The Real Deal New York

FiDi investors bet — again — on office developments

Buyers try new strategy, sticking with commercial instead of converting to apartments
By Katherine Clarke | October 01, 2013 07:00AM
From left:

From left: Kent Swig, Jared Kushner, 1 Chase Manhattan Plaza and 100 Broadway

True to its name, the Financial District was historically the center of business in New York City. But when it comes to commercial real estate, the area has taken a backseat to other Manhattan neighborhoods in recent years — especially since the 9/11 terrorist attacks.

Indeed, most of the investors who snapped up office buildings in FiDi converted them into high-end residential condos or rentals.

That’s now beginning to change, however. As several long-awaited megaprojects debut in the neighborhood — including One World Trade Center, the new Fulton Transit Center, and a new retail atrium at Brookfield Place (the former World Financial Center) — demand for FiDi commercial buildings is growing. And unlike in the past, investors are planning to maintain the buildings as office towers.

Todd Korren, an executive managing director at investment sales firm Massey Knakal Realty Services, said he’s seeing “heated interest” from investors looking for Lower Manhattan office buildings as rents rise.

“Investors think the office market will continue to tighten as tenants [who] have historically gone to Midtown South, Hudson Square and Meatpacking move to FiDi,” he said. The neighborhood “is definitely the value proposition.”

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Overall building sales are up significantly in FiDi. Indeed, five major office buildings below Canal Street traded hands in the third quarter. That’s up from just one each in the first and second quarters, according to data provided to The Real Deal by data company Real Capital Analytics. It’s also a significant increase from the third quarter of last year, when there were only two FiDi office building trades, RCA’s data shows.

In August, Northwood Investors paid $150 million to buy the 380,000-square-foot office building at 100 Broadway from Meadow Partners and Madison Capital. Also this summer, California-based private equity firm CIM Group acquired 335,000-square-foot 5 Hanover Square from institutional real estate private equity firm Savanna, while the investment advisory firm Emmes Asset Management agreed to pay $154 million for Melohn Properties’ 180 Water Street, a 509,000-square-foot tower.

Meanwhile, East End Capital and GreenOak Real agreed to buy the 500,000-square-foot 123 William Street from the Chetrit Group for $133 million. And Brookfield Office Properties last month reportedly inked a contract to buy the 16-story, 560,000-square-foot 1 North End Avenue in Battery Park City for $200 million.

And there are more potential sales coming down the pike.

One of the next Financial District office buildings to trade may be 110 William Street, a 900,000-square-foot office property owned by landlord Kent Swig. Doug Harmon and Adam Spies of Eastdil Secured are marketing the property, which does not have a publicly available asking price. And the landmarked, 60-story 1 Chase Manhattan Plaza is also on the block. The 2.2 million-square-foot building, owned by JPMorgan Chase, hit the market in August with CBRE’s Darcy Stacom and Bill Shanahan, and is expected to fetch up to $1 billion.

“It’s uncanny how sale prices and leasing activity have picked up in Lower Manhattan as the government has turned a corner on major infrastructure incentives,” said Mark Weiss, a vice chairman at commercial brokerage Newmark Grubb Knight Frank, referring to projects with government funding like the World Trade Center. “The more progress government makes, the more activity we’ll see in Lower Manhattan.”

Of course, some of the developers buying up these properties will stick with the tried-and-true strategy of residential conversions. For instance, the Lightstone Group earlier this year paid nearly $1,200 per square foot for an office building at 114 Fulton Street, with plans to raze it to make way for a 463-unit residential tower. And in September 2012, Fisher Brothers and the Witkoff Group reportedly paid $943 per square foot for the American Stock Exchange Building at 22 Thames Street, where they plan to build a 428-unit residential property. And Emmes’ 180 Water Street buy is also seen as a potential residential conversion, since its leases expire in 2015, but sources said it could also remain commercial.

And indeed, homes prices in the neighborhood still outpace office rents, brokers said. The median monthly rental listing price for a Financial District apartment is $57 per square foot, according to the real estate website StreetEasy, while the median price per square foot for a condo in the neighborhood is $1,175. By contrast, the average asking rent for Downtown office space was $47.13 per square foot in the second quarter, according to commercial brokerage CBRE.

But other investors have a new strategy for FiDi: buying office buildings and hanging on to them in anticipation of rents rising. In some cases, investors plan to complete capital improvement programs at these buildings, updating systems and renovating lobbies, to further maximize rents.

While Brookfield Office Properties declined to comment on its plans for 1 North End Avenue, sources said the property is likely to remain commercial. And Scott Rechler of RXR Realty told TRD last month that his firm is considering acquiring 1 Chase Manhattan Plaza, and would maintain it as a commercial office tower, despite speculation that it could be turned into apartments or a hotel. A residential conversion would be problematic given the building’s landmark status, Rechler noted.

Rising rents

RXR, like other investors, is confident that office rents in Lower Manhattan will tick up over the new few years, Rechler said at an industry panel event last month.

When FiDi “get[s] through that awkward phase, it’s going to be an incredible place,” Rechler said. “If you have patience, you’re going to be successful.”

Financial District office rents and activity have already been on the rise for some time. The average asking rent for Downtown office space in the second quarter was up 20 percent year-over-year, according to CBRE. The second quarter was also the ninth consecutive quarter that Downtown Manhattan logged above-average leasing activity, with 2.46 million square feet of space leased, up 22 percent from the same period in 2012.

Still, there remains a major discrepancy between office rents in FiDi, where low floors in Class A buildings might command $30 per square foot, and in Midtown, where comparable space rents for more than $60 per square foot, said Eric Anton, a principal at commercial brokerage Brookfield Financial. To investors, that means there’s still plenty of room for growth before the FiDi catches up with Midtown.

One reason FiDi office space is cheaper is that many of the buildings in the area are older. Office product in the neighborhood tends to be somewhat “antiquated,” with smaller floor plates on buildings’ upper floors, said Richard Lechman, director of the Eastern region at Marcus & Millichap.

A second-quarter office market report by brokerage Newmark Grubb Knight Frank showed that around City Hall, where buildings tend to be older, the average asking office rent was $36.78 per square foot, while rents in the newly renovated World Financial Center and World Trade Center came in at an average of $61 per square foot.

But even in older buildings, investors are hoping that office rents will rise substantially as new-construction projects like the World Trade Center come online, pushing FiDi rates closer to Midtown levels.

“I expect the differential to shrink as [the neighborhood] begins to take shape,” said commercial broker Raymond Cecora of CIA Group, which represented Jared Kushner and CIM in their recent purchase of 2 Rector Street. The buyers paid $140 million, or $270 per square foot, to buy the 26-story office tower from Savanna and Stellar Management’s Laurence Gluck.

Kushner told TRD that the partners plan to rehab some of the office space, and may also convert some of the space into rental apartments, but no final decision has been made.

He said with commercial rents on the rise in the FiDi, the decision to convert an office building to residential is no longer a no-brainer. That’s especially true since the common spaces in residential buildings, including hallways, are not calculated into the building’s leasable space, eating into a landlord’s earnings.

“Right now, if office rents pick up another $5 [per square foot], you’re pretty close to what you can achieve in residential on a cost adjusted basis,” Kushner said.