Rising Skyline: New Construction Rent Premium

Manhattan

Construction activity in Manhattan is the highest it has been in over two decades. The resurgence of new development will have a substantial effect on the overall market in terms of both vacancy rates and pricing.

• Delivery of new product usually causes a spike in vacancy and in average asking rents—particularly in older/less desirable buildings.

• Newly-constructed space typically commands a rent premium over other class A properties.

Surprisingly, New York City’s inventory has remained nearly stationary since the early 1990’s. Residential conversions and the loss of the World Trade Center buildings in 2001, among other factors, have offset the square footage added to the market over the last 10 to 15 years. New York City is now in the beginning stages of inventory expansion with several projects recently delivered and currently under construction. Between 2013 and 2014, more than 6.5 million square feet (msf) of new office construction will be completed in Manhattan—representing the largest amount of new construction to hit the Manhattan market since 1989 when nearly 7.8 msf was delivered.

Manhattan Inventory Over Time

NEW CONSTRUCTION RENT PREMIUM
Many large scale developments in Manhattan over the last few years have been build-to-suit, including 620 Eighth Avenue (The New York Times), One Bryant Park (Bank of America) and 200 West Street (Goldman Sachs). Speculative projects such as 11 Times Square, 510 Madison Avenue, 250 West 55th Street and 51 Astor Place, however, have been able to secure tenants at a substantial rent premium than surrounding buildings within their respective submarkets. In Midtown, asking rates for vacant spaces in buildings constructed between 2001 and 2013 are 31% above other class A properties in the market. The same trend holds for Midtown South (51%) and Downtown (39%). Over the last three years, base rents for completed deals in new construction have averaged $85 per square foot (psf) in Midtown, $82 in Midtown South and $60 Downtown—all significantly higher than broader market averages. Furthermore, a few of these properties have had base rents starting north of $100 psf.

New Construction Premium

The latest emerging trend around construction activity in Manhattan is that of tenants taking equity positions in new developments. The most recent examples include Coach, Inc, and Time Warner, Inc. Both tenants will anchor two separate towers at Hudson Yards. Coach purchased more than 700,000 square feet (sf) in the south tower of 10 Hudson Yards, while Time Warner is expected to purchase over 1.0 msf in the north tower of 30 Hudson Yards.

BUILDING THE CASE
Additionally, the lack of new construction over the past decade has resulted in an aging inventory. Indeed, over 65% of Manhattan’s total square footage is more than 45 years old—while 42% is over 75 years old. Compared to other international business hubs, particularly those in the Asia Pacific and Europe regions, New York’s office stock is much older. In Central London, 23% of the stock there has been built or refurbished since 1997. In Hong Kong, 76% of the inventory has been built since 1990, and in Shanghai nearly 75% of the inventory has been built since 2000.

Manhattan Inventory

DEMAND
When employment begins to rise, newer space gets absorbed more quickly than older product. As a result, significant leasing activity is not only occurring in recent completions, but in buildings currently under construction (see list below), illustrating tenants’ preference for new space. During the late 1990’s and early 2000’s, a surge of new development took place in Times Square When Three, Four, Five and Seven Times Square were all built within a five-year time span. Times Square, which years before would not have been considered by corporate tenants was soon transformed. Major corporations such as Condé Nast, Ernst & Young and Reuters all made substantial commitments—showing a demand for state-of-the-art space. Hudson Yards is affecting a similar change to Manhattan’s far West Side.

Significant Prelease Commitments

CONCLUSION
Over the next four years an additional 12 msf of new construction is scheduled to be added to Manhattan’s inventory. Although the total amount is comparable to the entire CBDs of Baltimore or Miami, it represents only 3.0% of Manhattan’s current building stock.

Employment growth is expected to remain strong over the next several years in New York City. This, coupled with occupiers’ need to maximize space efficiency in order to keep real estate costs in check, and to provide a collaborative work environment for their employees, will ultimately result in increased demand for new office space and sustained absorption levels. Although there is a premium associated with new office space on a per square foot basis, tenants have demonstrated a willingness to pay this rent premium because it saves money or is revenue-neutral on a per-employee basis.

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