The Economics of Office Leasing in 2010
Tom Acitelli Dec. 16, 2009, 7 p.m.
Amid the Bureau of Labor Statistics’ most recent reports of narrowing economywide job losses, the nation’s leading employment centers are exhibiting a wide range of labor-market trends. At one extreme, employment in Detroit has fallen by 7.2 percent in the past year. Since the beginning of the recession in January 2008, more than one in every 10 jobs has been wiped out in the Motor City. In the District of Columbia, on the other hand, payrolls have actually grown over the same period, fueled by an increase in government programs and a corresponding uplift along K Street.
As for the host of metropolitan areas that fall between these two poles, the timing and extent of the resumption in job growth will dominate economic and property-fundamentals trends over the next year. This point was reemphasized last Thursday when Bruce Katz of the Brookings Institution testified before the Senate Committee on Banking: “The American economy, like most developed economies, is a network of metropolitan economies. … The Great Recession has affected different metro economies in radically different ways. … Even as economists talk about national recovery, a large number of our metropolitan economies are still mired in recession.”
As challenging as the past year has been for New York City, the Big Apple is not among the laggard markets to which Mr. Katz referred. At the center of the crisis in the global financial system, New York has undoubtedly seen its labor market come under unique strains since the recession took hold here. Subsequent to the economic shocks of September 2008, the city shed more than 60,000 jobs in the final three months of the year. A disproportionate share of those jobs was in financial services and related occupations, where relatively high wages otherwise feed multiplier effects across the local economy. Stepping away from the textbooks to read conditions from the sidewalks, it is clear that losing our best-paying jobs has been devitalizing.
Coincident with the labor-market contraction and the watershed events that precipitated the job cuts, business confidence also plummeted. As businesses were loath to make any long-term commitments while under a shroud of economic uncertainty, their capital investment and leasing activity came to a standstill in late 2008. The evaporation of demand for space and the sudden rise in sublet availability sparked one of the most abrupt declines in rental rates ever observed in Manhattan’s office submarkets.
WHAT A DIFFERENCE a year makes.
At the close of 2009, it is apparent that the direst predictions for the city’s economy and the financial services sector have not been realized. By the New York Fed’s own estimation, “the pace of decline eased considerably in spring 2009 and leveled off in July.” In fact, many of the financial services firms that are the backbone of New York City’s agglomeration have stepped away from the precipice and into surprising profitability. So much so that they are now imperiled in the court of public opinion.
Similarly, the tally of New York City’s job losses has fallen short of popular perception. Across New York’s wider metropolitan area, payrolls have fallen by 2.5 percent over the past year. In contrast, the one-year payroll contraction in each of the Chicago and San Francisco metros is 4.4 percent; in Atlanta, 5.7 percent; and, in Houston, 3 percent.
Seasonally adjusted, New York City’s 12-month job losses narrowed from 123,900 in September to 109,900 in October.
Of course, relatively smaller job losses do not translate into new demand for space. The disconnect between profitability and job creation at financial services firms remains a key qualifier to any positive characterization of market conditions. In this regard, current policy initiatives designed to elicit hiring are of limited relevance for Manhattan’s office market.
Speaking at the Brookings Institution last Tuesday, President Obama outlined new steps that the administration will propose to spur job growth. The administration’s three-part program focuses on supporting small businesses; increasing investment in infrastructure beyond what is called for in the American Recovery and Reinvestment Act; and incentivizing homeowners to retrofit their houses with energy-saving upgrades.
Subjectively, the administration’s proposal is curiously lacking in measures that might stimulate near-term job growth. Of its three prongs, the first—supporting small business—offers the best prospects of triggering job growth that will benefit low- and moderate-cost office demand. But the plan of action is unclear. Aside from measures that expand on those already in place, including tax breaks on capital gains and enhanced support for Small Business Administration loans, the president indicated only that “it’s worthwhile to create a tax incentive to encourage small businesses to add and keep employees, and I’m going to work with Congress to pass one.” For millions of unemployed Americans, specific efforts to reduce the direct costs of payroll growth will not be undertaken soon enough. In the worst case, small businesses will delay hiring in anticipation of accruing some benefit for doing so only after a new program is in place.
FOR MANHATTAN, THE LAST year’s efforts to stabilize the financial system, while the subject of much public debate and occasional derision, have been more important for the city’s economic, labor-market, and property-fundamentals outlook than are current efforts to spur small-business activity. And while many of the risks to the city’s economic outlook have yet to abate, a degree of normality and predictability that was absent at the close of 2008 now graces the market.
With business confidence improving in tandem with corporate profits, a growing cadre of firms has moved to take advantage of the market’s sharply lower rent levels. Suffice it to say that the past few months have been characterized by surprising robustness in office leasing activity given the nature and strength of the shocks that roiled the market not so long ago. Some of this increase is a result of pent-up demand; the balance is sustainable. It is a false choice to require that it be entirely one or the other.
What is motivating the most stable firms to reenter the marketplace at this early juncture? Absent any expectation of runaway job growth, meaningful improvements in asking and effective rents are a ways off. The last recession was relatively mild compared to the current downturn, and yet New York City’s office vacancy rate did not reach its peak until late 2003, two years after the recession’s formal end. In turn, it was not until some time after vacancy rates had trended down that rent growth developed real momentum.
The last downturn shows that while we do not need to replace all of our lost jobs to see rent growth increase, we must replace a large share of them. And the market must believe that gains will be sustained. While firms reentering the space market in 2010 will anticipate the improvements in fundamentals that will only follow them, these prospective tenants are also leading a move to quality.
And therein lies part of their motivation: The early movers into the market’s nadir are securing higher-quality space at lower relative rents than were available before or may be available after.
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Sam Chandan, Ph.D., is president and chief economist at Real Estate Econometrics and adjunct professor of real estate at the Wharton School.
John Brod is principal and founder of PBS Real Estate. He has facilitated more than 30 million square feet of commercial property leases, including the Hollister store at 600 Broadway and the Fifth Avenue Abercrombie & Fitch.