Office Market 2016: The IBM factor, downtown allure and the rise of multifamily

As of the end of the third quarter of 2016, office leasing velocity was on par with last quarter”™s total of 500,000 square feet. For the year to date, leasing activity grew by 17.1 percent and direct rental rates rose about 24 cents per square foot over last year”™s rates. Renewals represented slightly more than 50 percent of the leasing in Q3.

New leases totaled 250,000 square feet, which was 22.6 percent less than in Q2, but up 12.5 percent from last year. The increase from last year was primarily due to a large increase in the number of smaller deals signed in Q3 versus the same time last year.

There was a 60.2 percent increase in deals under 5,000 square feet, while deals between 5,001 and 10,000 square feet increased more than 50 percent. The average deal size in Q3 dropped to 4,227 square feet from 7,067 square feet in the same period last year. This is a reversal of trends we have seen in the last couple of years and is really a return to the norm of many years, when deals of less than 5,000 square feet dominated the market.

However, availability countywide at the end of Q3 grew to 25.9 percent against a 23.1 percent availability a year ago, with less occupancy than last year at this time. With a total of 1.1 million square feet of IBM Somers space now officially on the market ”“ compared with 200,000 square feet a year ago – year-to-date absorption is negative 833,000 square feet. This is an example of the tremendous impact of a single large block of space on the market”™s vacancy statistics and another souvenir of the downsizing of large corporations.

In fact, year to date absorption statistics are negative in Class A product in every submarket. The additional 900,000 square feet IBM put on the market this year amounts to approximately 3.24 percent of the total market inventory. Add in the 580,000 square feet vacant at One Pepsi Way and those two large blocks alone amount to approximately 6 percent of the county”™s total inventory of office space. It was recently announced that IBM sold the entire Somers campus to an unnamed buyer.

Karolina Pardo-Alexandre, research manager for Newmark Grubb Knight Frank who provided the statistics for this article, said, “Certainly the biggest news of the year was the sale of the 1.1 million square foot IBM Somers campus at 294 Route 100. It remains uncertain as to what its future use will be. On the leasing front, 2016 is anticipated to finish with more than 2 million square feet of transactions, on par with 2015. Activity in the White Plains CBD (Central Business District) remains strong and we expect to start 2017 with a reduced inventory countywide due to the removal of additional obsolete product. Medical picked up during 2016 and will be one of the industry sectors most likely to be affected with the new administration, especially if Obamacare is repealed. All in all, the market is stable and continuing its efforts to repurpose older buildings and their sites into new uses.”

It is interesting to note that the amount of quality office inventory is shrinking in the practical sense, which is a contradiction to what the statistics are saying. What I mean by this is that a lot of the best spaces in various buildings have been leased. I think this is a combination of the typical “flight to quality” that takes place in soft markets, when the cost of higher quality space is only slightly more than the cost of lower quality space, and certainly did during the Great Recession. And when deals are scarce, landlords will do what they have to do to make them, including leasing their most desirable spaces at lower market numbers rather than trying to incentivize tenants to lease less desirable spaces. In addition, we have been emptying and in some cases demolishing the oldest buildings in our inventory. So tenants have relocated or have been relocated by their landlords to better product, thus reducing vacancy in their better quality buildings. These are some of the nuances that the statistics do not show.

Overall, market velocity has been pretty good this year. On the supply side, we seem to have worked our way through – with the exception of IBM Somers this year – the multiyear wave of large and midsize tenants downsizing. The multitenant inventory continues to shrink and is down to about 27.8 million square feet countywide, according to the Newmark Grubb Knight Frank statistics.

About a decade ago, the inventory was about 32 million square feet. It has been reduced for a variety of reasons, including removal of obsolete, unmarketable buildings and repurposing of existing buildings, from office to medical or from multitenant to corporate owner/user. In some cases, buildings are being demolished for other uses, such as the new residential development on Corporate Park Drive and the LifeTime Fitness Center in Harrison, but typically these buildings are empty and have been removed from the database inventory well before they are demolished. Unfortunately, the amount of square footage occupied per person is also shrinking significantly and companies are not leasing space for employees who are not primarily office workers, such as outside sales people and telecommuters. These dynamics are counterbalancing the reduction in inventory, which is keeping vacancy rates fairly stable and somewhat blunting the positive effects of repurposing and demolition of old buildings.

Resurgence in the White Plains CBD

Renewals and new leases are tightening up the Central Business District market in White Plains. Large transactions in the pipeline, including Dannon for 90,000 square feet and New York Life Insurance for approximately 160,000 square feet, are showing that White Plains is now included in the trend of companies relocating to transit-oriented urban areas. The New York State Insurance Fund signed a lease to relocate from 105 Corporate Park Drive – scheduled to be demolished to make room for the new Toll Brothers/Normandy multifamily development – to 33,894 square feet at 44 S. Broadway. It becomes one of a number of state agencies in that building. A number of Westchester”™s largest law firms, including Cuddy & Feder; DelBello, Donnellan, Weingarten, Wise & Wiederkehr; Greenberg Traurig, and Kurzman, Eisenberg, Corbin & Lever) renewed their leases within the CBD this year.

Sumitomo Bank is reportedly in the market to lease about 90,000 square feet and is focusing on the White Plains CBD. If New York Life settles at Gateway at 1 N. Lexington Ave., much of the absorption in that building will be from Alliance Bernstein sublease space rather than direct space, which will reduce the positive impact on the vacancy statistics from New York Life”™s large lease. If it lands at Westchester One, some of that space will have been recaptured from existing tenant Arcadis, which has been trying to sublease 88,000 square feet of space for years.

White Plains Plaza, at 1 N. Broadway and 445 Hamilton Ave., is undergoing a full-out top to bottom renovation. It is also seeing significant leasing activity, both with renewals and new tenants. Three of the law firms mentioned above renewed at White Plains Plaza for a total of about 77,000 square feet.

Mack-Cali has been working on the design of major renovations for its newly expanded Westchester Financial Center. Earlier this year it closed on the purchase of the former Pace University condominium that comprises approximately half of the building at 1-11 Martine Ave. This vacant 82,000 square feet will now be integrated into the complex as office and amenity space. This complex has not really benefited from the leasing velocity in the CBD. If and when this renovation moves forward, it should create a modern amenity-rich Class A office complex directly across from the Metro-North Station. Among the items in the plan are an expanded food service, a fitness center, conference center, and an enclosed pedestrian link between the two buildings, as well as new lobbies, public corridors and bathrooms throughout the buildings.

But its smaller floor plates, from 22,000 to25,000 square feet, and unusually shaped floors have difficulty accommodating large tenants. Competing buildings such as 1 N. Lexington Ave. and Westchester One have floors of 33,000 and 44,000 square feet respectively. Everything being equal, larger tenants would rather be on as few floors as possible.

On a smaller scale, KOI Creative Space opened on Mamaroneck Avenue this fall. It is a very cool co-working space located above Lilly”™s Restaurant, with touchdown stations, a conference room, kitchen and a phone booth for calls that need privacy. It is owned by two millennial partners who work in the internet space and wanted to create a physical space that they would want to occupy. This is the WeWork of Westchester and it will be interesting to see how popular this format becomes. The space has already hosted a number of events for the Westchester Angels and the Westchester County Association.

The Galleria Mall was sold to a new owner from California. The City Center is undergoing an extensive renovation and enhancing its pedestrian access from Mamaroneck Avenue. And 189 Main St., the glass cube building opposite the Ritz-Carlton, is the home of the newly opened Mediterraneo Restaurant. This building has been vacant since it was constructed in 2010 and it is good to see it occupied and adding to the quality restaurants in the city.

Yogurt maker”™s move

Dannon has asked White Plains Common Council to approve a zoning change that would allow it to relocate its headquarters to a portion of the retail building formerly occupied by Fortunoff, which declared bankruptcy and vacated a number of years ago. This is a very interesting real estate play. The Hudson Gateway Association of Realtors also ended up here as a result of Lennar displacing it due to its redevelopment of the HGAR”™s former site at the Westchester Pavilion. The major tenants are the furniture store Raymour & Flanagan and Dick”™s Sporting Goods.

Apparently Dannon was bored with the standard CBD office product available and was attracted to this large space with 20-foot ceilings and covered parking at the front door. Not to mention it was across the street from The Westchester, with its high-end retail, and in the same building as the Cheesecake Factory Restaurant and Whole Foods Market. It also has a big floor plate and ground-floor retail space, now occupied by Morton”™s and a maternity apparel store, which will serve as Dannon”™s test kitchen.

I view this as good, creative real estate strategy. Unfortunately, however, it further highlights the fact that the office product in our CBD is dated and not very exciting. Statistically, this will be a non-event for CBD office vacancy, as the retail space it will occupy is not included in the office inventory.

This relocation will be a big blow to Dannon”™s former headquarters building on Old Tarrytown Road, which I predict will have difficulty in re-tenanting the space, primarily due to the difficult access to and from Route 287.

As Lennar will build more than 700 units of multifamily rental housing on the site of the former Westchester Pavilion across Maple Avenue from the Dannon site, there will be a significant change for the better in this section of the White Plains CBD. The redevelopment of the former Esplanade Senior Residence next door should also bring additional millennials and empty nesters to this section of White Plains.

White Plains Metro North Station study moving forward

I am a big proponent of the redevelopment of the White Plains Transportation Center. It is important to use it as a platform to add service and retail establishments to this section of the CBD. As I have written many times before, the office buildings near the station desperately need eating options and there will soon be about 1,000 residential units within two blocks of the station that will need service establishments and eating options. There is extremely little retail space planned in the new residential buildings, so this is a logical area in which to correct that situation.

 

Construction is booming

The construction crane is working on the new high-rise LCOR project on Bank Street in White Plains, but I have not heard of a start date for the demolition of the Westchester Pavilion for Lennar to start its large residential project. This is hopefully the key to the revitalization of the East Post Road retail corridor, which has suffered from high vacancy for many years. With over 700 units of new residential in the Lennar project, plus the 212-unit Esplanade conversion to residential, there will be a significant number of residents to support new businesses in the area.

The former Good Counsel Academy on North Broadway has been purchased by a group led by George Comfort and Sons. The first indication is that there will be approximately 400 residential units, plus 66 units for graduate and professional housing for adjacent Pace University, as well as 80 assisted living beds and 45 memory care beds in a facility to be operated by Sunrise Senior Living.

Grid Properties has slightly modified its plan to construct a high-end open-air retail development between Maple Avenue and Post Road just south of White Plains Hospital. While some might question the success of this type of development in a lower-middle-income neighborhood, it may well surprise the doubters. It is on a major route from Scarsdale to White Plains and easily reached from Route 287. It will replace what is now a large vacant site and was formerly a group of automobile dealerships. With 230,000 square feet of space, they should be able to create an interesting destination if their leasing projections are met.

The town of Harrison has fully approved 421 units of rental residential to be developed by Toll Brothers and Normandy Partners on Corporate Park Drive. This will be the first significant multifamily residential project that is not located in a TOD or transit-oriented development area. I am very interested in seeing how successful the lease-up will be. But it is a beautifully designed project, with all indoor parking right at each tenant”™s door in a wooded setting. It should be a winner.

Harrison continues to remain in the lead in terms of redeveloping obsolete office space and turning these sites into popular new venues which will pay significantly higher real estate taxes than the empty obsolete office buildings they are replacing.

As many units as there are under construction, the multifamily vacancy rate in Westchester is 2 per cent, so they should be absorbed. Also, the average age of existing stock is over 50 years, so replacement with new product is certainly overdue. If existing residential tenants gravitate to the new units in significant numbers, we may see a movement toward repurposing of older residential product.

Westchester submarkets in flux

The only positive space absorption for this year in the statistics is an interesting anomaly. The eastern submarket showed year-to-date absorption as of the end of Q3 of 174,212 square feet. This was not only the result of leasing activity. It was also the result of three old Class B buildings being taken off the market. They are the sister buildings to 103 and 105 Corporate Park Drive, which are to be demolished for the new Toll Brothers/Normandy multifamily residential development. As the above buildings are all of similar vintage, it is not economically feasible to reposition them into product that will be attractive to today”™s tenants. Through attrition and relocation of existing tenants to more modern buildings in its portfolio, Normandy will shut down these obsolete office buildings. You may argue with the way the statistic is presented, but at the end of the day this space is no longer on the inventory, so calling it absorption is really the only way to properly show the effect of the shutdowns.

Again, we have reduced supply by removing obsolete product from the available space inventory. Essentially, five of the oldest speculative office buildings on the Platinum Mile have been eliminated from the inventory – more than 400,000 square feet of space in our now 27.8 million-square-foot market.

Over the last decade, our total countywide multitenant space has been reduced from approximately 32 million square feet to approximately 27.8 million square feet. The first wave of this reduction came with statisticians removing buildings carried in the statistics that were really not being marketed. Over the last few years, the inventory has been reduced due to repurposings from office to medical use. Most recently, obsolete buildings have been emptied and shut down or demolished. All of these have reduced the inventory by approximately 4.2 million square feet. This is a very significant number and it is also one that aligns the statistics with the realities of the market.

Other than two buildings that are owned but still not occupied by Histogenetics, Corporate Park Drive contains no more multitenant office buildings. Going forward, this former office park that used to include IBM and Nokia among its tenants will contain a Hyatt House Hotel, the Toll Bros. /Normandy residential development and uses to be named later for the contiguous sites of the 106, 108 and 110 Corporate Park Drive buildings. In the adjacent park, the old Gannett building has been demolished and converted to a very popular 209,000-square- foot LifeTime Fitness venue – essentially a country club without a golf course.

The building at 3 Westchester Park Drive, formerly 3 Gannett Drive, was sold to a special loan services for $2.29 million, or about $14 per square foot. This 160,000 square foot building lost its 132,000 square foot anchor tenant when law firm Wilson Elser relocated to 1133 Westchester Ave. in 2012 and went into default on its mortgage. This building will have a tough time going through a re-lease process, if it can at all.

Tarrytown Corporate Center on the sale market

Tarrytown Corporate Center has been on the market for sale this year, either as a whole or in pieces. These buildings have not seen any capital investment in years. There is a rumor that the almost empty 555 White Plains Road, which sits on the other side of Route 119 from the balance of the park, may be demolished for residential development. Once these buildings find new owners, virtually the entire 119 corridor will have changed hands in the last few years. Keystone Property Group purchased all of the former Mack-Cali buildings on Taxter Road and White Plains Road a few years ago.

Northern Westchester is awash in vacant space

At the end of Q2 this year, IBM formally offered its 1.1 million-square-foot Somers campus for sale. As one of the buildings was already being marketed for lease, this announcement officially added 900,000 square feet of space to the already swollen office inventory in the northern submarket. This increased the availability in this submarket to 38.4 percent from 26.8 percent last year.

As I stated before, if these buildings magically vanished, the countywide availability would shrink from 25.9 percent to approximately 19.8 percent. If the former IBM campus is taken off the inventory due to a conversion to another type of use, that will reduce the countywide vacancy by almost 4 percent.

While the 580,000-square- foot One Pepsi Way has been marketed for a while, I have heard of no tenant interest in that property to date. There are large tenants in the market – Dannon, New York Life and Sumitomo – but they are gravitating to the White Plains CBD.

On Nov. 18, it was announced that IBM had sold its 1.1 million-square-foot campus on 723 acres to an unidentified buyer for $31.75 million. The sale was worth $28.86 per square foot based on the building size – a small fraction of replacement cost – or $43,914 per acre based upon the land size.

It will be very interesting to see who the purchaser is. If it is a user, that would be a great boon for the county. If it is a developer, I am very curious to hear what the plans for this large site will be. Unless and until it is announced that the buildings will be occupied by a user, demolished or repurposed for non-office uses, the square footage will remain on the available office inventory. As much as we are doing our best to demolish or repurpose buildings on the 287 corridor, the IBM and Pepsi buildings are the equivalent of 17 100,000-square-foot office buildings that have been added to the county as vacant office inventory in the last couple of years.

Where is county on Fareri deal? Why is it taking so long?

When will John Fareri get the go-ahead from the Westchester County Board of Legislators for the land lease for his Westchester BioScience and Technology Center? As I have mentioned before, this 3 million-square-foot project will take multiple years to construct. Regeneron continues to expand. The county”™s only biotech incubator is full. The Landmark at Eastview is almost totally full and the former Ciba-Geigy laboratory campus in Ardsley is totally full. We have the start of what could be a booming biotech cluster, but with no product to grow it.

We recently read that the county legislature has been given a deadline of less than six weeks to review a contract for an outside contractor to take over operation of the airport for 40 years, but there seems to be no pressure on the approval of the Fareri land lease, which it has been reviewing since January of this year. I just spoke to a national broker who specializes in the biotech sector and learned that three biotech companies, tenants of Landmark at Eastview, have recently signed leases in other states. One of these companies moved to New Jersey and one moved to Pennsylvania because they could not find laboratory space in our county. We cannot build a biotech cluster if we have no laboratory space.

Update: The Business Journal in late November reported that a team of consultants hired by the county to review the North 60 lease have basically given it a green light to move forward. It appears that the county legislature will vote on it in January.

The good news is that we will potentially have new space for biotech tenants. The bad news is that it will take so long to be built ”“ well more than five years. With opportunities in the former Pfizer complex in Rockland County and in New Jersey, a lot of biotech tenants will be forced to relocate across the river before the Fareri project gets built.

New industry, new construction

In October, uniform rental company Cintas announced that it would build a 62,445-square-foot building in the South Westchester Executive Park in Yonkers, where the company will consolidate its New York area operations, including its commercial laundry. New industry in Westchester: who would have thought?

Final thoughts

As I wrap up this year”™s real estate review, it occurs to me that 30 years ago it would have contained, almost exclusively, information on the office market. In those days, private family companies – Schulman, Robert Martin, Halpern and Cappelli – owned most of the multitenant office space and deals were pretty much done on the back of the proverbial envelope. A number of major multinational corporations called Westchester home, many occupying buildings they built and owned.

We have not built a new speculative office building since 1986, but development is accelerating in Westchester. The hot product is now multifamily rental housing. First-generation office buildings of the 1970s era are being demolished to make way for some of this development. Many former corporate headquarters buildings have been converted to multitenant formats. These are our “new” product that has been repositioned, rather than being built from the ground up.

REITs and large private partnerships own most of the multitenant office buildings and deals are done with corporate- style rent pro formas and construction budgets. And some of these owners – Mack-Cali and RXR – are selling off some of their office buildings in Westchester to redeploy their capital into more profitable product types or other regions.

Part of the reason for this is that there has been no real rent growth – not even to keep up with inflation – since the mid-1980s. The only things that have gone up are operating costs, real estate taxes and tenant fit-out costs. Space per person continues to be reduced and mobile workers and telecommuters are further reducing demand for office space.

Probably the most notable leasing trend of this year is the resurgence of the White Plains CBD as a desirable submarket. A little suddenly, the Central Business District is attractive to local companies moving from our nearby suburban submarkets as well as to new tenants, such as Sumitomo Bank, potentially relocating from New York City.

So maybe we are turning the battleship a little. And repurposing and demolition of obsolete space is helping to turn the battleship a little more. New multifamily housing will provide additional residents on our city streets and on the sites of old suburban office buildings. It will also provide increased real estate tax revenue to our municipalities.

Stay tuned for the next chapters – how those new residents will affect Westchester”™s demographics and our economy. It should be an interesting next few years.