Girding for Growth in Midtown
Sam Chandan April 4, 2013, 10 a.m.
There are good reasons to envisage a refresh of Midtown Manhattan’s office inventory.
A prolonged lull in construction has left us with an abundance of heirlooms but few modish buildings. As a global center of finance, Midtown East’s built environment compares especially poorly with its peer markets. Average rents are much higher in London, but the premium over Midtown is less pronounced when comparing our small basket of best apples with theirs. Rezoning with an eye to new construction has its winners and losers. As new properties come online over the next decade, incumbents saddled with older buildings may find their highest and best use takes them outside the office sector altogether.
We’re not in trouble yet. Aging inventory leaves the country’s largest agglomeration at a competitive disadvantage with regard to other global centers, but this shortfall does not yet define the ranking order of business capitals. Unless the financial industry’s priorities have changed, caps on bonuses in London and Frankfurt will drive more location decisions than the nettlesome columns that portion floorplates in Midtown. Investors from abroad have cast their vote for New York, targeting core assets even as prices have inched past pre-crisis peaks.
Even on a local level, the rise of Midtown South points to other factors at play alongside space quality, at least in the high-tech sector if not finance. A singular focus on newness and quality would hamstring Midtown on the global stage and in local competition. Businesses would flee en masse to lower Manhattan, which finds itself on the cusp of its second bloom, and with lower market-clearing rents at that. Firms are certainly moving Downtown, and lower Manhattan will soon boast several infrastructure advantages. But the space is only one part of the business production function; Midtown competes rather effectively along other dimensions.
Even if it has offsets in the present, the competitive drag of aging properties will worsen over time. So it’s no surprise that a far-sighted mayor is working to clear development hurdles while he can still exert sway over the politics involved. For Midtown East, the process is moving at an unusually brisk pace. Complacency will not be well-rewarded, even if its opposite risks marginalizing the less well-heeled.
Rezoning to higher density in Midtown East is not an end in itself. As a means to an end, however, tradable air rights and the potential for larger buildings on expensive land afford higher returns to developers. All else being equal, investment in new properties will rise as restrictions on scale are relaxed, even if that means higher market vacancy rates. In a well-crafted regime, private returns will be sufficiently high that developers can also fund their share of required public infrastructure.
Whether in Midtown East or any other market, properties that come online will invariably exhibit greater energy efficiency than their grizzled neighbors. The overall demands on the power grid won’t fall, but the distinction between buildings that are green and those that are not is increasingly consequential for investors. To restate a proposition from a year ago: buyers will opt unequivocally for the green building when choosing between two properties that are otherwise undifferentiated. As transaction activity has accelerated, a cursory review of the data suggests the value placed on being green has momentum independent of energy costs.
If being green is an advantage, its absence is an increasingly glaring defect. There are measurement issues that confound the analysis, principally as relates to the way greenness is measured and why developers opt to certify, but the trend clearly shows certification as the norm for new institutional-quality assets. That holds a cautionary note for would-be buyers in any neighborhood girding for growth. If the asset you covet is not green and does not lend itself to retrofitting, the discount it already commands will grow wider as its illiquidity becomes more pronounced.
Sam Chandan, Ph.D., is president and chief economist of Chandan Economics and an adjunct professor at the Wharton School.