By Taylor Williams
The New York City retail market is currently functioning like an episode of The Price Is Right.
Developers, investors, brokers and operators are all trying to attach fair values to rents and sales prices for spaces of all sizes and submarkets. But after a tumultuous period marked by a global pandemic and record inflation, followed by a string of severe interest rate hikes, accurately assigning those numbers is easier said than done — at least in some submarkets.
According to data from JLL, at the end of the third quarter, the average rent throughout New York City was $290 per square foot, down 5.3 percent year over year. That figure represents an improvement from the second quarter of 2022, when rents posted a 12 percent decline on a year-over-year basis. In addition, JLL’s data shows that 58 new leases were signed in the third quarter. While that figure marks a decline of 13 percent from the second quarter, it also constitutes an increase of 7.4 percent on a year-over-year basis.
These numbers suggest that after retail leasing and sales completely stagnated in 2020 due to an unprecedented public health crisis, the market corrected sharply in 2021 and is now moving back toward some semblance of equilibrium.
Some industry professionals believe that the reset of rents is already well underway, especially in certain areas where leasing activity has escalated this year. In these submarkets, tenants, landlords and brokers now have more data to work with in terms of establishing floors and ceilings for rental rates. This stabilizing of rents sets the stage for growth in 2023.
“As leasing velocity has improved drastically, it has become easier to establish market rents,” says Ariel Schuster, a vice chairman at Newmark who represents both tenants and landlords. “While all neighborhoods have begun to see a rebound in activity to some extent, there are some submarkets, including SoHo and The Flatiron District, that have seen a huge spike in leasing. We have also seen a lot of activity along Madison and Columbus avenues.”
In its third-quarter report on the Manhattan retail market, Newmark identified several of the larger leases across various submarkets, including:
• French department store Printemps, which leased 54,365 square feet at 1 Wall St. in The Financial District for its first U.S. location
• Women’s fashion boutique Aritzia, which signed a 33,000-square-foot lease at 680 Fifth Avenue
• Immersive marijuana museum House of Cannabis, which took 30,000 square feet at 427 Broadway in SoHo
• Confectionary IT’SUGAR, which committed to 20,335 square feet at 234 W. 42nd St. near Times Square
Other notable activity in recent months included Howard Hughes Corp. (NYSE: HHC) opening a 53,000-square-foot food hall in the Seaport District that will feature six full-service restaurants, six fast-casual eateries and specialty retailer space. Known as The Tin Building by Jean-Georges, the project is an adaptive reuse of a historic waterfront property that once served as the site of the Fulton Fish Market. Additionally, sports entertainment concept Five Iron Golf recently announced plans to open a 30,000-square-foot venue — complete with a full restaurant and bar — at 101 Park Ave.
Rebounding Drivers
Validating the premise that a retail correction is well underway in New York City simply requires acknowledging the fact that retail success stems from the confidence and spending of those who inhabit the surrounding residential, office and hospitality properties.
“Retail is a trailing asset class — you need density of people and other uses around it to drive success,” says Patrick Smith, vice chairman of retail brokerage at JLL. “In New York City, that encapsulates three groups: residents, daytime office users and tourists.”
Each of these groups appears to display some positive momentum behind it in terms of patronizing and spending at retail and restaurant establishments.
As for residents, a new law was recently passed that caps the amount of annual increases that apartment owners can impose on rent-stabilized units, ostensibly increasing the disposable incomes of these renters. And after months of rampant growth, rents for market-rate apartments have finally begun to cool. A new report from multifamily rental platform Zumper stated that across New York City, median apartment rents fell by 2.3 percent between September and October.
Traffic and density within core office districts, most notably Midtown Manhattan, have picked up as city leaders have pushed for returns to traditional workplaces and structures, even on reduced bases. According to a recent report by the New York City Comptroller’s Office, office occupancy across the city hit its highest level of the post-pandemic era this fall, clocking in at about 46 percent. That figure is based on data from Kastle Systems, which tracks fob and keycard usage at office buildings throughout the country.
JLL recently represented landlord Brookfield Properties in a deal with Bank of America to occupy 14,000 square feet of retail space on the ground floor at 2 Bryant Park in Midtown Manhattan in 2022. As the city’s largest office hub, Midtown has seen a slower rebound in retail leasing activity, but that is changing as office usage gradually picks back up.
“Although density is more concentrated on certain days of the week, since September, we have undoubtedly seen an accelerated level of traffic at office buildings in Manhattan’s primary business districts,” says Alan Rosinsky, principal broker at Metro Manhattan Office Space. “Many of the short-term office leases that were negotiated during the pandemic are expiring, and tenants are flocking to trophy buildings with top-notch amenities to entice their employees back to the office.”
Rosinsky adds that with this flight-to-quality trend prevailing in the office sector, retailers and restaurants that are easily walkable from these buildings for corporate lunches or post-work drinks are reaping benefits. He cites Hudson Yards and One Vanderbilt, SL Green’s 1.7 million-square-foot skyscraper, as examples of developments in which Class A office spaces were delivered amid COVID but are still seeing high levels of leasing activity.
Tourism, both domestic and international, has been revived with the retiring of vaccine mandates, helping hotel occupancy flirt with pre-pandemic levels. According to data from City Guide New York, a 40-year-old destination marketing firm that tracks tourism-driven statistics and activities, the volume of domestic tourism is currently at about 87 percent of its 2019 level. The outlet also reports that New York City expects to welcome some 6.5 million tourists during the holiday season, and that 38 new hotels will have opened by the end of the year to meet that demand.
To that end, a summer report from PricewaterhouseCoopers revealed that the hotel occupancy rate at the end of the second quarter had risen to 81.3 percent. In addition, revenue per available room, the most commonly used metric in calculating financial growth in the hospitality industry, increased by 166 percent year over year in the second quarter.
What Discovery Entails
Retail sales data and forecasts for the holiday season indicate that despite 40-year highs in inflation, consumers are still spending on luxury goods, elective services and good old-fashioned entertainment.
Bars and restaurants are crowded, with establishments hurt more by lack of staffing than product cost increases or shortages of customers. Throughout Manhattan and the city as a whole, there is a collective sense of relief of moving on from the disruptions of the last three years.
Taken in tandem, these cultural and economic factors lay the groundwork for a return to more normalized, healthy consumer spending. For commercial real estate, that typically means that leasing and investment sales activity are about to pick up.
Except it can still be difficult to accurately price deals in some areas.
The valuation conundrum goes both ways. In submarkets where retail and restaurant businesses were hit particularly hard by COVID, opportunities to absorb quality spaces at discounted rates define the primary tenant strategy. In other areas, healthy demand and minimal supply has sent the rent rebound into overdrive, forcing operators to pony up at a time when their own costs of occupancy and capital are increasing.
“In certain areas of Manhattan, there’s a perception of value in the sense that rents are still down 25 to 30 percent relative to their 2019 levels,” says Smith. “At the same time, there’s concern from city and industry leaders about chronic vacancy in certain submarkets.”
Smith notes that in the current environment in which costs of capital are skyrocketing and construction for tenant buildouts and improvements also remains lengthy and time-consuming, softened rents are almost necessary to sustain basic business operations. But like the legitimacy of the rent numbers themselves, the amount of time for which that dynamic is likely to exist remains uncertain.
“If asking rents in most of Manhattan’s retail corridors are off by 20 to 40 percent, which they definitely were at one point, then the impacts of macroeconomic factors are somewhat tempered by the lower cost of occupancy,” he explains. “But when rents stabilize, that all goes away.”
Another factor that is muddying the waters when it comes to pricing rents lies in the design and construction of retail spaces. Whereas in most other major urban areas, retail generally exists within larger multi-tenant centers, in New York City, retailers tend to operate in single-tenant buildings. In other big cities, landlords will often put a sales reporting requirement into their leases as a means of finding the maximum accurate value for the rent — a provision that is fairly rare in New York City.
Because rents, as the embodiment of net operating income, directly influence sales prices and cap rates, significant discrepancies in sales prices are also abounding. According to JLL’s third-quarter data, the average sales price for retail assets across Brooklyn, Queens and Manhattan that traded at or above a $10 million price point was $1,996 per square foot.
That figure represents only a modest improvement from the average citywide price of $1,625 per square foot in the third quarter of 2021, but also a significant rebound from the depressed pricing levels that abounded throughout 2020. In addition, JLL’s research team notes that transaction volume was down 43 percent in the third quarter of 2022 relative to that time in 2021. Overall deal volume in the retail sector is on pace to close the year 33 percent below its 2021 total, the firm’s research team stated, with “Manhattan being particularly affected.”
The decline in the total number of sales means that there is a smaller sample size of comparable transactions by which to price deals — yet another hiccup in establishing fair and accurate market values.
Interest Rate Impacts
Interest rate bumps of the frequency and magnitude that the U.S economy has experienced in 2022 — nearly 400 basis points across four hikes in six months — also ensure that some level of larger pricing reset will take place. This holds true for retail as well as other asset classes.
“While we see healthy foot traffic and sales throughout Manhattan, which would be even better if the labor market was stronger, investment sales have slowed as we’ve entered a period of price discovery,” says Joel Dabu, managing director of leasing for the New York metro area for TSCG, an Atlanta-based brokerage and consulting firm. “Yet most buyers remain very bullish on the Manhattan retail market’s long-term prospects.”
“Buyers are still trying to figure out what assets are really worth,” adds John Horowitz, first vice president and Northeast division manager at Marcus & Millichap. “The market is operating in mini-cycles. The Fed announces a rate hike, and for a month or so, investors and lenders feel like they have a grasp on how to price deals. Then activity pauses about a week before the Fed meets; rates go up and everyone readjusts all over again.”
Horowitz, who is based out of the firm’s Manhattan office, says that the most visible indicator of this uncertainty lies in the bid-ask spread, which has widened in recent months as buyers and sellers have attempted to factor rate hikes into their offers and list prices. Still, retail investment sales activity has not ground to a halt as it did in 2008, and there are a couple of reasons for this.
“Rates are still low by historical standards, and the spread between where the 10-Year Treasury yield is (3.81 percent at the time of this writing) and where cap rates are still represents positive leverage,” says Horowitz. “In addition, it’s the sectors like multifamily and industrial, where cap rates have been lowest, that are being most impacted right now. Because cap rates have been higher in retail, the price correction and bid-ask spread haven’t been as severe, which means there’s still decent interest from buyers.”
As for when the pricing reset will take place on the investment sales front, that’s largely a function of the Federal Reserve’s actions. But when investors feel that the nation’s central bank has completed its inflation-fighting work, sales volume and velocity can be expected to pick back up.
When that happens, a rental rate correction should follow. Further, Dabu says that this reset will be primarily concentrated in retail properties whose owners are forced to sell in the high-interest-rate environment.
There are a number of retail properties in New York City that are leveraged to a degree that the current ownership may not be able to sustain if facing a capital event like a refinance or balloon payment,” he says. “Often, owners don’t have the financial flexibility to take lower rents due to these commitments, and cash-strapped owners may have to divest.”
“New buyers will come in and acquire these properties at lower bases, and that’s where you’re likely to see a degree of rent reset,” he concludes. “There needs to be some sort of reset in this environment to have a healthy market and consumer ecosystem.”
— This article originally appeared in the November/December 2022 issue of Northeast Real Estate Business magazine.