By Taylor Williams
Across Manhattan’s major retail corridors and pockets, leasing agents, operators and owners are all gaining greater clarity on what levels of rent various submarkets can bear and, by extension, how much spaces are truly worth.
After three years of disruptions of the public health and financial variety — each devastating in its own right — a reset of sorts is a major windfall for the country’s largest and arguably most dynamic retail market. Closing deals is challenging enough when all parties are on the same page and the economy is stable. When markets are going through tumultuous phases of discovery in which perceived valuations of spaces fluctuate wildly, negotiations tend to flame out even more quickly — if they even get going at all.
“A year ago in Manhattan, you could have two adjacent stores, and one might have been asking for $120 per square foot while the other wanted $220 per square foot,” says Chase Welles, partner at TSCG, an Atlanta-based brokerage and consulting firm that is active in New York City. “There’s certainly more definition relative to last year, and the range of asking rents in each submarket has narrowed.”
“The market has become more defined in asking rents, comps, tenant improvement (TI) packages, delivery conditions and other economic factors,” he continues. “So people have more confidence in the state of the market. Brokers with similar listings should have about the same idea of what they think the space and TI packages are worth, whereas last year there were a lot more question marks.”
“We were previously coming out of an environment in which we were working with a robust demand pool, and landlords were being flexible to get their spaces absorbed,” adds Jackie Totolo, senior managing director in Newmark’s Manhattan office. “We’ve established more stability since then, and there are clearer indicators of where terms and concessions are landing in prime corridors. The opaqueness of deal structures has largely disappeared.”
Even if greater market stability is code for “rents will rise,” tenants aren’t objecting because quality space is scarce. Further, sources agree that while the framework for rent escalation is now mostly in place, rates are not at and should not approach pre-pandemic levels any time soon. Against that backdrop, the retailers that accept new realities, tailor their business strategies to the recalibrated landscape and act quickly are seeing success.
“Those tenants who come into the market thinking it’s still 2022 and ask for unreasonable requests are at a disadvantage in terms of competition in prime corridors,” says Totolo.
Shifts in TI Packages
Even with some newfound stability and tacit agreement on new market parameters, brokers, tenants and landlords in New York City still face hurdles to getting deals done.
One might immediately point to the 11 interest rate hikes totaling 500-plus basis points that have pummeled the industry over the last 18 months as the root cause of this dynamic. But sources say that the effects of rate hikes on retail leasing mainly impact TI packages and not so much tenants’ expansion plans.
“There’s not much in the way of TI right now because landlords can’t access capital to do the improvements on spaces themselves,” says Welles. “They also can’t give tenants allowances to do the work, which brings rents down because tenants are being asked to shoulder the capital burden. So tenants are either not doing the improvements or are taking a big bite out of the landlord on the rent.”
“Deal packages are still different from what they were pre-COVID,” adds Andrew Mandell, vice chairman and principal at locally based brokerage firm RIPCO Real Estate. “The fallout of credit markets has yet to fully occur, but that will change the dynamic of what the leasing environment looks like when it does happen.”
As is often the case with TI allowances, the profile of the tenant is a critical consideration.
“Owners that are facing higher interest rates or [have loans] coming up for refinancing that have creditworthy tenants can borrow against those [guaranteed] leases,” says Mandell. “Some owners are still willing to put cash out there, but not at the same level as if it was a very creditworthy tenant.”
The city’s food-and-beverage users, which spearheaded the post-pandemic rebound with aggressive expansion plans and creative uses of space to maintain business, are perhaps the only major exception to the current trends in TI allowances.
“If you’re working with a full-service restaurant and there’s no TI, the deal isn’t getting done,” says Totolo. “This is because the construction costs of building a restaurant and getting it to a point where an operator can put their finishes in and open for business are incredibly high. Any landlord seeking that use has to be prepared to contribute.”
Sean Moran, managing director at Cushman & Wakefield’s Manhattan office, notes that for restaurant spaces that are housed within larger commercial or residential buildings, there’s an added incentive for landlords to contribute. And if there are hot, trendy operators circling the market, that incentive is further augmented.
“Construction costs are higher, so if it previously cost a full-service restaurant $1,000 per foot to build-out and open, it’s more like $1,200 or $1,300 today,” he says. “As for who eats that cost, it’s being shared between landlord and tenant. We are seeing an arms race to amenitize office and residential buildings, and retail is a component of that, so landlords of those buildings have been more willing to participate on TI. In some cases, we’ve seen landlords turn a raw space into an F&B space and still participate at 50 percent of what it cost the tenant to build, just to secure the right tenancy.”
Supply Shortage
Perhaps a bigger threat to leasing velocity is the lack of quality space — though one could argue that crushing interest rates have exacerbated the lack of new supply growth.
According to data from CBRE, in the third quarter, there were roughly 200 spaces available across 16 major retail corridors/submarkets in Manhattan. That is significantly less vacancy than the market-high of 290 open spaces that was recorded in the second quarter of 2021. But the recalibration of rents and added stability within the leasing market means that tenants can better identify and distinguish quality spaces — and it’s those spaces that are fielding the bulk of the demand.
In explaining the prevailing flight-to-quality trend in Manhattan, the report’s authors provided some aggregated data for the third quarter. The rolling four-quarter aggregate leasing velocity, which measures the total volume of new leases and renewals for the four prior quarters, totaled 2.8 million square feet, per CBRE. That figure represents a 17 percent decrease on an annual basis. In addition, that 2.8 million square feet of leasing activity is a 33.4 percent decline from the high-water mark of 4.2 million square feet that was achieved in the second quarter of 2019.
In any major market like New York City, land is at a premium, and pure-play retail projects are rarely considered the highest and best use for shovel-ready parcels in infill locations. And with the average construction loan priced in the double digits, any vacated space from retailers with large- or mid-sized footprints is a key source of potential supply growth.
Pictured is 551 Madison Avenue, a 17-story office building in Midtown Manhattan that offers proximity to an array of luxury and boutique retailers within this high-end submarket. And while office usage as a whole remains inconsistent, brokers say that retailers in the area are nonetheless gaining a better feel for traffic patterns among users.
Stores previously occupied by Bed Bath & Beyond received immediate and intense interest when the home furnishings retailer filed for Chapter 11 bankruptcy liquidation earlier this year. But with many of those spaces now absorbed or spoken for, brokers say that the market is turning its attention to former drugstores. CVS and Walgreens announced closures in 2023, and Philadelphia-based Rite Aid filed for bankruptcy in October.
“Every retailer is figuring out how to rightsize their stores and offerings, how to achieve higher per-square-foot sales within a smaller footprint,” says Welles. “That could mean a retailer that usually took 20,000 square feet now only needs 10,000, like some of these drugstore users. Consequently, there’s a mini-frenzy over some of these Rite Aid spaces.”
Rightsizing is indeed a trend with legs, as it’s a natural next step for retailers to take when faced with threats of rising rents and occupancy costs, as well as additional competition from e-commerce platforms.
“Tenants have shown a lot more rent discipline over the last few years in rightsizing not only their store fleets, but also their store sizes,” says Moran. “H&M used to [have a prototype store] of 40,000 square feet; now they want 15,000 to 25,000 depending on the market. Sephora used to do 10,000 square feet and now wants to be 5,000 to 6,000. Everyone has that underlying occupancy cost number on their minds moving forward.”
Still, backfilling a space designed for one subcategory of retail usage with a tenant in a completely different field can always present challenges.
“The spaces these pharmacies took when they were expanding aggressively weren’t always the most desirable — some had low ceiling heights and tons of columns and weren’t retail-friendly,” says Totolo. “Where there’s adjacent retail, there’s opportunity to reposition all the retail at the base of the building and re-cut the space, but it’ll be challenging for landlords to get the same rents.”
Moran offers anecdotal evidence to support the notion that vacated spaces could see some unusual and interesting reconfigurations.
“We represent the retail condo owner at the northwest corner of 86th and Lexington where there’s an existing Best Buy and a former Duane Reade drugstore that closed as part of the proposed Walgreens-Rite Aid merger,” he says. “Now we have the opportunity to combine and reconfigure the spaces. And while Best Buy is working to stay, and we’re entertaining that option, we have 13 different proposals in hand for different division configurations.”
Office-Area Resilience
Mandell of RIPCO agrees that based on demand skewing toward high-quality spaces in established submarkets, there are more opportunities in areas that have otherwise seen more sluggish leasing velocity in recent years. Midtown Manhattan, home of the borough’s biggest cluster of office buildings, is an obvious example.
“Overall, the market is in a healthier place, but there’s still a fair amount of space available in certain areas like Midtown,” he says. “But tenants have options now, and a major variable is quality of space — high ceilings, frontage, signage potential. Those spaces are winning the day.”
Sources say that while some soft goods merchandisers are reluctant to target Midtown due to sporadic and unpredictable office usage, the area’s food-and-beverage scene has improved markedly relative to the past couple of years. These operators have a better understanding of when and where foot traffic tends to peak, helping them more accurately forecast sales — a direct factor in establishing a ceiling on affordable rent.
“In office districts, we represent quick-service restaurants that surround Midtown and Bryant Park and serve that daytime population. They tell us they’re back to about 85 percent occupancy and have adjusted pricing and caught on to traffic flow based on workplace and office usage trends,” says Totolo.
Perhaps time was all they needed. However the ability of these operators to identify patterns within office usage is another show of stability in and of itself.
“They’ve been able to fine-tune their models; they have enough data to understand the flows of traffic, and they can report sales more accurately versus just hoping that more offices get filled up over time,” she continues. “They have raw data and use that to determine how much rent they can pay, and that’s been beneficial to the market as a whole.”
Owners of retail buildings in office districts are similarly catching on.
“Office occupancy is increasing, but rents have shifted enough to compensate for the lower-density or lower-occupancy buildings,” says Mandell. “If you own an office building that’s 50 percent occupied and you adjust rents to reflect that occupancy, you’ll have more activity. If you try to push those rents to pre-COVID levels, it’s going to be harder to lease space.”
— This article originally appeared in the November/December 2023 issue of Northeast Real Estate Business magazine.