Properties, Autumn 2003

Properties, Autumn 2003
The Future of the Manhattan Office Market
Joshua Kahr

If an image defines New York City, it is one of a skyline dominated by office towers. The number and scale of these towers, filled with financial and business-service workers, is testimony to the city's importance on the world stage.

However, cities change. The core question that the recent Newman Institute Industry-Government Seminar tackled is the relationship between potential future development of office buildings and New York's role as a global city. To answer this requires more than just a projection of new construction and the local economic conditions for the next few years. It requires an understanding of what makes New York a global city, and whether or not it will retain that role in the years to come.

The title of the conference - "The Future of the Manhattan Office Market: Can New York Remain the World’s Premier Global City?" - is a loaded one, implying that New York's global status and its office market are one and the same. Not all of our speakers agreed with that assessment. To be a global city is not a matter of how many office towers a city has. It means something more.

A number of experts in various fields presented what they see as the future of office development in New York. Their presentations from the recent conference comprise this issue of Properties. The most common points discussed were transportation, the future of downtown, and the future of New York City as a capital for financial and business services. Problems and potential solutions from the public sector were suggested.

Transportation
Transportation is a recurring theme in many of the presentations. There is common consensus that New York City has serious transportation problems. The biggest problem is that the city's mass transit network is strained in its ability to transport people on and off Manhattan and into the central business district (CBD). This problem affects a significant number of workers. As Robert Paaswell, director of the City University Institute for Urban Systems, aptly points out, nearly 75 percent of the labor force in New York does not live in Manhattan and must commute.

As it currently exists, commuting for suburbanites is becoming untenable. There are workers who have been forced by rising housing prices to move to areas that require a daily commute of ninety minutes or more each way. As conference participant William Wheaton points out, when workers consider what their true wage is, they factor in time spent commuting. If New York City does not lower the commuting time through mass transit improvements, it is essentially imposing an extra tax on employees and encouraging employers to move their operations to locations that are more convenient for their workers. Mass transit access plays as much of a role as land costs in determining whether or not a proposed office development is viable. This conclusion should not come as a surprise to the private sector. Unlike other real estate marketplaces, many owners in New York will not consider an asset for their portfolio unless it can be reached by foot or by subway.

9/11, Downtown, and the World Trade Center Site
Most writers that have covered future office development in New York City, whether it be for brokerage reports or trade magazines, include something about 9/11 and the World Trade Center site in their discussion. This is not to say that they believe that future office development in New York City will hinge on what happens with the World Trade Center site. But it was such a milestone event that one would seem negligent to discuss office development without at least paying homage.

Where will the new office development go? Some have argued that downtown could be revitalized as New York City's second CBD with the World Trade Center site as its new heart. There are many problems with the idea that downtown could emerge as a new CBD. The first and most basic is that the downtown office market has been dying a slow death for over thirty years. Tenants who could afford Class A space have tended to migrate to midtown, and the amount of new construction downtown has been minimal in comparison to midtown. As a result of this, the quality of space downtown has declined overall. It will be hard to turn around such a prolonged trend. The justification for the original World Trade Center was that it would reverse this trend and save downtown. It didn't then, and there is little reason to believe it will now.

At this time, the only significant construction that is occurring downtown is the conversion of office buildings to residential use. The forces pushing for downtown as a second CBD have a battle ahead of them. A CBD is supposed to be the prime location for business, not residences. If new residential units are outbidding commercial use, it's fair to say that the marketplace does not view downtown as a CBD. We should also remember that one is hard pressed to think of a city with two CBDs. New York City is arguably unique and a project the scale of the new World Trade Center would make an impact in a community of any size, even one the size of New York City. But is it such a significant project that it could reverse prevailing market trends and enable two CBD's to thrive concurrently?

In the conceivable near future, downtown's role for future office development is that it will become a "back-office" location, albeit one that, surprisingly, is located in the oldest commercial district in the United States. At this time, downtown does not have the transportation links, short commuting time to where decision makers live and amount of Class A office to establish itself as a CBD. Downtown is dwarfed by midtown's current size and breadth of brand name tenants. Nonetheless, downtown will serve the city well as a back-office location. In the rest of America, a back-office location is often miles away from the CBD. In New York, one can achieve significant price savings by simply moving to a different neighborhood. Downtown is one such neighborhood, but there are others - Midtown-West, Jersey City, and Long Island City. The one benefit that the new World Trade Center complex will have over these other areas, when the project is finalized, is that it will be a master planned, mixed-use project of such scale that it should have a critical mass that will enable it to stand on its own, regardless of what happens to the rest of the declining downtown office market.

Financial and Business Services
New York City has traditionally had global-city status because of the presence of financial and business services. The big question facing the industry and the city is whether or not the financial and business services will continue to play as large a role in the city's economic development. As hard as it is to imagine, these industries' presence in New York City is not guaranteed.

Joel Kotkin and Steve Malanga discuss what it means for New York to be a global city and how it can remain one. Kotkin effectively punctures the myth that New York has a magical quality that forces companies to stay here. While Manhattan still has a great number of educated workers both in absolute and per capita terms, the city as a whole does not have an educated labor pool when compared to other communities. Kotkin argued that unless New York City renews itself and creates an environment that will attract more educated people and integrate the poorer and less educated communities into the fabric of the city, it is unlikely that it will thrive. Malanga's presentation looks less at general issues such as education and the city's competitive environment and focuses more on the financial-services industry. This industry has been a major force for the creation of new office space. While there are many office-dwelling industries in New York, few industries have the capability to pay the high rents that are needed to justify the construction of new office towers. While it is hard to imagine, if those high wage industries cease to thrive, office-tower development could slow dramatically.

Whether one tries to understand the future of New York City by looking at how the City fits into the region [Kotkin] or by how it has coped with past crisis such as the crash of 1987 [Malanga], the city's dependence on the financial-services industry is inescapable. This was not always the case. New York City used to dominate other cities in the number of headquarters of Fortune 500 companies. It does not anymore, so one is tempted to ask: Why are the financial and business services that serve these major corporations still here? Isn't there a significant pressure for them to relocate their operations so that they are closer to their primary clients, wherever that may be?

In his presentation, Hugh Kelly discusses how New York City has been reinventing itself out of necessity for a long time. The evolution of New York City from a headquarters for Fortune 500 companies to a headquarters for financial and business services is one such example. Based on this city's history of dynamism, there is cause for hope. The big question now is what does the city evolve into if financial and business services start to weaken. Kelly also points out that when the city's market for office space has dipped, it has done so suddenly and dramatically. As anyone who has worked for one of these companies can testify, the cycle can be harsh, as layoffs come quickly. Randy Anderson covers this issue in greater detail. He points out that the FIRE sector (finance, insurance, and real estate) and the service sectors lead employment in New York (that is, they have a location quotient greater than one). These two industries have also had the greatest downturn in employment and occupy a high amount of office space. Is the dip in employment a cyclical or structural event? For the health of the office market, one hopes that it is simply cyclical.

Does it really matter to the office-development market if financial and business services migrate out of the city? What if they are replaced by a corresponding increase in other industries that New York is known for, such as publishing, advertising or fashion? For the new development of office buildings, the issue is not total metropolitan employment but whether the businesses are willing to foot the high rent that is required to build a new office building. Otherwise, office buildings will either not get built or will only get built with public subsidy. Regardless of how many people these industries employ, few of them are paid salaries that are comparable to employees in financial services. It is hard to justify the cost of a new office building without these high-wage laborers.

New York City is also a very expensive city to build in. As Eric Deutsch points out, the good news is that there are many things the city government can do to try and lower the cost of new construction. The flip side of this is that if New York does not act, the city is at risk of losing new office development to other communities. The threat of an employer leaving Manhattan because it wants cheaper office space has been relatively ignored; the common belief seems to be that the farthest an employer will move is to Hudson County, New Jersey, and so while the city government will feel the effect on its tax rolls, the city as a whole will be unaffected. Michael Gallis shows how New York fits in with its sister cities in the northeast. Could we lose some of our core businesses to these other communities? While not probable, if there is not careful planning and effort on the part of local government to encourage new development, businesses can and will leave.

Conclusion
The issues that these collected speakers have raised challenge more than New York's future for office development; these challenges threaten its role as a global city. In the final analysis, there is more to New York than striking architecture. New York is a global city, and it is so because of the financial and business services. Without their continued viability, or another industry that pays comparably high salaries (for example, biotech), it will difficult to justify the construction of new office buildings on Manhattan. Also, because of the impact of strained mass transit systems, it is possible that any new office development will occur in secondary locations that are within commuting distance of Manhattan, and, more important, closer to the homes of the labor force. The vision that all new office development must occur on Manhattan is limited in scope. In today's marketplace, the island of Manhattan is in competition with everyone else for high-wage businesses and their new gleaming towers.