New York’s Class B and C Office Owners Mull Flex to Fill Space
Imitating WeWork isn't their first choice, but the pandemic has forced changes on a market still struggling with historically high vacancy
New York’s white-collar workers aren’t the only ones fretting a return to the office this spring.
Two years after a respiratory contagion ravaged the city, forcing many of its offices to close indefinitely, the owners of New York’s aging commercial buildings are at a crossroads.
These landlords of what are known as Class B and C buildings, which are smaller, older, and located in less desirable corridors than their Class A counterparts, are mulling several options. (Much of the city’s Class B and C office space is concentrated between the 20s and 60s east of Park Avenue and west of Avenue of the Americas, with a smattering of buildings below 14th Street.)
Some landlords rode out the pandemic without making additional investments in their assets and now aim to compete on price alone. Other owners saw prospective tenants pivot to Class A office space dripping with 21st-century technological upgrades, cozy lobbies and soaring rooftop terraces, and renovated their modest-sized high-rises to compete with the One Vanderbilts of the world. Still others contemplated tearing down their buildings after missing out on months of rent while inflation rose and their debts piled up.
Yet one in five Manhattan offices was vacant at the end of last year, according to a Cushman & Wakefield report. Less than 40 percent of the New York area’s office space was occupied on a given day in mid-March, according to security firm Kastle Systems’ estimates. Hybrid schedules are likely to outlast the pandemic as workers are increasingly demanding the flexibility to work from home at least part of their week, which will in turn affect office layouts, restaurant and hospitality locations, and the zoning of New York’s central business districts.
The dangers of the coronavirus are far from over too. A highly transmissible new COVID-19 variant could upend plans for employees to return to their workplaces this spring, making Class B and C building owners that much more anxious about the future.
“There’s a lot of uncertainty in that space at the moment,” said Robert Knakal, chairman of New York investment sales at JLL (JLL) Capital Markets. “The turnover in New York City has been so low historically that a lot of these buildings have been owned by the same owners for decades. They’ve been taking money out of their buildings; many owners are reluctant to put capital into the building, and they’re stuck in a place to figure out which direction to go in.”
The volatility in the market and high vacancy rates have given tenants leverage to request changes better suited to their needs. That’s pushed Class B and C owners to accept deals as short as six months to a year.
Some have even turned to a flexible office space model on certain floors or throughout their entire building, despite the struggles of third-party operators like WeWork (WE) or Knotel even before the pandemic.
“What’s going to happen in the next six to eight weeks is going to be pivotal in terms of the future of office space and whether people move back to the office,” said Kate Wittels, a partner with HR&A Advisors, which advises governments, businesses and developers in their strategic planning. “Companies have been accepting of realistic health concerns. Assuming the next variant doesn’t turn into an omicron and delta, now is the conversation about work preference.”
Why flex now
Before the pandemic, developer Jeff Gural leased floors in his Manhattan buildings to flexible office operators like Knotel, Breather and Jay Suites. Knotel has since filed for bankruptcy and been acquired by Newmark while Breather closed its locations as work-from-home predominated office culture over the past two years. (Jay Suites is still around.)
Gural isn’t so eager to rent office space to that business model again. Instead he’s embraced hybrid offices where workers may end up sharing desks during shifts in the space and shorter leases to tenants willing to snap them up.
“I’m just not sure anybody knows how this is going to all turn out. I would prefer to wait and see,” Gural, chairman of GFP Real Estate, said. “We’ve seen that our restaurants are full and Madison Square Garden is okay, but the offices are still not returned. Unless owners of companies are going to insist employees come back, my guess is we’re still going to see fewer people occupying. I doubt it will ever go back to the way it was.”
But coworking and flexible office space hasn’t become extinct. Far from it. Owners of smaller Class B buildings in Downtown Manhattan and on the edges of Midtown are experimenting with coworking models as well as prefabricated, built-out office spaces for tenants to move in quickly for shorter periods of time than the five- or 10-year leases they had been offered pre-pandemic. And a number of nimbler third-party operators are approaching owners about sharing risk.
“Folks in that business are scouring Manhattan right now,” Michael Cohen, president of Colliers’ tri-state region, said. “They believe there will be a growing demand for the product they offer post-COVID and they want landlords to be partners if not proprietors. Some landlords are embracing the concept for a portion of their portfolio, which would be diversified by adding office suites. Some even have their own label.”
Brian Soto, director of acquisitions and asset management at Time Equities, has included flexible office options in two of his properties, 55 Fifth Avenue and 125 Maiden Lane, a Financial District building of which Time Equities owns a third. He lost tenants at the start of the pandemic once leases expired but leasing has picked up again as tenants flock to his pre-built suites and short-term leases, instead of making demands for particular specifications.
“You walk right into it, it’s finished, plug-and-play, you can drop your furniture in, get your IP vendor and, depending how quickly you sign a lease, you could be moving in tomorrow,” Soto said. “It’s not that they need flexible space to grow, it’s that people want the flexibility to be in a space they want to be in; not necessarily a smaller space, but something that still has a high-level finish to it.”
Who is looking
A flexible office space has always appealed to a certain type of tenant but those categories are broadening now.
Myriad tech companies as well as digital media, advertising and marketing firms are among the most prevalent industries snapping up coworking or flex spaces, brokers say. Their workers, who are often from firms with fewer than 10 to 15 people, come to the office part of the week and share desks, keeping their footprints small.
“There is a significant hangover of Gen X, thirtysomethings and younger who do not want to be in an office five days a week, looking for a flex space three days or less,” said Grant Greenspan, principal of real estate company the Kaufman Organization. “These companies are competing for talent and are forced to accept individuals that want this lifestyle. They’ll rent a space from me, and they’ll populate it with phone booths and unassigned seats, and staff will rotate in and out.”
On the other end of the spectrum, blockchain- and cryptocurrency-related firms are taking larger flex office spaces with bench-style seating and packing as many employees as they can into their workspaces.
Affordability is an important consideration but brokers and developers say tenants drawn to flexible office spaces in Class B and C buildings are as concerned about the quality of the building and its work environment.
That appears to be reflective in recent prices. New York boasts the highest cost of private office desk space in flexible office spaces among global cities, at $961 per month, according to a March report from Savills. San Francisco had the second-highest price at $950 per month, followed by Singapore ($834), London ($803) and Berlin ($800).
“Similar to the Manhattan office market as a whole, there has been an undeniable flight to quality which has resulted in a shrunken set of options to choose from and ultimately higher asking rents,” said Griffin Foley, the Northeast lead for Workthere Americas, a flexible office business formed by Savills.
Still, sole proprietors remain the most common users of coworking spaces. Karen Zabarsky, who started her own creative studio Ground Up after working at Kushner Companies, has camped out in coworking offices in SoHo, Jersey City, N.J., and Downtown Brooklyn depending on clients’ locations and which project her team is tackling.
“People are starting to think of more traditional office spaces like a college campus,” Zabarsky said. “You go if you need to go to network and have face time. You want that second space to have community and meet people and have the opportunity to advance your career and make connections.”
Flexible office space options are increasingly moving beyond Manhattan’s central business districts and into neighborhoods where company’s employees are concentrated.
“Coworking is going in neighborhoods with walkable communities or neighborhoods with a main street,” said Wittels of HR&A Advisors. “Some places are functioning like a gym model that you can rent by the hour or by the day. We see people testing that out.”
Jamie Hodari, CEO and co-founder of Industrious, one of the country’s largest coworking operators, has touted a “hub-and-spoke model” with locations in urban centers as well as residential neighborhoods and suburbs.
“It’s pretty clear the one amenity to rule them all right now is to have a flex operation in the building,” Hodari said. “You look at operators and no one is saying, ‘I need a rooftop terrace and an Equinox or I’m not going to sign.’ Lots of people are saying, ‘If I’m going to sign a long-term lease I need to know I can shrink down in size and have a flexible space.’”
So far he has 13 locations in New York with his busiest sites in Midtown, but the biggest demand for satellites are in walkable neighborhoods where a company’s workforce lives. Hodari is eyeing Class B and C sites in Brooklyn’s Prospect Heights and Williamsburg; Manhattan’s Upper West Side; and Jersey City for expansion.
“A lot of companies are saying, ‘Well if all my employees can walk to work, we’ll be happy to have an office on the second story of a brick building rather than the 50th story of an office tower,’” Hodari said. “Plus, the in-and-out style of working is a better fit for midsize buildings than the Class A building where you get in, start work at 9 a.m. and work for 10 hours. That style of working is diminishing right now.”
The desire for smaller, flexible office space has benefited developers in outer-borough neighborhoods like Brooklyn’s DUMBO, Williamsburg and Prospect Heights, as well as Jersey City and Long Island City, Queens.
Two Trees has invested in industrial space along the Brooklyn waterfront since the 1970s and began converting it into office space in the late 1990s. Its buildings would reliably be categorized as Class B but some have amenities that outstrip their “A”-rated rivals across the East River.
Not that most of the firm’s tenants are even looking at Manhattan as an option. The DUMBO-based developer has found that three-quarters of the 62 lease deals it made last year were with companies whose decision-makers or workforce lived in Brooklyn. One of its newer office properties in Williamsburg, Ten Grand Street, has added tenants from a nearby WeWork that closed as well as a Spaces coworking space in South Williamsburg.
For these tenants, a neighborhood where its workforce can easily walk or bike to the office is as much of an amenity as the building and office layout itself.
“When I think of the class of an office building, I can’t disassociate it from its neighborhood,” Alyssa Zahler, director of commercial leasing for Two Trees, said. “So much of what we have in DUMBO is the neighborhood. It’s the business improvement dstrict, the streets getting closed off, people are mingling and there’s the park that’s here. There’s so much beyond the building that’s part of the value proposition here. The neighborhood is part of it; it’s a living, breathing thing.”