In Manhattan’s tight commercial market, ambitious developers are turning out office buildings without knowing who’ll occupy them, laying out large sums of cash with increasing confidence they’ll find future tenants.
New Jersey developer SJP Properties recently announced it will build a 40-story, 600-foot office building at 11 Times Square on the southeast corner of West 42nd Street and Eighth Avenue. That’s the biggest sign that speculative, or spec, development may be catching on.
“We are confident that the Midtown Manhattan market, with low vacancy and no large blocks of space available, will readily absorb this new Class A space,” said Peter Eppie, executive vice president of SJP. “There is a significant amount of pent-up demand for large blocks of new office space.”
Decreasing vacancy rates, smaller available land parcels and higher rents are making New York City an environment ripe for spec projects. This has not always been the case.
“There’s no way that deal would have gone down a couple of years ago,” said Nick Griffin, a broker at commercial real estate firm Winslow & Company. “No one would have built it because it would have been much too risky.”
Major spec projects built in the last few decades include the World Trade Center in the 1970s, when what’s now Ground Zero broke ground without a lead tenant lined up, and the Durst Organization building at 4 Times Square, which opened in 1999.
Spec development doesn’t always work according to plan, say market experts.
“World Trade Center was a debacle for 15 years after that,” Winslow & Company’s Griffin said. As a commercial proposition, the early days of the Twin Towers were hampered by high vacancy rates and cheap leases. “That was actually a perfect example of why not to do a spec deal or why it was risky. If that had been a private developer, they might have gone bankrupt.”
Today’s economic climate is different, with a great demand for new office space.
The vacancy rate in Manhattan Class A buildings declined in August to 7.0 percent from 9.4 percent a year earlier, according to Colliers ABR. Average rents exceeded $45 a square foot in early September, said Steven Spinola, president of the Real Estate Board of New York. “In trophy buildings, new rents are averaging $93 a square foot. That’s a clear indication that there’s a desire for space.”
On a national scale, the National Association of Realtors said the national commercial vacancy rate, which hit 13.1 percent in the second quarter of 2006, would continue to drop. The New York City rate represents nearly half of the overall nationwide vacancy rate.
“Building on spec is clearly a more risky proposition than having tenants lined up, but the rewards can be far greater,” said Paul Glickman, executive vice president at Cushman & Wakefield and the leasing agent for 505 Fifth Avenue, a spec project that just welcomed its first tenants.
Developer Axel Stawski erected 505 Fifth Avenue as well as 360 Madison Avenue; the latter opened a few years ago.
Spec developers are vulnerable to shifting market conditions, and their projects involve a degree of crossing their fingers and hoping their finished buildings can fetch rental income that exceeds construction costs.
Construction costs continue to climb. In the second quarter of 2006, the cost index rose 2.75 percent from the preceding three months, according to Turner Construction, and finished up 11.9 percent from the same period a year ago.
“The problem with building office space in general is land cost is high, as is construction cost,” REBNY’s Spinola said.
He said developers must evaluate the demand for office space, the cost to build the structure and the time it will take to construct, and then weigh those factors against future demand for the space two or three years later, when a building is ready to open. “People are guessing yes,” Spinola said.
Some real estate professionals expect demand for spec buildings to increase.
“The strength of the market will probably encourage speculative building,” said Howard Dolch, executive vice president at the Lansco Corporation. “The problem is there aren’t a lot of Midtown sites on which to build spec buildings.”
Demand still exceeds supply. Manhattan gets the most spec office development, followed by Brooklyn, according to brokers. Queens might well become a hotbed of spec office activity, particularly in the Long Island City area, though it recently suffered a blow when MetLife said it was moving some of its workers from there to Manhattan.
Scott MacIntosh, the senior economist of commercial and investment real estate at the National Association of Realtors, offered a different perspective. Because building costs are high, he believes there will be fewer spec buildings emerging in the marketplace, or at least fewer constructed without a lead tenant.
On the national front, in “a lot of markets, we’ve seen a cutback in speculative buildings,” he said.