Class A Meet Plan B: How the Coronavirus Could Impact NYC’s Newly Built Office Space

“People are going to be gun-shy,” said Timothy King, the managing partner at Brooklyn-based brokerage SVN | CPEX. “There’s going to be a reluctance to expand … This is going to scar people.”

So what happens to the millions of square feet of new office space in the pipeline carrying asking rents of more than $100 per square foot? The rest of the 28-acre Hudson Yards with a price tag in the billions? The similarly priced and expansive Manhattan West just across the street? One Vanderbilt, the colossus rising from Grand Central like a glass and steel beanstalk? The Chelsea freight house known as Terminal Stores? Essex Crossing in the Lower East Side? Two Trees’ Domino project along the Brooklyn waterfront? The list goes on and on.

“These projects are underway, they’re going to get built,” said David Goldstein, a vice chairman at Savills. “I think you’ll see some of these projects deliver later than they anticipated.”

Goldstein said there’s between 15 to 16 million square feet of new office space coming online in Manhattan between 2020 to 2023 with only about 9 million square feet committed. In late March, the state halted work on all non-emergency construction projects and coupled with construction costs being at an all-time high makes it difficult for owners to push down rents much to attract new tenants.

“You have a little bit of a capital crisis,” Goldstein said. “The big question is how far will the needle move on pricing in order to keep the velocity of leasing on pace with a normal market.”

A recent report from Savills found that the average asking rents for Class A office space in Manhattan increased slightly from $89.70 per square foot in the first quarter of 2019 to $96.60 per square foot in the first quarter of 2020. However, experts said it will likely take two quarters for the asking rents to drop post-COVID-19.

In Midtown, the average asking rent for space was $87 per square foot in the first quarter of 2020, according to CBRE (CBRE). That’s a big gap from the $125 to $200 per square foot SL Green (SLG) Realty Corp. has been asking for its under-construction One Vanderbilt tower in Midtown East.

It’s not just new construction that could feel pain post-COVID-19 but the city’s entire office market. The emergency measures put in place to curb the spread of the disease forced many businesses around the city to temporarily shutter, leading to mass layoffs and decimated revenues. Many are expected to permanently close and the ones that do survive are unlikely to want to spend money on splashy new office space.

“We will see companies — having gone through a very difficult quarter or two — be very, very financially prudent,” said David Falk, the president of the New York tri-state region at Newmark (NMRK) Knight Frank. “A lot of companies when we came out of [the previous financial crisis] spent the first year doing more renewals than they typically would.”

In that period, Falk said about 40 percent of all leases signed around the city were renewals. That’s likely to be the case coming out of the coronavirus pandemic as well since companies will be unsure of their financial standing after a months-long pause.

“It’s going to be a cautious environment, people are going to want to see where business goes,” Falk continued. “They’re going to want to see if we get back to doing business quickly or is it slow.”

Plus, many companies could be rethinking just how much office space they need after seeing the success of remote work. Major tenants like Google and Facebook announced this month it will allow its entire staff to work from home until at least next year — with Twitter going one step further and allowing its employees to do the same permanently — making it unlikely they will pull the trigger on high-priced office space. (Facebook has reportedly been in talks to take 700,000 square feet at Vornado Realty Trust (VNO)’s renovated James A. Farley Post Office.)

“Companies are in a saving mode mentality,” said Falk, adding that many companies he’s talked to anticipate they’ll have at least 20 percent of their workforce staying at home in the future. “They had to lay off employees. They have excess space and they need to cut costs.”

Which doesn’t mean that others aren’t boosting a rosier scenario and a traditional need for quality office space. Vornado chairman Steven Roth said in a recent earning class he doesn’t “believe working from home will become a trend that will impair office demand and property values.” (A spokeswoman for Vornado did not respond to a request for comment.)

However, Morgan Stanley CEO James Gorman said the financial services firm has started to consider shrinking its sizable office footprint once it saw the success of nearly 90 percent of its workforce staying at home.

“Clearly, we’ve figured out how to operate with much less real estate,” Gorman said on Bloomberg. “Can I see a future where part of every week, certainly part of every month, a lot of our employees will be at home? Absolutely.”

But even if major office tenants don’t give back space the amount of sublease space will likely increase in the future because businesses simply might not exist after the coronavirus pandemic. A report from the Center for an Urban Future and Tech:NYC found the city could lose a “sizable portion” of its technology startups — a major driver of leasing activity in recent years — since the pandemic cut revenues, delayed product launches and canceled desperately needed fundraising rounds.

“We’re already seeing some signs of subleases being added to the inventory at a faster pace and the sublease space starts to compete with direct space,” Goldstein said. “The big question is when does the base rent needle start to move.”

In the first quarter of this year, the available sublease space around Manhattan increased to 13.9 million square feet from the 12.6 million square feet it had in the fourth quarter of 2019, according to Savills. The total availability rate climbed to 11.5 percent from 10.7 percent year-over-year, the report found.

That could put more pressure on landlords offering direct deals to lower their asking rents since subleases tend to be cheaper, Goldstein said. (The CBRE and Savills’ reports did not have average asking rents for sublease space.)

And it’s not just shuttered companies that could add to increased sublease space, another hit could come from coworking and flexible office space providers.

In Manhattan alone — where WeWork is the single largest office tenant — coworking companies lease a total of 14.7 million square feet and take 3.1 percent of the borough’s total office supply, a report by Savills found.

WeWork has been struggling to survive because of the coronavirus pandemic — trying to renegotiate its leases to cut down on its rent bill — while competitor Knotel already announced it plans to give back about 1 million square feet of its global portfolio, with a good chunk of that in Manhattan.

However, if coworking providers can come out of this alive on the other side, brokers expect tenants to flock to them because many companies will be leery of committing to long-term leases.

“Companies are going to have a short-term mentality because they just don’t know where they stand in the business based on the period they’re going through,” Falk said. “That’s good for the flexible office space industry.”

While that looks like another pressure point to the city’s new construction, it’s not all doom and gloom for the shiny glass-and-steel going up in Manhattan. Last month, SL Green announced that it signed a combined 34,013 square feet of leases with two private equity firms in the 67-story One Vanderbilt. Those deals brought the skyscraper to 67 percent leased ahead of its projected summer completion date. (A spokesman for SL Green did not respond to a request for comment for this story.)

“2020 leasing activity continues albeit at a slower pace in the current environment,” Steven Durels, SL Green’s director of real property and leasing, said in a statement announcing the deals. “Tenants are re-assessing per employee space allocations with an eye toward de-densifying and providing more space per employee.”

That mindset could prove extremely helpful for new construction since many companies may be willing to spring for pricey new digs to create office environments that limit the spread of infectious diseases to put their workers’ minds at ease.

“I think the buildings that will lease the fastest are the ones that have taken all the precautions post-COVID-19,” Falk said. “It’s going to be important and brokers are going to be asking on behalf of tenants what initiatives are the buildings taking.”

And with activity expected to slow, brokers said the tenants willing to sign leases could be in a position to grab a good deal or score generous concessions from landlords.

The tenants who will do deals are going to be focused on larger, column-free offices so their workers can stay socially distanced as much as possible in the office. Another importance will be the air-flow and air-filtration of buildings, said Kevin Denlinger, the vice president of architecture for meetings, events and flexible office company Convene.

“Everyone’s trying to improve the air quality, everybody’s trying to improve the cleaning,” Denlinger said. “I think it will be challenging for very hermetically sealed buildings.”

Those new design and infrastructure concerns could give new buildings a leg up since many already have those features in place or can pivot easily to add them in, Goldstein said.

“That, we think, gives new construction an edge,” he said. “They can really build it in and design this new way of thinking into their plans.”

Companies will likely be looking to limit the headcount for single offices and workers might be wary of hopping on public transportation to get to work, which could bring the return of satellite offices in Brooklyn and the suburbs.

“If you did a census of your typical office building, it’s likely that a significant portion lives in the outer boroughs,” King said. “Having a short commute time will be important.”

King pointed to the Rudin family and Boston Properties’ Dock 72 building in the Brooklyn Navy Yard — which has yet to announce a lease since it opened last year — as a project that could be especially poised to take advantage of that because of its “enormous” floor plates.

“It gives potential tenants much more of an opportunity to create the sort of environment that we’re discussing than in your classic older Manhattan building,” King said. “It’s going to take a lot of demolition to open those spaces up and make them COVID compliant.”

The owners of the older buildings will likely have to throw huge sums of money at properties to bring them up to that new standard to attract new tenants, which could be difficult during a downturn.

“Antiquated buildings are going to really have to reinvest money so that there’s a reason why companies will want to move there,” Falk said. “They’ll have to make their standards up to the 2021` type of architecture.”

New constructions won’t feel that issue much and the older buildings that already started capital improvement projects with those changes in mind have already seen an increase in interest from tenants, even during the pandemic.

Developer Olayan Group started work on a renovation project for the 1984-era, landmarked 550 Madison Avenue last year and was already incorporating many of the elements tenants want in a post-COVID-19 office.

“We still are engaged with people because it’s hitting on these fantastic points that tenants care about,” said Erik Horvat, Olayan’s director of real estate, adding one key feature for companies has been the property’s “hospital-grade filtration.” “To be able to say that with a straight face, saying we have that level of filtration in your air quality, will resonate with new tenants.”

Horvat said Olayan hasn’t had to change its asking rents for the project so far, but declined to give the price. Even with renewals expected to increase in the future, Horvat remains confident that new or renovated buildings will be in a much better place to ink deals.

“If you’re saying that I have to make a long-term commitment for the future, I don’t know if you want to be in an old building with not good filtration,” Horvat said. “That’s an option really on a short-term basis.”