the death of the urban office building

[bizaro86]

This probably isn't a perfect conparable, but Calgary office vacancy has been in the 25% range for awhile now. The cause there is low oil prices and pipeline issues, not Covid, so the city is well ahead of the curve there.

 

This has been going on for years, and so far there haven't been conversions, even though residential has held up way better. Asking rents are holding firm in the $15 psf range, which is down ~70% or more from peak figures 5-7 years ago.

 

 

[Gregmal]

Yea NYC suburbs it isn't uncommon to see multi tenant office at 20-30% vacancies even pre COVID. It will be interesting to see what the incremental changes turn out to be, as the data becomes available. I've long been more negative on future of office than future of retail for this reason. I've personally visited dozens of the non big city office complexes and campuses, and frankly, always came to the same conclusion. If all you have to offer your workers is a cubicle or at best, a window with a view of I-80...why would they want to come to the office. Well, when governors and mayors are effectively shutting everything there is to do in the big cities, that same narrative is what you are left with. Hopefully this insanity corrects itself. You look at a place like NYC, and its sad, but also deserved given that they voted these politicians into office, but you tax everyone to death and drive out your wealthy....you shut down small businesses...you put severe restrictions on what businesses can operate and those that can are at fractional capacity....well, after a while there just won't be anything or anyone left willing to keep the scheme going. As the big dollar tax contributors flee..who is left to pay? The firms you won't let operate? The ones still around who you put on poor financial footing because of politically driven policy decisions?

[fareastwarriors]

Safe bet? Sovereign funds rethink once-reliable real estate

 

https://www.reuters.com/article/us-swf-realestate-insight/safe-bet-sovereign-funds-rethink-once-reliable-real-estate-idUSKBN25K0JC

[SharperDingaan]

The reality is that there's just too much RE - and a lot of it is stranded.

A NYC has so many bars/eateries, because so many travel in/out of the city every day - reduce flow by 20%, and you clearly don't need all the existing bars/eateries. The demand for bars/eateries didn't just displace to the 'burbs either - WFH people don't eat/go out anywhere near as much as they did when travelling to/from the city core.

 

Rational capital allocators will simply asset strip RE, and reallocate the capital to 'hotter' categories of the utility segment.

Less capital in the asset buy/sell cycle reducing prices. Growing unpopularity reducing sentiment, and compressing multiples. Hardly surprising that owners are very nervous - there's lots of uncertainty, and very little upside.

 

The same $ for a place in the city, gets you a much bigger place in the 'burbs - and better schools/infrastructure. All you need to make it worthwhile, is good internet, good public transit, and ability to do WFH at least 2 days/week - not a big stretch. If a company allows 2 days/week WFH, it only needs 60-70% of the current space. Split that space between core and 'burb 'rent a space', and the annual rent expense comes down by HALF.

 

Sure, industry will argue against WFH, but it's pretty much a done deal.

Industry just doesn't want the disruption.

 

SD

 

 

 

[Guest cherzeca]

my question is to what extent is this a massive buying opportunity for RE, and if so what kind.  I am intrigued by the AirBnB IPO as I think it will be offered at an attractive valuation compared to mid to long term value (when covid is a nasty memory).  I also think this can be a reverse-japan moment, where unlike buying at top in mid 80s (Rock Center), patient capital might get distressed urban RE at some point (I don't see distressed selling yet but you would think this should arise soon).  with stock market at all time high, where can one find value today?  real assets like RE as opposed to financial assets? especially if inflation returns?

[thepupil]

I think supply/demand imbalance is inevitable (at least in NYC) and spot lease rates will endure significant declines for an extended period of time. I do think working in an office has appeal and that a decline in rents will increase demand and also decrease new supply formation, such that the fundamentals of the far out years are more likely to look like today (the peak) than the trough. If you think rents go down 30-40% and stay there, you don’t really want to own any offices (They are priced such that you probably won’t lose a ton of money, but you may not make any). If you think the potential for long term mean reversion (after the fall) and the NYC premium continuing  exist to any degree, you want to own these.

 

To mitigate risks and have staying power, focusing  on tenant quality and lease duration is important, even better if there is non recourse interest only financing in place, or unlevered buildings, giving the equity full access to contracted NOI / cash flow, which again de-risks you. To use PGRE again, they do about $700mm or rent /$400mm NOI/$50mm g&A/$120mm interest/ $200mm ish free cash flow. 40% of leases expire in more than 10 years and the WAL is 7-8. Let’s say FCF glides to $100mm over 8 years and averages $150mm/year as tenants go bankrupt or space is renewed at lower rates. Over 8 years the equity would get $1.2B of FCF; the stock trades for $1.4B equity (market cap less net cash). There are some holes in this argument (not all their maturities are that long) but my point is that contracted cash flow de-risks you over time. They also own 2mm sf w/o a mortgage.

 

I don’t think I’m going out on a limb and saying the share price implies almost no residual value for the buildings; I can’t tell you the future of remote work, only the present of low valuations a a collapse in implied value/foot / rapid rise in cap rates.

 

 

this is still how I feel about all this discussion.

 

I agree with LearningMachine's point as it relates to the operating leverage in a building. There's a good chapter in Jim Grant's book "the trouble with prosperity" that outlines the history of a single building (40 Wall Street) from its construction right before Depression to when the Donald takes it over for basically nothing outlining the cyclicality in valuations/rents of this single asset over the years/decades. I recommend the book in general.

https://en.wikipedia.org/wiki/40_Wall_Street

 

I think it's very difficult to analyze the macro and have zero answers to the "what's the rent per foot / value per foot, 3 years out" as I don't think that's underwriteable and is a cause for the general puking of these stocks. Can only observe the present de-rating, the balance sheet/leases/liquidity/quality of individual companies and decide whether or not its a good risk reward. I think this is a very unsatisfying answer and makes one feel like a sucker. But i think any bull or bear who tells you occupancy/rent per foot / whatever with any degree of precision is probably kidding themselves. 

 

I think bifurcation and a flight to quality is also likely. I own a mix of truly trophy/high quality and more commoditized stuff. In some cases (PGRE) my bear case on the more commoditized stuff is about 2/3 lower than peak prices on an asset basis.

 

I hate to always go back to the individual stocks, but it's the only way in my view to meaningfully frame the risk/reward or what may happen in certain scenarios. 

 

As an example, PGRE owns 1325 AoA. I'm marking this at $360mm ($450 / foot. 13.5% gross rental yield, ~7% cap rate before taking into account some known/likley moveouts/bk's) in my base case and at $180mm (an unscientific 50% haircut) in my bear case ($225 / foot). this building was marked at $595 million in PGRE's 2014 IPO.  I do this for their 3 unlevered buildings and get 30-60% of the stock price (bear to base) and they have 20-23% in net cash), so from cash and unlevered buildings I get 50-83% of stock price. Then I value the two trophy assets at a 6 cap (1633 and One Market), which is a significant haircut to recent trades/refinances and get equity stakes worth 30-60% of the stock price. In my bear case on those I cut the equity in half on the 6 cap. For example, 1633 broadway in a bear case is at $1.675B (they sold a recent stake at $2.4B asset value) with $1.25B of debt = $375mm equity value ($337mm for PGRE's stake).

 

the financing is in place for 9 years and the buildings is throwing off $80 mm of cash flow after w/ long lease terms, so 4x net cash flow for the equity it feels pretty bearish to me.

 

All in before I get to the other 8 buildings, I'm at 80-150% of the stock price. In my bear case, I assume they give up every other building and the stock has 18% downside on value basis (but would surely go down even more). 

 

so I'd repeat that to me it feels like there are a ton of problems "priced in", and that the risk/reward is asymmetric to the upside. I could be wrong and shit could be worse than I expect. Maybe my bear case haircuts of 1/3 (asset level, 50% equity level trophy asset w/ long term financing in place) to 2/3 (commodity w/ known move-out / vacancy) aren't bearish enough. Maybe NYC will be driven into the ground by its leadership. Maybe not.

 

who the hell knows. I sure don't.

 

we'll just have to see how dumb this post looks in a few years.

 

 

 

[thepupil]

also i think it's veyr hard to pin down a "value per foot" for anything because this stuff is not fungible. the differences in quality/occupancy/term/etc. are pretty wide between an individual REITs own buildings and then between the various REITs, and then between cities and property types etc.

[fareastwarriors]

 

Real Estate Investors Skip Paying Loans While Raising Billions

 

Mall and hotel CMBS debts go into default as Covid hits value

Some lenders are willing to sell back loans at a discount

 

https://www.bloomberg.com/news/articles/2020-08-24/real-estate-investors-skip-paying-loans-while-raising-billions?srnd=premium

[fareastwarriors]

 

 

JPMorgan will have staff cycle between office and remote work in a move that may remake Wall Street

 

Workers in JPMorgan’s corporate and investment bank will cycle between days spent at the office and at home, keeping the ability to work remotely on a part-time basis, according to Daniel Pinto, head of the massive division.

 

The announcement by JPMorgan, the world’s biggest Wall Street bank by revenue, could pressure other financial firms to offer similar arrangements.

 

JPMorgan could shutter backup trading floors located outside New York and London as a result of the move.

 

https://www.cnbc.com/2020/08/25/jpmorgan-will-have-staff-cycle-between-office-and-remote-work-in-a-move-that-may-remake-wall-street.html

[Guest cherzeca]

"JPMorgan could shutter backup trading floors located outside New York and London as a result of the move."

 

I would think traders would definitely prosper from working on site.  it is the corp fin deal/relationship guys who could easily switch between WFH and office. 

 

as for law firms, a large tenant base for urban offices, I could see similar fluidity, with office attendance balanced with WFH for all lawyers, and senior lawyers probably WFH as much as they can

[fareastwarriors]

Hundreds of thousands of people looking for suburban homes — Sternlicht on exodus from cities

 

“I would say it’s not as driven by the Covid situation as it is safety and law and order,” global investor Barry Sternlicht told CNBC.

 

The  Starwood Capital founder said tax policy is another critical force contributing to affluent people leaving, particularly New York City.

 

“I’ve become a real estate broker for Miami. I keep sending friends down and showing them houses they can buy, and they’re buying,” he said.

 

https://www.cnbc.com/2020/08/25/barry-sternlicht-hundreds-of-thousands-looking-for-suburban-homes.html

 

“They’re leaving now. I’ve become a real estate broker for Miami,” added Sternlicht, who firm is headquartered in Miami Beach. “I keep sending friends down and showing them houses they can buy, and they’re buying.”

 

Mr Sternlicht still has time to act as a broker?  ;D

Always hustling, I guess...

[LearningMachine]

Workers in JPMorgan’s corporate and investment bank will cycle between days spent at the office and at home, keeping the ability to work remotely on a part-time basis, according to Daniel Pinto, head of the massive division.

 

A big telecom company in Vancouver, Canada went along the same path, and guess where it led eventually?

 

Some years ago, everyone was working 100% in offices.  Then, they started letting people WFH one day a week.  After sometime, that went to WFH two days a week.  After sometime, it went to working from office two days a week, and rotation model similar to what JPM is thinking, where each team knew which two days of the week they were in office.  Then, they went to "hoteling" at the team level where you could book one day a week for your team.  Then, the teams started meeting downtown for lunch one day a week instead of going into office.  The company then started realizing teams are socializing outside and not even coming to office.  This was all Pre-Covid.  Then Covid hit.  Having had that realization before Covid already, the company told folks to get their stuff out of the building by end of July because they are going to now sell the building.

[fareastwarriors]

Sam Zell: CEOs can help cities recover by returning to offices, not ‘hiding out in the Hamptons’

 

https://www.cnbc.com/2020/08/26/sam-zell-ceos-can-help-us-cities-recover-by-returning-to-offices.html

 

Billionaire investor Sam Zell told CNBC that corporate leaders have a role to play in helping U.S. cities stave off a serious economic decline.

 

“It’s going to require leaders of all the companies to come back to their offices and lead the people and create the opportunity,” Zell said.

 

“Hiding out in the Hamptons or hiding out in Vermont or wherever doesn’t make any sense and is counter-productive,” said the chairman of Chicago-based Equity Group Investments.

[rkbabang]

Sam Zell: CEOs can help cities recover by returning to offices, not ‘hiding out in the Hamptons’

 

https://www.cnbc.com/2020/08/26/sam-zell-ceos-can-help-us-cities-recover-by-returning-to-offices.html

 

Billionaire investor Sam Zell told CNBC that corporate leaders have a role to play in helping U.S. cities stave off a serious economic decline.

 

“It’s going to require leaders of all the companies to come back to their offices and lead the people and create the opportunity,” Zell said.

 

“Hiding out in the Hamptons or hiding out in Vermont or wherever doesn’t make any sense and is counter-productive,” said the chairman of Chicago-based Equity Group Investments.

 

Corporate leaders have a duty to do what's best for their companies and shareholders.  They have no obligation to "save cities".

[Jurgis]

Sam Zell: CEOs can help cities recover by returning to offices, not ‘hiding out in the Hamptons’

 

https://www.cnbc.com/2020/08/26/sam-zell-ceos-can-help-us-cities-recover-by-returning-to-offices.html

 

Billionaire investor Sam Zell told CNBC that corporate leaders have a role to play in helping U.S. cities stave off a serious economic decline.

 

“It’s going to require leaders of all the companies to come back to their offices and lead the people and create the opportunity,” Zell said.

 

“Hiding out in the Hamptons or hiding out in Vermont or wherever doesn’t make any sense and is counter-productive,” said the chairman of Chicago-based Equity Group Investments.

 

Sam Zell should lead by example and go into a crowded office every day.

[SharperDingaan]

He's just talking his book.

If nobody follows his advice the Q4/Q1 opportunities can be more reliably identified.

 

https://markets.businessinsider.com/news/stocks/stock-market-outlook-sam-zell-invest-significant-opportunities-end-year-2020-8-1029537249#

 

"One industry containing this uncertainty is retail. Zell said he used to be one of the largest retail owners in the US, but called the industry a "falling knife" that hasn't reached its bottom yet. The industry hasn't fully felt the impacts of ecommerce yet, and Zell is hesitant to invest in it right away. The pandemic has led to low transaction levels, but as activity picks up it will be easier to identify potential investments, the investor famous for buying distressed assets said." 

 

The obvious target is the retail heavy REIT's, and conversion of the surplus space into large condominiums - the mystery is to what extent 'burb WFH becomes the norm. Who is going to buy those condominiums, how many, why, and at what price. Then how do you move the remaining space when retail and office are over-saturated. 

 

SD

[fareastwarriors]

U.S. Commercial-Property Prices Fall With Worst Yet to Come

 

https://www.bloomberg.com/news/articles/2020-08-26/u-s-commercial-property-prices-fall-and-worst-is-yet-to-come?srnd=premium

 

Hotel, retail and office values all decline year-over-year

 

Outlook dims as the economic toll from pandemic deepens

[Spekulatius]

Sam Zell: CEOs can help cities recover by returning to offices, not ‘hiding out in the Hamptons’

 

https://www.cnbc.com/2020/08/26/sam-zell-ceos-can-help-us-cities-recover-by-returning-to-offices.html

 

Billionaire investor Sam Zell told CNBC that corporate leaders have a role to play in helping U.S. cities stave off a serious economic decline.

 

“It’s going to require leaders of all the companies to come back to their offices and lead the people and create the opportunity,” Zell said.

 

“Hiding out in the Hamptons or hiding out in Vermont or wherever doesn’t make any sense and is counter-productive,” said the chairman of Chicago-based Equity Group Investments.

 

Sam Zell should lead by example and go into a crowded office every day.

 

What he means is that somebody else takes the lead while He runs his empire from a yacht. It’s all Bs anyways. There will be plenty of people and jobs going back to the cities if rents and RE becomes cheap enough.

[fareastwarriors]

NYC Landlord Stepping Up Back-to-Office Campaign With Banks

 

https://www.bloomberg.com/news/articles/2020-08-27/nyc-landlord-stepping-up-back-to-office-campaign-with-banks?srnd=premium

[Gregmal]

https://nypost.com/2020/08/28/madison-square-garden-to-be-a-2020-voting-site-starting-oct-24/

 

 

Hmmm. We can open the Garden for political reasons, but not for business as usual....thats the current state of NY, and probably what I'd expect it to be for the next few months.

[thepupil]

https://www.sfchronicle.com/business/article/Pinterest-cancels-huge-SF-office-lease-in-unbuilt-15523170.php

https://www.bizjournals.com/sanfrancisco/news/2020/08/28/pinterest-terminates-soma-lease.html

https://sfist.com/2020/08/29/pinterest-abandons-massive-soma-office-lease-amid-surge-in-remote-work/

 

 

https://www.tmgpartners.com/portfolio/88-bluxome

https://news.theregistrysf.com/alexandria-pay-140mm-88-bluxome-san-francisco-plans-project-1mm-sq-ft/

 

will be interesting to see what happens with this project after Pinterest cancels a huge lease

[fareastwarriors]

Return to big offices? Why bank branches may get a new lease of life

 

 

https://www.reuters.com/article/us-health-coronavirus-banks-branches-ana/return-to-big-offices-why-bank-branches-may-get-a-new-lease-of-life-idUSKBN25S3UB

[fareastwarriors]

Aby Rosen buys Midtown office building for $350M

 

RFR seeking to lease 522 Fifth Avenue to a single tenant

 

https://therealdeal.com/2020/09/01/aby-rosen-buys-midtown-office-building-for-350m/

 

Aby Rosen’s RFR just closed on a 23-story, 575,000-square-foot office tower in Midtown Manhattan for $350 million. Morgan Stanley sold the property at 522 Fifth Avenue, which it used as its headquarters for its wealth management division.

...

In April, Rosen considered but decided against buying 900 Third Avenue in Midtown from Paramount Group for $400 million and a retail condo at 1600 Broadway in Times Square that was on the market for more than $200 million, according to Business Insider.

[LearningMachine]

Aby Rosen buys Midtown office building for $350M

 

RFR seeking to lease 522 Fifth Avenue to a single tenant

 

https://therealdeal.com/2020/09/01/aby-rosen-buys-midtown-office-building-for-350m/

 

Aby Rosen’s RFR just closed on a 23-story, 575,000-square-foot office tower in Midtown Manhattan for $350 million. Morgan Stanley sold the property at 522 Fifth Avenue, which it used as its headquarters for its wealth management division.

...

In April, Rosen considered but decided against buying 900 Third Avenue in Midtown from Paramount Group for $400 million and a retail condo at 1600 Broadway in Times Square that was on the market for more than $200 million, according to Business Insider.

 

Wondering if anyone knows how the quality of square footage of VNO, PRGE and ESRT compares to Morgan Stanley Headquarters at 522 Fifth Avenue trading at $609 PSF?

[thepupil]

I don't want to make too much of one data point, but I'd say its a generally postive comp. It's a well located, but very old building that was last renovated substantially in 1998 according to what i can find. I assume there will be substantial rehab/capital to invest in addition offset by the income from MSIM's rent.

 

it looks like some of ESRT's assets or maybe PGRE's 712 Fifth (but 712 Fifth looks nicer/higher rent), unless i'm missing something where they were renovated substantially. I could be wrong and this is testing the limits of my understanding the nuances of NYC office.

 

Morgan Stanley wants to be in a more modern space.

 

without knowing the economics of the leaseback it's hard to conclude much though. 

 

http://wikimapia.org/169522/522-Fifth-Avenue

 

318-foot, 23-story office building originally completed in 1898 as the 11-story Sherry Hotel. Designed by McKim, Mead & White, it was converted to offices in 1919. It was the scene of notorious parties while the Sherry Hotel: At one held by C.K.G. Billings in 1903 to celebrate the opening of his stables, the guests sat on horseback and the waiters dressed as jockeys. James Hazen Hyde, vice president of Equitable Life Insurance, spent $200,000 of his company's money here at a party meant to recreate Versailles; public outrage forced Hyde to flee the country and prompted reform of the insurance industry.

 

The building was extensively renovated and expanded in 1960, to designs by Eggers & Higgins, with a setback ziggurat peak rising to 23 stories. The building was renovated again in 1996 to a design by Sydness Architects, when the sole tenant was still JP Morgan, and a new base by Gensler Architects was constructed in 2016, except for at the west end on 44th Street. On the Fifth Avenue side, the building is distinguished by a landmark clock and a grand colonnaded entrance foyer illuminated by tiered iron chandeliers. It was reclad in 2018.

 

The modern 2-story base is clad in a glass curtain wall with clear panes exposing pale-green paneled piers. Beige metal panels run across the tops of the 1st & 2nd floors. The main entrance is at the center of the east facade on 5th Avenue. The western bays on 44th Street are clad in light-grey granite with light rustication. There is a service entrance is the westernmost bay and a loading dock in the next bay to the left, both with brown metal louvers at the 2nd floor.

 

The upper floors are clad in limestone, with rows of single-windows in silver metal frames. The western two bays on the north facade set back above the 10th floor, with the rest of the building setting back above the 11th floor. In the western two bays, the windows are replaced by metal louvers at the 3rd & 4th floors, and also at the 3rd floor in the next bay to the east. There are additional setbacks above the 14th, 18th, and 21st floor, deeper on the east facade than the north.

 

522 Fifth Avenue had been home to J.P Morgan since 1919, and is also currently occupied by Botticelli and Orvis, however, in 2006 Morgan Stanley executed a long-term lease of the 595,430 square foot facility to house its growing wealth management business.

 

https://www.cmalert.com/search.pl?ARTICLE=189592

 

CMA

May 22, 2020 

RFR Seeks Debt to Buy Fifth Avenue Offices

RFR Holding is on the hunt for a $300 million loan to finance its purchase of an office condominium at 522 Fifth Avenue in Midtown Manhattan.

 

The New York investment shop is asking for quotes on a mortgage with a term of five years, including extensions, on the 553,000 square feet of space. That would match the lease agreement with the sole tenant, Morgan Stanley. Newmark is shopping the assignment, which has some atypical aspects that could help attract lenders in a time of economic uncertainty.

 

RFR, led by Aby Rosen and Michael Fuchs, agreed to buy the condo from Morgan Stanley via CBRE in early March, before the full fallout from the coronavirus pandemic became apparent. The purchase price would be around $350 million.

 

As previously reported by sister publication Real Estate Alert, RFR negotiated a relatively long due-diligence period, as it occasionally does, that gave it about six months to close. That was viewed as an advantage given that the commercial-property financing market had essentially frozen. It has since begun to thaw a bit, but remains spotty.

 

The proposed deal carries features apparently meant to ease lenders’ concerns about backing a large acquisition. For example, a source said Morgan Stanley has agreed to a sale-leaseback arrangement that includes a full corporate guarantee of its rent for up to five years. However, either RFR or the investment bank can cut the lease short, at 3.5 years, if they choose. RFR intends to lock in one or more tenants to take all of the space before the term is up.

 

In addition, the proposed structure includes an unusual cash sweep that, for a period of time, would direct income from the property toward reducing the balance of the loan.

 

Morgan Stanley uses the property as the headquarters for its investment-management division. It bought the 23-story building from Broadway Partners in 2007 and divided it into office and retail condos in 2014. That year, it sold the 27,000 sf of retail space on the first two floors for $165 million to a partnership including Ashkenazy Acquisition of New York and German investor Deka Immobilien. That space has remained vacant. The bank listed the office portion around the beginning of the year.

 

The property is at 44th Street, one block north of Bryant Park and two blocks west of Grand Central Terminal. It was constructed in 1896 and opened as the Sherry Hotel. It was later converted to offices, and heavily redeveloped in the 1960s.