At lunch yesterday someone raised the lurking question—“Have values topped out?” Since we were sitting in the middle of Manhattan sushi den, I presumed he was talking about the New York office market. And of course, New York is a special case—a unique, global gateway where everybody wants in and foreign money all too readily grabs for a piece of the action.
Given fundamentals, office pricing looks awfully dear and has for at least a year. In New York, West Side development is beginning and companies committing to new space are looking eagerly to downsize into more efficient quarters by as much as 20%. Virtually none of these big movers will be in expansion mode. Meanwhile, some prime existing buildings along Sixth Avenue are looking to fill space that's been given back as technology encourages shrinking tenant requirements.
If an owner sells one of the prime existing assets how will they replace it at a better price? If it's an opportunity investor they may be cashing out, but then where is their next play—in the typical secondary market where demand is even more spotty? And as we have beaten to death for years, the suburbs are a quagmire for office investors. These markets don't offer much of an opportunity for a peak—at best they offer more of a flat line track with considerable downside risk.
Now we may see some continuing horse-trading in the top 24-hour markets with prices heading higher, but the more we go into obvious nosebleed levels without rental rates supporting expectations and the specter of high interest rates leading to cap rate decompression you would have to expect buyers will be disappointed unless they are willing to be very long-term holders.
The good news is office development has remained generally in check, but that's the bad news too only highlighting how lackluster demand remains. By now—four years since market bottom-- you would expect enough tenant interest to spark a round of projects. Developers of new age office with highly efficient floor plates and all the new-tech features should do extremely well in the major business centers where tenants will leave older product to squeeze down space, but all at the expense of existing buildings.
And then what happens with this older product which may face a considerable challenge in leasing their space at decent rates unless they upgrade?
As a result, we will see more owners of existing Class A (now looking more B+) forced into retrofitting to stay competitive and that will take big bucks. Of course, some pre-1980s construction increasingly looks long-in-the-tooth and investors need to be extremely careful to make sure they can accommodate the requirements of companies looking to shoehorn in their workers in reasonably comfortable environs. That could be an increasingly tall order.
So have values topped? All indicators—tenant downsizing proclivity, select new projects, higher interest rates—suggest that current buyers are pushing the envelope in the office markets even in New York.
And yes it seems much too early in the cycle to say—“This never ends well.”
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Jonathan D. Miller
A marketing communication strategist who turned to real estate analysis, Jonathan D. Miller is a foremost interpreter of 21st citistate futures – cities and suburbs alike – seen through the lens of lifestyles and market realities. For more than 20 years (1992-2013), Miller authored Emerging Trends in Real Estate, the leading commercial real estate industry outlook report, published annually by PricewaterhouseCoopers and the Urban Land Institute (ULI). He has lectures frequently on trends in real estate, including the future of America's major 24-hour urban centers and sprawling suburbs. He also has been author of ULI’s annual forecasts on infrastructure and its What’s Next? series of forecasts. On a weekly basis, he writes the Trendczar blog for GlobeStreet.com, the real estate news website. Outside his published forecasting work, Miller is a prominent communications/institutional investor-marketing strategist and partner in Miller Ryan LLC, helping corporate clients develop and execute branding and communications programs. He led the re-branding of GMAC Commercial Mortgage to Capmark Financial Group Inc. and he was part of the management team that helped build Equitable Real Estate Investment Management, Inc. (subsequently Lend Lease Real Estate Investments, Inc.) into the leading real estate advisor to pension funds and other real institutional investors. He joined the Equitable Life Assurance Society of the U.S. in 1981, moving to Equitable Real Estate in 1984 as head of Corporate/Marketing Communications. In the 1980's he managed relations for several of the country's most prominent real estate developments including New York's Trump Tower and the Equitable Center. Earlier in his career, Miller was a reporter for Gannett Newspapers. He is a member of the Citistates Group and a board member of NYC Outward Bound Schools and the Center for Employment Opportunities.
