The Window for Seizing on New York’s Class B and C Office Rebound Is Closing

For years, the narrative surrounding New York City’s Class B and C office market was overwhelmingly negative. Vacancy was rising. Leasing activity was sluggish. Remote work was ascendant. Institutional lenders were retreating. Distressing headlines dominated the conversation. And, perhaps most importantly, pricing collapsed.

Buildings in Manhattan that traded 10 years ago for $800 or $900 per square foot suddenly found themselves changing hands in the low $200s and, in some cases, even the high $100s per square foot. Owners who had financed assets at dramatically higher valuations were under pressure. Buyers were circling cautiously. Many investors believed the decline would continue indefinitely.

But markets do not bottom when sentiment is negative. Markets bottom when reality begins improving before the majority of people recognize it. And that is exactly what has happened in New York City’s Class B and C office sector.

The bottom has already passed. In fact, I would argue we are now probably six months beyond it.

One of the most important drivers of this recovery has been the extraordinary success of the 467m office-to-residential conversion tax abatement program. The efficacy of this program has been far more powerful than many anticipated. There are well over 80 office buildings in Manhattan actively pursuing residential conversion, representing the removal of around 26 million square feet of office inventory from the market.

That is an enormous number.

For years, the market’s biggest problem was not simply weak demand, it was oversupply. There was simply too much obsolete office product competing for too few tenants. Older buildings with inefficient floor plates, weak light and air, aging infrastructure and inferior amenity packages could not effectively compete against newer, highly amenitized office product.

Conversions have materially changed the equation.

When 26 million square feet of office inventory begins disappearing from the competitive leasing pool, the overhang of vacant space shrinks dramatically. At the same time, leasing activity has quietly but steadily strengthened. Positive absorption has reduced vacancy rates meaningfully, and the market is now approaching equilibrium far faster than most observers expected.

This is how recoveries begin. Not with dramatic headlines. Not with a sudden overnight rebound. But through the gradual tightening of supply, increasing tenant activity, improving absorption and, eventually, upward pressure on rents. And we are now seeing all of those dynamics unfolding simultaneously.

What is particularly interesting is that many investors still appear psychologically anchored to the fear that dominated the market 12 to 18 months ago. They continue speaking about the office market as though conditions are deteriorating when, in reality, conditions have already begun shifting materially.

That creates a fascinating disconnect.

Because, while many investors were waiting for “certainty,” the opportunity to buy at the bottom quietly disappeared. I often say that you never know you are at the bottom of the market until you are past it. That statement applies to virtually every cycle in real estate history. At the actual bottom, fear is highest, financing is hardest, headlines are worst, and conviction is most difficult. 

By the time the recovery becomes obvious to everyone, pricing has already moved significantly.

That is exactly what is happening today in the Manhattan office market.

We are currently marketing a building in the Flatiron District that illustrates this phenomenon perfectly. The property is approximately 90 percent vacant, and for months virtually every investor evaluating the opportunity viewed it exclusively as a residential conversion candidate. The pricing discussions reflected conversion economics.

But, over the past month, something changed. Investors emerged who wanted to retain the property as office. Not only did they emerge, they began aggressively competing against one another, leapfrogging bids higher and higher. Ultimately, the winning office buyer exceeded the pricing we were receiving from residential converters by approximately 10 percent. The contract was signed two weeks ago, and we expect to close within the next couple of months.

That transaction would have been very difficult to imagine a year ago. Today, it is becoming increasingly logical.

Why?

Because sophisticated investors are beginning to recognize that Class B and C office values already experienced their severe repricing. They also recognize that supply is shrinking, leasing activity is strengthening, and rental pressure is beginning to move upward. In other words, they understand that the risk-reward equation has fundamentally changed.

Importantly, this does not mean every office building will recover equally. Commodity office product without a viable repositioning strategy will continue facing significant challenges. Poorly located assets and buildings requiring massive capital expenditures without a clear path forward will remain under pressure.

But well-located Class B and C buildings with leasing optionality, conversion potential, upgrade pathways or repositioning opportunities are beginning to attract increasingly aggressive capital.

Broadly speaking, the indiscriminate pessimism surrounding New York City office has become increasingly disconnected from market reality. The smart money is beginning to move. And, once momentum shifts in New York City real estate, it often shifts far faster than people expect.

This gets back to something I have said for decades: Never bet against New York City.

New York has survived fiscal crises, recessions, terrorism, financial collapses, pandemics, and periods where people confidently declared the city was finished. Yet, over and over again, New York reinvents itself, adapts, absorbs shocks, and emerges stronger than expected.

The Class B and C office market appears to be doing exactly that right now. The investors who had the courage to buy when fear was greatest are likely going to be rewarded handsomely.

The investors still waiting for complete certainty may ultimately discover what investors in every cycle eventually learn: By the time the fear disappears, the opportunity usually has too.

Robert Knakal is founder, chairman and CEO of BK Real Estate Advisors.