Wednesday, June 26, 2019

Midtown Manhattan Office Challenges May Not Be Ominous for CMBS

By MBA Insights Staff
June 9, 2019

Commercial Mortgage-Backed Securities
Kroll Bond Rating Agency

Larry Kay is Senior Director with Kroll Bond Rating Agency, New York.  Eric Thompson is KBRA's  Senior Managing Director.

The Hudson Yards neighborhood has established itself as Manhattan's new and vibrant live, work, play area and it is drawing office tenants from other areas of the city, especially Midtown Manhattan.

Jones Lang LaSalle reported 92 percent of Hudson Yards tenants who have already relocated to Hudson Yards or plan to do so were previously based in Midtown. Some of the space left behind from this migration has been re-let as tenants move from other parts of the city to Midtown, but when the dust settles, some Midtown properties could be left with large vacancies.

With 16 million square feet of office space scheduled to be completed over the next few years, excess supply could result in higher vacancies, particularly if economic conditions soften. This could well be the case; the National Association for Business Economics reported more than three-quarters of surveyed economists expect the U.S. to enter a recession by the end of 2021.

Despite the negative headlines, the ramifications for approximately $25.3 billion of CMBS 2.0 Midtown office collateral (85 properties) may not be as ominous in the near- to intermediate-term. An analysis of leases at the related assets indicates that approximately 61 percent (77 percent for the top 10 properties by whole loan balance) of the total square footage is not subject to a lease expiration for more than four years.

Another area of concern centers on shared workspace provider WeWork. The company, which announced that it occupies the most private office square footage in Manhattan--at 5.3 million square feet--has been a bright spot regarding new tenancy throughout the city. However, the tenant's credit strength has yet to be tested in poor economic conditions, and sentiments surrounding this have grown somewhat after the company's negative first-quarter earnings report, in which it posted a $1.9 billion loss. However, while the company serves as a tenant in 23 Midtown office properties, only six in Midtown serve as collateral in CMBS transactions.

Let's take a closer look at several of the challenges and potential issues facing Midtown office, with a focus on CMBS 2.0.

Go West--The Grass May Be Greener
Midtown-area office buildings have been losing out to newer space, the New York City Department of City Planning reported. City officials had already recognized the issue and in 2017 rezoned a section of midtown Manhattan known as Midtown East. The project was intended to encourage modernization efforts to increase the competitive profile of that area of the city. Much of Midtown East's office stock has low floor-to-ceiling heights and numerous interior columns that don't meet the needs of corporate tenants. Rezoning allows property owners to convert assets to better meet the needs of modern-day tenants, with more efficient space configurations and the latest technology including building systems that promote greater energy efficiency.

While rezoning should help to mitigate the tide of future departures from Midtown Manhattan (such as JP Morgan staying in place at 275 Park Avenue), it will also be important for the city to maintain the convenience and functionality of Midtown's mass transit system. With the fees collected from the recently announced congestion pricing program, the Metropolitan Transit Authority is planning to use the funds to help support the city's subway system, bus lines and commuter rail. With or without improvements, the proximity to Grand Central station gives Midtown a distinct edge over other areas of the city--particularly to those commuting from Connecticut, Westchester County, N.Y. or using the extension line of the MTA Long Island Railroad.

However, even with the rezoning, Midtown tenants looking for greener office pastures are relocating to Hudson Yards. Some Midtown tenants who have announced relocation plans to the Hudson Yards area include WarnerMedia, BlackRock, Skadden Arps and Wells Fargo, to name a few.

To maintain its appeal to existing tenants and attract new ones, some area buildings, particularly Class C assets, will need to be transformed. In many cases, these buildings may be less competitive or even obsolete due to outdated infrastructure and technological deficiencies. They also lack open floorplates and flexible work spaces that are conducive to an increasingly competitive work environment. Absent refurbishment, many landlords will need to increase concession packages--including free rent--to attract tenants, who are more dollar conscious.

Midtown landlords are giving improvement allowances totaling around $104 per square foot, up by 6 percent from 2018, CBRE has said. In addition, these landlords were also giving 12 months of free rent, slightly down from 13 months in 2018. But while most of Manhattan office rents are higher than their recessionary peak, Midtown office rents are not, based on our review of CoStar data. The average asking rent for Midtown Manhattan office space reached $63.59 per square foot in the first quarter, which is still 12.8 percent below its prior peak of $72.93 per square foot in 2008. This compares to the rest of Manhattan office, where rents increased to $60.81 per square foot in Q1 2019, 19.1 percent above the Q3 2008 peak level of $51.06 per square foot.

However, with rents in Hudson Yards at about $115 per square foot in early 2019, according to CRE firm Savills Studley, many tenants may find themselves priced out.

While CMBS 2.0 Midtown office assets are not immune from relocations to Hudson Yards, our analysis of tenant lease expirations using CoStar submarket classifications and Trepp data suggests it may not present a near-term issue to building cash flow. Based on available information, approximately 61 percent of existing property leases across 85 assets will not come due for more than four years.

Among the assets securing the 10 largest loans in the market, the outlook is more favorable, with 77 percent expiring in more than 48 months. As a result, the potential movement to Hudson Yards may be somewhat mitigated by the timing of tenant lease expirations and a number of rolling tenants that may decide to stay in place. This is particularly the case with four new office projects that are scheduled to open in 2022, including 50 Hudson Yards, The Spiral, Three Hudson Boulevard and Two Manhattan West. Unless tenants have lease termination clauses, much of the expirations occur after this date..

(Views expressed in this article do not necessarily reflect policy of the Mortgage Bankers Association, nor do they connote an MBA endorsement of a specific company, product or service. MBA Insights welcomes your submissions. Inquiries can be sent to Mike Sorohan, editor, at; or Michael Tucker, editorial manager, at

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