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Weekly Market Report - May 1, 2023


Fast-growing cities from Miami to Phoenix are still benefiting from businesses moving south, drawn by lower taxes, warmer climates than in the Northwest and Midwest, and more business-friendly government policies, market participants say. Nashville, Tenn., and Austin, Texas, recently topped the list of 2022’s hottest job markets. Average asking rents for office markets in major Sunbelt hubs reflect that job growth and are still rising, according to data firm CoStar Group Inc. That contrasts with markets such as New York and San Francisco, which are losing tenants and posting rent declines. Yet some recent data now signal that growth in many of the top Sunbelt office markets might be starting to taper off. Vacancy rates remain higher than before the pandemic throughout Sunbelt markets. Also, rents increased at a slower rate in most large Sunbelt markets during the past two quarters. Some have fallen off significantly.

In Atlanta, for one, office rents rose by just 8 cents a square foot from the third quarter of 2022 to the first quarter of this year, compared with average gains of 21 cents a square foot during the previous six quarters. Slower growth in the Sunbelt is another setback for the multi trillion-dollar office building industry, which is already contending with the surge in mortgage rates and has been counting on these cities to support their business when office markets in other parts of the country have been reeling. It also shows how even in cities where job growth is strong, a shift toward remote and hybrid work can soften demand for office space. Companies bracing for a possible recession are also less likely to add as much workspace.


Landlords are contending simultaneously with a cyclical market downturn and with secular changes in the way people work, live and shop. The sudden surge in interest rates caused property values to fall, while the rise of remote work and e-commerce are reducing demand for office and retail space. Investors and economists say these two forces haven’t come together on this scale since the 1970s, when a recession followed surging oil prices and a stock-market rout while new technologies enabled jobs to move out of major cities. This time, the pandemic is largely responsible for accelerating the commercial property upheaval.

The U.S. office vacancy rate reached a milestone in the first quarter when it rose to 12.9%, exceeding the peak vacancy rate during the 2008 financial crisis. It is unknown how bad the commercial property downturn will get. Some analysts say it may well end up less severe than the previous two downturns, in the early 1990s and after the 2008 financial crisis, especially if the U.S. economy avoids a deep recession and interest rates start to come down quickly. But the deeper problems facing office and certain retail landlords mean building values are less likely to rebound to new highs the way they did after those previous meltdowns. That, in turn, suggests that commercial real estate won’t contribute as much to the country’s economic growth as it had during previous rebounds.

Depressed building values could hurt cities, which depend on property-tax revenue, and weigh on bank balance sheets, leading to less lending throughout the economy. It is also bad news for the banks, pension funds and asset managers that are among the biggest lenders to and owners of commercial buildings, which means they could face losses for years to come. Commercial mortgages account for around 38% of the median U.S. bank’s loan holdings, according to KBW Research. North American public pension funds on average hold around 9% of their assets in real estate. Office owners are at the beginning of the process of working off their glut and could face many years of falling tenant demand. The growing popularity of remote work, made possible by technologies like email, Zoom and Dropbox, means offices are far emptier than they were before the pandemic. The occupied space per office worker is 12% below where it was in 2015, a sign that corporate tenants may want less space when they renew office leases.


For instant gratification, tenants needing up to 20,000 square feet are snapping up fully furnished pre-built offices that are designed with a hospitality-infused vibe. Meanwhile, owners hope that by wrapping up the lengthy build-out process on the front end, they can compete with the nearly 25 million square feet of sublease space now available in Manhattan alone. “It is still very difficult for landlords to compete with heavily discounted sublet rents as they have lenders and investors that monitor their rental rates,” said Ruth Colp-Haber, CEO of Wharton Property Advisors who specializes in sublets. To win the deals, “landlords are starting to offer turnkey space with the furniture in place.” Tenants also want to hang onto their cash, not wait months to get into the space and pick a term tailored to their business.

The ongoing supply chain issues that arose during the pandemic also made tenants fret about when they could get their furniture and actually move in. The Empire State Building is offering a 22,620-square-foot prebuilt on the 68th floor designed by Fogarty Finger. Empire State Realty Trust’s president, chairman and CEO, Anthony Malkin, said the floor serves as a model for other spaces. Its asking rent is $79 a foot — and would be about $75 per foot without furniture because there wouldn’t be a period of free rent for construction. “We want to present people with the easiest pathway to get a deal done,” Malkin said. ESRT will therefore pre-build with or without furniture and/or wiring. The building owners say additional pricing for furnished spaces can range from nothing to as much as $20 per foot, depending on the size of the space, the furnishings and technology. But most insisted that the costs largely even out because they no longer have to provide months of free rent, tenant improvement allowances or work letters.


Landlords listed roughly 13.4 million square feet of Manhattan office space at asking rents above $100 per square foot in 2022, the most in a single year since 2016. The first quarter of 2023 saw 28 deals with starting rents of $100 per square foot or more, above the five-year quarterly average of 25 deals, though a 12.5 percent slip from the fourth quarter’s total. In Manhattan, the number of months of free rent an average tenant scored rose from 13 months pre-pandemic in 2019 to a peak of 17 months in 2022, before sinking slightly to 16 months as of April 1, 2023. Tenant improvement allowances, or the amount of money a landlord gives a company to build out its offices, also peaked last year, rising to $147 per square foot on average before dipping slightly to $145 per square foot in the first quarter of 2023. It averaged $104 a square foot in 2019. Those 2022 numbers represent the highest amount of free rent and tenant improvement allowances since 2011 and discounts are having quite the impact on high-priced buildings.

The pandemic, and the subsequent shift to remote work for traditional office users, pushed landlords to offer souped-up amenities such as daycares, beehives, cafes and golf simulators to get tenants in the door. But there’s nothing like cold, hard cash to make a company sign a deal. Larger tenants and those in a better financial position tend to score better deals, and landlords also offer additional benefits that might get a tenant to sign, Slattery said. The Durst Organization, for example, offers furnished, ready-to-go space at its trophy World Trade Center buildings for leases as short as 13 months, letting a firm test the space before signing a long-term deal. But, overall, concessions are up, and not just because of the pandemic, potential recession and all-around craziness of the office and debt markets right now. Concessions have also slowly risen as construction costs have gone up, making it more expensive to build out office interiors, said Wallach. Plus, a landlord may list a higher face rent, with plenty of concessions, to keep a property in line with the expectations of a lender who financed that building.

The availability rate in Manhattan has also remained high, at around 16 percent in the first quarter. For trophy buildings, properties with the highest asking rents, top-notch amenities and great locations, the availability rate was as high as 24 percent in Midtown South in the first quarter of 2023. In Midtown, it was 16.5 percent, while Downtown posted a 13 percent availability rate. Availability could tighten into the year as fewer Class A buildings come online.


Before the pandemic, San Francisco’s California Street was home to some of the world’s most valuable commercial real estate. The corridor runs through the heart of the city’s financial district and is lined with offices for banks and other companies that help fuel the global tech economy. Nearly every large U.S. city is struggling, to some degree, with reduced office-worker turnout since the pandemic spurred remote work. No market was hit harder than San Francisco, for reasons including its high costs, reliance on a tech industry quick to embrace hybrid work, and quality-of-life issues such as crime and homelessness. Nearly 30% of San Francisco’s office space is vacant, which is more than seven times the rate before the pandemic hit, and the biggest increase of any major U.S. city. Today it is hard to know just what office buildings in San Francisco’s financial district are worth, because transactions have practically dried up.

A sale of 350 California promises to establish new pricing. Though business activity in the district was upended by the dot-com bust in 2000 and the 2008 financial crisis, its office towers refilled not long after both of those downturns. In February, San Francisco Mayor London Breed rolled out her plan to revitalize the downtown office market, the latest U.S. city to announce steps to recover from the office-worker exodus. Her proposal includes a mix of tax incentives. Ms. Breed asked city department heads to prepare for cuts of up to 13% over the next two years to cope with a projected budget shortfall over that time of $780 million, or 6% of the total general-fund revenue, amid overall economic risks. As recently as 2021, San Francisco office-building owners were still hopeful the financial district would emerge with renewed vigor, as after the previous downturns. That year, the owner tried to sell the office tower. It pulled the listing after bids failed to exceed $180 million, or 60% of the estimated 2019 value.


NEW YORK, April 26, 2023 (GLOBE NEWSWIRE) -- Vornado Realty Trust (NYSE:VNO) announced today that it will postpone dividends on its common shares until the end of 2023, at which time, upon finalization of its 2023 taxable income, including the impact of asset sales, it will pay the 2023 dividend in either (i) cash, or (ii) a combination of cash and securities, as determined by its Board of Trustees. Vornado also announced that, in order to enhance shareholder value, its Board of Trustees has authorized the repurchase of up to $200 million of its outstanding common shares under a newly established share repurchase program. Cash retained from dividends or from asset sales will be used to reduce debt and/or fund share repurchases. Share repurchases may be made from time to time in the open market, through privately negotiated transactions or through other means as permitted by federal securities laws, including through block trades, accelerated share repurchase transactions and/or trading plans intended to qualify under Rule 10b5-1.

The timing, manner, price and amount of any repurchases will be determined at Vornado's discretion depending on business, economic and market conditions, corporate and regulatory requirements, prevailing prices for Vornado’s common shares, alternative uses for capital and other considerations. The program does not have an expiration date and may be suspended or discontinued at any time and does not obligate Vornado to make any repurchases of its common shares. Vornado Realty Trust is a fully-integrated equity real estate investment trust.


Why economists believe First Republic’s Failure isn’t the end of the regional banking crisis

The second-largest commercial bank failure in American history has shocked capital markets and created concern among economists that the U.S. banking system might be on the verge of a more widespread crisis. JPMorgan Chase purchased First Republic Bank at the behest of federal regulators on Monday, ending the rumor mill that reached fever pitch late last week and completing the stunning collapse of what was the 14th-largest bank in the U.S. at the start of the year. Despite holding more than $176 billion in deposits at the end of 2022, First Republic reported in mid-April that it saw deposit outflows of $102 billion in the first three months of the year, much of it occurring in March following the demise of Silicon Valley Bank (SIVBQ), Silicon Valley Bank (SIVBQ) (SVB), and Signature Bank (SBNY), events that set off an ongoing regional banking crisis.

In all three bank failures, skittish depositors pulled out billions of dollars in what amounted to a classic run sparked by concerns about balance sheet viability and asset-price valuations amid rising interest rates. The Federal Reserve has raised its benchmark Federal Funds Rate roughly 5 percent over the last 13 months, the swiftest rate increase in 17 years. Now economists are worried other regional banks across the U.S. are at risk of runs similar to what befell First Republic, SVB and Signature Bank. For commercial real estate, the concern is how the demise of First Republic will impact the outstanding loans made to borrowers in a field that is already reeling from an uncertain capital markets environment.

First Republic’s balance sheet reveals a firm with modest commercial real estate exposure. By the end of 2022, First Republic’s commercial real estate loans stood at $10.8 billion, or 6 percent of the firm’s loan portfolio, with an average CRE loan commitment size of $4 million, according to the firm’s 2022 annual report. Total loan originations were $73.4 billion in 2022, compared to $64.8 billion in 2021, and $52.7 billion in 2020.


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