The Real Deal New York

Commercial bubble trouble: Q&A, Part I

NYC investment sales brokers say talk of a market peak is exaggerated, but concede investors are exercising more caution

March 23, 2016 11:00AM
By Farah Halime

Michael Cohen and William Silverman

Michael Cohen and William Silverman

From the March issue: Predicting a market bubble is almost always a losing pastime. But that hasn’t stopped brokers, market analysts and economists from talking about whether the New York commercial market is peaking — and what the global economic slowdown will mean on the ground here.

This month, The Real Deal talked to investment sales executives who said that while investors and lenders are exercising more caution these days, the bubble theory is being overblown. That’s even as prices have soared since 2010, prompting comparisons to the boom and bust of the mid-2000s.

In our first web installment, we bring you TRD‘s interviews with William Silverman, managing director of Hodges Ward Elliott and Michael Cohen,
president of Tri-State, Colliers International.

William Silverman
Managing director, Hodges Ward Elliott

There’s been a lot of handwringing by economists lately about a possible commercial bubble. What do you think based on the deals you’re seeing in today’s market?

The answer is not cut and dry. The gap between premier and mediocre assets this year appears to be duly widening. The warts that were overlooked in 2014 and 2015 are receiving more scrutiny in 2016. But best-in-class assets will still attract demand.

What kind of properties are attracting the most investment in NYC and which properties are investors avoiding?

The shift in the market is away from “momentum” investing to “thesis-based” investing. For the last several years it was not about what you were buying because it was just a good idea to get as much exposure as you could. But now people cannot rely on mere bull-market momentum. While some investors think there’s room to grow in the luxury multifamily sector, others say Long Island City and Bushwick will be the next office markets. The Downtown Class B office market is also seeing more demand as a result of a high rate of residential conversion and increased demand from commercial tenants seeking refuge from Midtown South rents.

Is NYC’s economy strong enough to handle all the space coming to the market Downtown and on the West Side?

The issue is not whether NYC has enough demand to fill Hudson Yards, it’s whether we have enough demand to backfill the spaces left behind by the tenants who are moving there, like KKR, L’Oreal, Time Warner and Coach. Old-school corporate tenants seem to be choosing these newer spaces, so maybe the new-school TAMI — technology, advertising, media and information technology — tenants will be the ones to take the spaces they vacate. The buildings that succeed will be those that offer the adult playground experience favored by those tenants.

Are there new markets emerging as tenants change their investing strategies?

Smaller tenants, requiring under 25,000 square feet on a floor, have long been relegated to secondary buildings in Midtown East. Perhaps now we will see them moving to areas like south Broadway and the Garment Center. When you see astute players such as Westbrook buying at 1375 Broadway or Vanbarton at 31 Penn Plaza, one has to imagine that part of the thesis is this western migration.

How has Chinese investment in NYC been impacted by the country’s economic slowdown, stock market turmoil and currency devaluation?

The second wave of Chinese investment is going to be a lot more choosy and specific. Many of these investors have planted their flag on the far right side of the bell curve with trophy purchases like the Waldorf Astoria
and One Chase Manhattan Plaza. Now they’re walking their way back as they develop a more traditional exposure to the market.

Michael Cohen
President, Tri-State, Colliers International

Do you think there’s a commercial bubble on the horizon and how do interest rates play into the current climate?

The likelihood of a bubble is vastly exaggerated. The market has long anticipated this first interest rate increase by the Fed and basically shrugged it off. The real question is: How much will the Fed increase rates by over the next few years? I don’t think the market is ready to shrug off three to four increases. And in a funny way, the lack of inflation, volatility in the stock market and global slowdown in growth all seem to argue against more increases in the near term, which is a net positive for commercial real estate values.

Which Manhattan neighborhoods are seeing the strongest leasing activity and which are struggling?

Midtown South will continue to be an undersupplied market until job growth in the TAMI grinds to a halt, which is highly unlikely to occur in 2016. On the other hand, the Downtown market has plenty of supply, albeit at rents 20 to 30 percent higher than a few years ago. Even factoring in those rent increases, Downtown is still attracting cost-conscious tenants, refugees from Midtown South, and offers some of the best values in Manhattan. In Midtown, supply seems likely to increase because of defections to the Far West Side and Lower Manhattan, but availability is already well into single digits, creating a challenging environment for tenants.

Do you think NYC’s commercial market has peaked or is nearing a peak?

There’s been so much talk about the market peaking in 2015 that it does seem likely to be self-fulfilling. The big question is whether foreign capital will really be affected by the global slowdown. There still seems to be an inexhaustible supply of buyers for every property on the market. [In terms of foreign investors] we may see less investment activity from Chinese and Russian oligarchs this year, but other sources will rise to replace them. We’ve seen activity from both Canada and Germany of late.

Is NYC’s economy strong enough to fill all the commercial space coming online?

The Far West Side is already a proven success with no shortage of demand. Downtown has been less successful in attracting tenants but should fill its space, albeit more slowly.

What do you predict on the commercial development front in Manhattan? Are developers and lenders going to be willing to tackle new commercial projects given the uncertain market?

New development will be highly site specific. Midtown South, which already has insufficient supply, will remain attractive to developers. The proliferation of boutique, speculative office buildings in the Meatpacking District is a perfect example of that. Developers will be more cautious in Midtown and Downtown.

What do you see as the biggest challenges to the market in the coming year?

Certain markets and submarkets are already oversupplied, and others will remain undersupplied throughout 2016. That said, there is clearly going to be a lot of space vacated by tenants that migrated to Lower Manhattan and the Far West Side.

Correction: In a previous version of this article, the company name Hodges Ward Elliott was misspelled.

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