Class B and C buildings yet to see recovery

Real Estate Weekly, April 20, 1994 by Andrew Roos

Manhattan's commercial real estate market is showing signs of increased activity with certain sub-markets leading the upturn. While upper segments of the market with quality buildings located near transportation hubs such as Grand Central and Penn Station show signs of improvement, this resurgence cannot be considered solid until it trickles down to the Class B and Class C real estate inventory.

During the recession, firms through-out corporate America re-engineered their approach to business, which has carried over to the way they occupy space - purging excess as quickly as possible in effort to cut costs and reduce overhead. In some cases this was done to encourage active communications in more intimate work settings. The ensuing sharp decline in Manhattan's overall occupancy rate forced a dramatic drop in the cost of prime commercial space. Although the economy has improved significantly, much of Manhattan real estate remains tenant driven. This has allowed smaller service industry firms, typically from older Class B buildings, to take advantage of the lower cost of occupancy. The result has been a flight to quality in which tenants trade up space or recast leases for lesser but improved space in the modern, prime class-A buildings of midtown Manhattan.

In addition, a paradoxical trend has re-emerged as certain industries, experiencing rapid growth, cannot acquire space quickly enough. In effort to avoid repeating mistakes of the past, these firms need to proceed with caution - ensuring they have instituted the proper safe-guards to allow the necessary flexibility for future needs.

The service industries such as insurance and banking require space that can accommodate heavy technical capacity needs with large, open floor plates. Fitting these space requirements, the Sixth Avenue corridor, with its prime, modern office towers, has benefitted tremendously, emerging as the "Park Avenue of the West Side." The next "hot pockets" of activity to follow the Sixth Avenue corridor will be midtown's Seventh Avenue and Broadway. The more stable sub-markets, such as prestigious Park Avenue, with its proximity to Grand Central and varied mix of elegant pre-war buildings and modern office towers, will "continue to" draw the traditional service industries including banks and law firms, and solidify its reputation as the "International Avenue."

The depth of the recovery for the commercial real estate market will be evidenced by the amount of space that is absorbed in the Class B and Class C buildings of Midtown and ultimately Midtown South. The rate of absorption in the Class B and Class C buildings demonstrates the remaining effects of the flight to quality, trading up for space, and recasting leases. When the market was at its peak, the Midtown and Midtown South Class B and Class C buildings became viable options of refuge for the service industries that could not afford or obtain space in the Class A buildings. These pre-war buildings have been renovated with advanced building systems and cosmetic improvements have been made in effort to retain old tenants and attract new ones. As the momentum of the market increases, these retro-fitted buildings, in good locations with viable floor plates, will be the first to go, followed by the remaining older Class B buildings.

The commercial property market has improved. Most banks have addressed their inventory of troubled commercial real estate, as other institutional investors now begin to address their real estate portfolios. As the top of the commercial real estate pyramid enjoys a revitalization, what remains to be seen for 1994 will be the effect of this success on the lower rated buildings.