamily sector is impacting the construction industry, which is already trying to recover from its own pandemic-era beating, industry players said. Construction costs are coming down, but high capital costs are making many office renovations or upgrades nearly impossible, said Jerry Nocera, managing partner at NAI Resolution Real Estate Partners.

“Certainly, if you’re not shovels-in-the-ground now, you’re not putting shovels in the ground,” he said. “These buildings are either going to survive this cycle or they’re going to be going back to the bank. They’re dead in the water otherwise.”

The shift in demand has some companies looking at alternatives to ground-up construction altogether.

“If we're literally talking about shovels on the ground, we're not doing it right now,” said David Orowitz, a principal and managing director at L&L Holding Co. 

Adaptive reuse makes more sense than ground-up construction, he said, although the math is stymying that as well, with the cost of land and property still too high for many to get projects off the ground.

“The only thing you can solve the cost of the dollar with is the cost of the land,” he said. “I think the only way you could get there is a significant decline in some of the value of existing buildings and existing land.”

The result is that construction companies, too, are beginning to feel more worried about their upcoming pipeline, Wolf said.

“It’s tough right now. You see it when you see the larger firms suddenly chasing smaller projects. When you see Turner Construction chasing two bathrooms on a floor for work, then you know that there are issues,” he said. “But you’ve got to keep your staff going.”