New York City Faces Class A Office Shortage

Right now, there's plenty of top-quality space to lease but it's going fast — and there's not enough in the pipeline to meet future demand

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According to brokerage JLL (JLL), office vacancy in New York City stood at 17.5 percent at the end of the first quarter of 2024.

This is certainly unsurprising, as the glut of office space created by remote and hybrid work policies has been one of the biggest stories in commercial real estate over the past few years, and a topic at the forefront of every conversation about CRE’s future.

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But there’s a flip side to this that’s been less discussed, as the future of New York City office could face a very different problem.

Given the flight to quality that finds companies seeking the most modern and amenity-filled office space available, owners and analysts say it’s essential that the city continue delivering new, optimized office product.

But after an incredible run from 2011 to 2023 that saw almost 61 million square feet of new, Class A office product delivered, office projects currently in the pipeline are stalled due to factors such as high interest rates, and projects aren’t breaking ground in nearly the numbers required to meet likely demand over the next five to 10 years.

As a result, the city could potentially face a drought of trophy office space nearly as pronounced as the current overall glut.

While there is currently 31.25 million square feet of Class A Manhattan office product in the pipeline, according to brokerage Colliers (CIGI), only 5.07 million square feet is under construction or in the midst of a major renovation with scheduled completion dates between later this year and 2026. Of this space, nearly two-thirds already has tenant commitments. Projects currently underway with scheduled completion dates include Alchemy-ABR Investment Partners and Cain International’s 125 West 57th Street, and J.P. Morgan Chase’s new headquarters at 270 Park Avenue.

This leaves 26.17 million square feet of Class A new construction or major renovation office space that is planned but has yet to break ground or begin work, and the vast majority of these projects have no specific delivery dates. These projects include Vornado Realty Trust (VNO)’s 15 Penn Plaza, Silverstein Properties’ 2 World Trade Center and RXR’s 175 Park Avenue.

Projections from Moody’s Analytics show a dearth of new, incoming office space that could impact the industry through the remainder of the decade.

“If you look at our forecasts over the next five years, 2024 is expected to be a relatively strong year with about 4 million square feet expected to come online,” said Moody’s senior economist Ermengarde Jabir. “But beyond that, we only expect one other year to be in excess of a million square feet coming online, and the rest will be under a million if we look through to 2029.”

There are numerous reasons for the slowdown, including those high interest rates.

“People are waiting to see what happens with the presidential election,” said Carlo Scissura, president and CEO of the New York Building Congress, a trade group. “There will then be a shift either way, and there will at least be clarity on what the Fed is going to do after that. Then there will be a reckoning that, OK, these are the rates we have to figure out, or, the rates are down, let’s start getting shovels in the ground.”

But the interest rates under the Federal Reserve’s purview are just one piece of the complex puzzle currently challenging the creation of new Class A office buildings in New York City.

Mary Ann Tighe, CEO of the New York tri-state region for CBRE (CBRE), notes that when the city built 55 million square feet of new office product in the 1980s, interest rates were higher than they are now. Tighe cites several other causes for the city’s office supply difficulties.

“It’s invisible to most people, but if you study where the money comes from, the institutional capital that typically supplies the equity for new construction has basically redlined the office sector,” said Tighe. “We also have few sites of scale — you have to knock something down to build a building. Typically, there is no fallow land where you can say, ‘Oh, I could build a building there.’”

New York is also a notoriously expensive place to build, a problem that the past few years has only exacerbated.

“The cost of land is very high, and New York state has the highest insurance cost in the nation, with liability falling 100 percent on the owner and contractor,” said Lou Coletti, the former longtime head of the Building Trades Employers’ Association (BTEA) who currently serves as senior adviser to the lobbying firm Davidoff Hutcher & Citron.

“When you compare costs with other cities throughout the country, the cost of insurance alone is five to 10 times higher in New York than it is anywhere else. Then, when you add the cost of materials, supplies and labor, which have all gone up, the only projects moving forward will be those that can identify one or two anchor tenants,” Coletti said.

Securing those tenants today, however, might be more challenging than ever.

“We have an absence of anchor tenants, [as they’re] reluctant to commit to anchor a building that can’t be delivered for four to five years,” said Tighe. “Think of how few companies can say, ‘I need better real estate for my people and I’m fine waiting five years to be able to move in.’ That’s not typically how it works.”

Even if a potential tenant could make that time commitment, the financial requirements for them are greater today than in recent years.

“Ten years ago, you needed a 30 or 40 percent commitment from a credit tenant to get a construction loan. To get that loan today, you need more than 50 percent. We’ve even heard 65 percent,” said Peter Riguardi, chairman and president of the New York region for JLL.

Tighe also points out that the type of buildings under discussion cost $40 to $50 a foot in real estate taxes alone to build, and that Manhattan’s density also adds to the cost.

“Manhattan, as dense as it is, has no natural staging sites for construction,” said Tighe. “If you were to build an office building that had empty land around it, you’d pile up steel and whatever supplies you need, or you’d pull your concrete truck right up to the site. That is not possible in Manhattan. Everything has to be brought in on a ready-to-go basis, and that adds to the cost.”

All of this could lead to a significant shortage of high-end Class A offices in the years to come, a shortage that some say is already being felt.

“We’re now seeing the highest rental rates in my 40-plus years of doing this because there’s so much demand for so little new office product,” said Riguardi. “In my opinion, that new office product will run out of available space in 2024.”

In an effort to both bolster supply and cash in on the demand, owners of Class B and C office buildings are investigating potential upgrades in an attempt to create more modern office environments.

Of course, much has been made of the potential for, and challenges to, office-to-residential conversions for the city’s Class B and C office stock, but a relatively small number of buildings are physically suitable for such conversions. As of March, fewer than 60 office buildings had enrolled in the city’s Office Conversion Accelerator Program, preparing for conversion into around 20,000 new homes for city residents.

But some of the buildings not suitable for residential conversion can still be upgraded as offices, with amenities including grander lobbies. These buildings won’t quite have the prestige of the newest luxury office product but can still be desirable enough for companies seeking modern accommodations without having to pay top dollar.

“[Tenants seeking Class A space] is a smaller slice of the pie,” said John Wheeler, an executive managing director at JLL. “The sector of the market that has elasticity into what they would be willing to pay for the best product has gotten a lot of attention — those that moved into Hudson Yards and One Vanderbilt. There’s also a very large sector that is looking for value. They want good quality and they want it to be amenitized, but they’re not going to pay $150 a square foot.”

Wheeler cites the example of 60 Broad Street, a Piedmont Office Realty Trust property represented by JLL, which recently underwent a capital improvement program, including a new entry and lobby, upgraded elevator cabs, and a hospitality-inspired layout with spaces that accommodate both individual work and collaborative efforts. JLL recently leased over 45,000 square feet in the building to several tenants, bringing occupancy to over 90 percent.

“There are well-capitalized owners investing in engaging workplace environments that can still offer good rental value,” said Wheeler. “We’ve done six leases at Broad Street in the last few months. If you look up and down Sixth Avenue, there are a number of assets that have invested heavily in creating great environments that don’t require $100 a square foot for the rent.”

But, while renovated properties such as these can fill a need in the market, they’re no substitute for the A-plus office environments many major companies insist on.

“The city can’t just be a museum with building stock that’s 50 to 75 years old. It needs to reinvent itself with new product,” Marc Holliday, chairman and CEO of SL Green Realty, said in an April interview with Commercial Observer. His firm opened One Vanderbilt in late 2020 and quickly leased up most of the space. “We and others have shown that there is a significant demand and need from some of the city’s best tenants. They want highly efficient, aesthetically well-designed, sustainable, amenitized and well-located buildings.”

Holliday holds up recent rental trends as demonstrating the resiliency of demand for Class A office product that delivers the best of everything to its occupiers.

“There were 192 leases signed in 2023 for triple-digit rents. That’s more than double what that number was five or seven years previous, and I think that number will continue to rise,” said Holliday. “A lot of big companies are somewhere between demanding and encouraging their employees to be back in the office, because it’s the only place where companies can really excel and create and have the energy of collaboration. They’ll pay a price for that, because they see multiples of benefit in their bottom line.”

Still, even with rising demand at the top end of the market, obstacles on the supply side make it an open question of whether, and when, the supply of highly amenitized Class A office product will be able to satisfy the demand, or whether New York will lose some major companies to markets where supply is both available and priced at more affordable levels.

“After you factor in all the elements — the hard and soft costs of construction, financing, concessions, fees — you can’t build an office building today for under $200 a foot,” said Tighe. “Nobody’s investing in you if you’re not able to demonstrate rents in the $200-plus range.”

Given this, Tighe believes that tax deferral programs and rezonings like the East Midtown Rezoning — which allowed for the creation of projects like One Vanderbilt and 270 Park — are the best bets to increase the odds that the city can meet the demand for office product worthy of New York.

“Real estate is far and away the largest category of tax that New York City collects,” said Tighe. “If we aren’t allowing the highest-taxed product to be developed, then by definition we’re going to collect less revenue from those taxes. And if we don’t give tax breaks for renovations, then we’re not going to get [the taxes]. It’s a negative cycle that has to be broken. We’ll get out of it by rezoning, and by creating tax deferral programs. That’s what has to be done.”

With additional reporting by Max Gross.