Crain's chats with Colliers International's Michael Cohen, Newmark Grubb Knight Frank's Barry Gosin, Cushman & Wakefield's Ron Lo Russo, Jones Lang LaSalle's Peter Riguardi and CBRE's Peter Turchin, by Erik Ipsen
What impact will rising interest rates have on real estate?
Michael Cohen (President, tristate region Colliers International): I don't think that the initial 25-basis-point rise in interest rates by the Federal Reserve will materially affect decision-making. Values won't tumble. Borrowers won't start defaulting. I'm more interested in how soon the next increase will occur, and where rates will be in the next 12 to 18 months. A 100-basis-point increase in a short-ish period would have a material impact, as it is not yet built into the market.
Barry Gosin (Chief executive, Newmark Grubb Knight Frank): Buyers who were doing due diligence late last year probably assumed a small rate increase was around the corner; it was already part of their formulas. Some investors may choose to be more selective with purchases, however. Rising rates generally burden developers more than buyers, given the cost of capital and the higher loan-to-value ratio needed to fund construction projects.
Ron Lo Russo (President, tristate region, Cushman & Wakefield): The consensus is that if rates are rising for the right reasons (stronger economy), then net operating income (rent) growth can offset the impact of upward cap-rate pressures. That said, my opinion is that cap rates will rise, and prices will flatten and could even fall slightly. But I don't envision a tumble, given the weight of capital currently in the market.
Peter Riguardi (President, tristate region, Jones Lang LaSalle): Manhattan buildings are being acquired at very low capitalization rates, with sellers projecting robust increases in rents. Any movement in the interest rate, even a half point to 2 points, will affect investors' analyses. But given the overwhelming amount of investor demand and the lack of supply, this type of interest-rate increase will not be enough to put the brakes on New York City's extremely active and competitive sales market.
Peter Turchin (Vice chairman, CBRE ): The equity markets had already “baked in” the effect of the Fed’s move last month, in all probability reducing its impact. Similarly, sophisticated commercial real estate investors have been looking at this issue for quite a while—and have no doubt produced game plans to reduce the risks involved and find a way forward without too much disruption. Owners of well-managed properties don’t have a lot to worry about because good managers know how to plan.
Will more commercial tenants turn to Brooklyn based on its costs, proximity to staff and "cool factor"?
Cohen: Brooklyn remains a niche market, although with broad appeal, particularly among firms in the TAMI sector. Large commercial options in Brooklyn used to be largely limited to MetroTech and Dumbo. Now TAMI demand has given rise to several new submarkets, some of which would have been unthinkable just a few years ago. We've seen some extraordinary and creative redevelopments taking place.
Gosin: Brooklyn has many opportunities to offer tenants. From the Navy Yard and Williamsburg to Industry City and Dumbo Heights, it has options for all. More and more tenants will be open to moving out of Manhattan and taking advantage of the millions of square feet of space currently being redeveloped in Brooklyn. Proximity to Brooklyn-based staff is a key selling point for small companies. We are confident enough in the Brooklyn market to have opened an office in the borough last year.
Lo Russo: Over the past three years, its labor force has grown by almost 12%, the biggest gain in the city. Brooklyn's demographic change over the past 15 years has been dramatic, as almost 20% of the population is made up of millennials, drawn to areas they can work and live. This, coupled with an average vacancy of 5% over the past eight quarters, has led to more than 6 million square feet of potential office development and conversions over the next three to five years.
Riguardi: Brooklyn has excellent prospects, as does Long Island City. But there has to be enough good product. There are some interesting projects, including JEMB's ground-up office tower at 420 Albee Square, and the converted Jehovah's Witnesses portfolio being spearheaded by Kushner Cos. These will definitely add to the "cool factor," but what Brooklyn and LIC need is a big-time, bellwether name that surprises the market with its decision to relocate from Manhattan. Just like Google energized the meatpacking district.
Turchin: There are definitely tenants looking for rent relief from the hot midtown south market. Not only has it reached record pricing, but each submarket within it has hit historical highs. Many tenants are looking not only to Brooklyn, but also Jersey City, Long Island City and the Bronx. Brooklyn is leading the charge, however. Many developers--some that wouldn't have looked at Brooklyn a decade ago--are spending real money to upgrade properties from manufacturing and warehouse uses to offices.
Will growing TAMI firms (tech, advertising, media, information) offset weakness among financial tenants?
Cohen: TAMI and financial firms consume space very differently, in different parts of the city, in different densities and quantities. TAMI is more focused on midtown south. Those firms tend to occupy prewar buildings and have a higher density than FIRE (financial, insurance and real estate) sector tenants. Meanwhile, we have seen stirrings of financial-sector growth, but not the 100,000-square-foot-plus expansions of previous cycles. There are only a handful of TAMI firms that can expand that quickly.
Gosin: TAMI companies have helped absorb much of the availability in the downtown market and have taken space in some of the non-Plaza-district, non-trophy midtown buildings. While TAMI offers substantial upside for growth, questions remain about these companies leasing space in institutional-quality properties in prime midtown corridors.
Lo Russo: Although TAMI companies leased the most space in Manhattan from 2011 to 2015--accounting for 27% of all new leasing--last year the financial-services sector bounced back. It reclaimed the top spot for new leases and accounted for almost 30% of the activity. With that sector hiring again in the city--adding over 25,000 jobs in the past two years--we are optimistic that coupled with continued growth in the TAMI sector, it will drive the market forward in 2016.
Riguardi: We are seeing some positive signs of continued TAMI growth, but tech companies in particular need to continue to add program engineering jobs to take up the slack in the market as the financial-services sector cuts back. Many financial tenants are gravitating to newly constructed buildings, and they are also using less space as they become more efficient and reduce their footprint in the city. So we need tech companies to be the growth engine to make sure the market continues to thrive.
Turchin: I wouldn't say that there's weakness among financial tenants. While larger institutions have been fairly stagnant, I see a lot of growth in midsize and smaller financial firms. For example, in two Class A buildings that I represent, we've started prebuilt programs--and 90% of the space is being leased to hedge funds. That said, the increase in financial tenants is not as strong as the gains in the TAMI sector.
With availability low, will more landlords raise rents?
Cohen: This is clearly true for office properties in most pockets of Manhattan, with shrinking availability rates and rising rents. But beware: This is not necessarily true for all asset classes. Many people are wondering if retail rents have reached their peak and if that market is already correcting.
Gosin: It bodes especially well for owners of midtown south buildings, where leases signed well before the big rent spike of recent years are expiring. But landlords of average midtown buildings might think twice, as they can expect increased competition with an anticipated escalation of availability. Large blocks are expected to come to market from tenants who are leaving traditional submarkets behind to relocate to the far West Side and lower Manhattan.
Lo Russo: The shrinking of available supply does put New York City in a landlords' market. Asking rents have reached historic highs in midtown south, mostly due to the lack of quality supply and an increase in demand. Downtown asking rents are also at an all-time high, but this is due to the addition of the World Trade Center to the market. Midtown asking rents are still 10% to 12% off the 2008 peak, but as availability tightens, pricing will go higher this year.
Riguardi: Buildings in terrific locations with great space will be in demand as companies look for sites that protect employee retention and recruitment. But raising rents is not a universal option. Some areas are threatened by the large availabilities projected for midtown, and many industries continue to reduce square footage per employee. There is also the potential for a recession in 2017 or 2018. Landlords would be smart to make deals now to avoid vacancies in the next few years, and it would be foolish to raise their rents now.
Turchin: Emphatically yes, but the real issue is where availability is relative to equilibrium. When availability goes to 14% from 16%, rents barely move. But when it dips to 8% from 10%, they fly. We've seen this in midtown south, a true landlords' market, where the market is below equilibrium and where barring significant additions to inventory, there's no reason why rents won't continue to rise. Meanwhile, in midtown and downtown the market is hovering right above equilibrium, so if availability continues to fall, rents could spike.
What impact will Mayor Bill de Blasio have in the second half of his first term?
Cohen: Mayor de Blasio's impact is largely on the residential sector, particularly the changes he's making to real estate tax-abatement programs. The most important thing he can do for commercial real estate is to see through the rezoning of the midtown core and support the modernization of the city's infrastructure.
Gosin: I expect some of his affordable-housing deals and initiatives will be put into practice. His actions haven't affected residential development because of how well the market has performed, but his influence may cause less development in certain areas if we experience a market or economic slowdown.
Lo Russo: The mayor has supported commercial development, and we see no reason to expect a change. One of the most important policy initiatives for the commercial real estate industry in the next two years will be East Side rezoning. The mayor has made proposals that would permit creation of larger buildings through the sale of air rights owned by landmarked buildings. The city would receive a transfer tax on the air rights that would be used for public improvements. This could lead to new development in the area.
Riguardi: I hope the mayor has come to understand that having companies feel comfortable about doing business in New York City requires a thriving commercial real estate sector. Creating that level of comfort leads to job growth. At the beginning of his term, Mayor de Blasio may not have seen that, but I think that he must now recognize the connectivity of the commercial real estate market and the growth of the city.
Turchin: The two biggest issues facing the de Blasio administration are midtown east rezoning, and transportation to growing areas, including ferry service to less-connected areas of Brooklyn, such as the Navy Yard, Red Hook and Sunset Park. With the center of gravity shifting--driven by development on the West Side and the popularity of the Brooklyn market--transportation needs to be readdressed to accommodate these new dynamics.
Will economic weakness in China, Brazil and Europe augur poorly for foreign purchases of New York City property?
Cohen: It sure doesn't look that way, although you can never be sure what's coming. So far we haven't seen any diminution in foreign investor interest due to overseas economic turmoil. There are good arguments that the opposite is true--that overseas turmoil stokes demand for New York City assets for flight capital.
Gosin: It may encourage more investment, as real estate in the United States offers higher and more sustainable returns than what is being offered overseas. China may be the exception, as capital is subject to considerable state controls--and in times of domestic weakness, they may seek to be held more within Chinese boundaries.
Lo Russo: Foreign capital flows accelerated from 10% of buyers on average to 20% in 2015, and to more than 35% in gateway markets such as New York. This acceleration comes despite global economic softness, oil in the low $40s a barrel and a China slowdown. This is because as global headwinds continue, the U.S. is a mature market with some of the strongest growth prospects. New York has become the "Treasury bond" of the global real estate market.
Riguardi: Large foreign institutions and wealthy foreign individuals overwhelmingly see New York City as a great market for all types of real estate. They are extremely comfortable here and feel it is a safe place to invest their capital long-term. Of course, any economic weakness will impact the flow of capital here, but with such a large number of potential buyers and a continued lack of supply, the trend of foreign investment in the city still has room to continue.
Turchin: One of the great things about New York is that it attracts capital from all over the world. Time and time again we've seen that as one capital source diminishes, another quickly replaces it. In the '80s we saw capital investment from Japan; in the 2000s it was Europe and Canada; and since 2010 it has been China and the Middle East. The key is that New York City needs to remain a safe and stable investment for foreign capital.
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