During the days and weeks immediately following the 9/11 attacks, scores of downtown residents fled their homes. In Battery Park City, the 90-acre residential complex due west of Ground Zero, many apartments were simply abandoned. Most residents sought temporary refuge from the contaminants and fumes that swirled in the air for weeks, but some vowed never to return.
Back then, it appeared that the catastrophe hadn't just decimated 15.5 million sq. ft. of lower Manhattan office space. Observers warned that downtown's future as a residential district was in jeopardy. By 2002, the city was helping landlords fill properties by using federal disaster funds to subsidize rents.
These days, residential landlords don't need subsidies and rebates to attract tenants. Even as the huge downtown office market sputters, residential sales and rentals are soaring. Over the past four years, the number of residents in the Wall Street area has nearly doubled from 15,000 shortly before the 9/11 attacks to approximately 27,000, according to the Alliance for Downtown New York, a local business group.
The Alliance also projects that lower Manhattan's overall population should grow by 21% over the next two years thanks to a flurry of residential conversions that have changed the character of the real estate market. In the mid-1990s, there were roughly three times as many office buildings as residential properties. Today, there are as many office buildings as residential properties in lower Manhattan.
Even before 9/11, tired pre-war (some pre Spanish-American War) office buildings could no longer attract businesses that needed large, open floors. As a result, many older buildings were converted in whole or part to condos, lofts and rental apartments. The landmark Woolworth Building, for instance, was bought by a developer who converted its highest floors into condo units.
“This would have happened in time, but the 9/11 attacks only sped up the pace of residential development,” says Robert Sammons, director of research at Manhattan-based commercial real estate services firm Colliers ABR. “We started to see this residential shift begin slowly in the mid-1990s.”
Conversion zone
Since 9/11, the federal government has authorized more than $1.6 billion in tax-exempt financing for apartment projects in the so-called Liberty Zone south of Canal Street. Developers have clamored to secure Liberty Bond financing since the interest on the bonds isn't subject to federal, state or city taxes. The upshot for borrowers is lower costs, though bond purchasers accept lower interest rates.
The party ends on June 30, 2006, when the incentives for residential conversions in lower Manhattan will effectively expire. Sammons of Colliers ABR says that this is a closely watched date, so he expects developers to press for tax-exempt financing while they can over the next 11 months. “I don't expect a huge number of conversions between now and then, but it can only help drive the trend some more,” he says.
But, if the future of lower Manhattan hinges on a residential foundation, where does the beleaguered office market fit into this grand scheme? Will the area continue to lose the kind of jobs that made it the financial capital of the world?
That's not likely. With its 91 million sq. ft. of office space, downtown remains the nation's third-largest commercial district after midtown Manhattan and Chicago. But its ability to compete — even with rents that are sometimes half the price of Midtown — is debatable. At the height of the bull market and the dot.com boom (which attracted hundreds of new companies to the area) in the late 1990s, vacancy fell to around 4%, a record low.
But the recession and the 9/11 attacks sent vacancies soaring. By 2004, an estimated 17% of downtown office space was left vacant. As of this June, real estate brokerage CB Richard Ellis pegged vacancy at 16.4%, only a slight improvement. Meanwhile, with new office construction under way, nobody is predicting a quick rebound.
But the residential trend could help by removing several million more square feet of office space from the market. That would bode well for projects like 7 World Trade Center, a 1.8 million sq. ft. project by Silverstein Properties that is due to open early next year.
Colliers ABR data shows that 14 office buildings, or a total of 5.2 million sq. ft. of office space, have been converted for residential use since 9/11. Class B and C office properties represented 9 of those 14 buildings, suggesting that the older stock is being targeted for conversion by developers. The steady conversion activity has brought the office inventory down from 113.4 million sq. ft. at the end of 1995 to 91.1 million sq. ft. in 2005. The remaining office space was eliminated on 9/11.
Another ray of hope for the commercial real estate market is the increasing demand for retail and entertainment, as the neighborhood becomes more residential. And residents aren't the only ones who will use such services. Restaurants, shops and clubs attract office workers, tourists and, increasingly, other Manhattanites.
There's another benefit, too. Those amenities make the area more attractive to businesses, says Sammons of Colliers ABR. “New residents create synergy,” he says. “Office workers like working in residential neighborhoods.”
Still, that kind of vibrant work/play/live atmosphere is not yet palpable. Services are popping up sporadically in lower Manhattan, as retailers get their bearings before making big commitments. That should change, Sammons says, as the residential population rises. The Downtown Alliance projects that more than 37,000 residents will live in lower Manhattan by 2010.
Retail in the wake
One lower Manhattan broker predicts that the retail component will lag residential growth for some time. “You do find pockets of retail that do quite well down here such as lower Broadway, but for the most part the retail services haven't caught up,” says C. Bradley Mendelson, executive director of retail at Cushman & Wakefield.
The biggest retail boost is expected to come at the beleaguered Ground Zero site, where contention over the Freedom Tower development continues. The early plan to replace the huge underground mall that existed beneath the Twin Towers has long since been shelved. In the various iterations of the Freedom Tower design, retail isn't even factored into the design. The latest version of the building rests on a bunker-like base that will have no commercial space. However, the Port Authority, which owns the land, is quietly canvassing developers for proposals to reintroduce a mall.
Port Authority officials expect to begin formal talks with retail developers later this year. Tishman-Speyer Properties, Vornado Realty Trust, The Related Cos. and Westfield Corp. were mentioned as possible candidates to develop a mall on the site. A Port Authority official says that any announcements will be made toward the end of this year.
Some retail development is already on tap. Upscale grocer Whole Foods plans to build a new store at 270 Greenwich Street. This is a new building that will house high-end condominiums. It's also believed that Home Depot is scouting for a location in lower Manhattan.
Meanwhile, Mendelson says the area still lacks the population to attract a critical mass of convenience retailers, such as drug stores and dry cleaners. “I think it will take a while before these retailers really fill in the area with services,” he says. “The financial district is still a relatively quiet area, and that's partially what draws people to live there,” he says.
Yet lower Manhattan's demographics are encouraging for retailers. According to the Downtown Alliance, roughly 323,000 office workers are located within walking distance of Ground Zero. These are people who earn an average annual income of $120,000 at private sector firms, and the buying power of residents is also significant. The Alliance pegs the median household income of a lower Manhattan resident at $153,000.
Wild ride
These numbers come as no surprise to developer Kent Swig, lower Manhattan's fourth-largest real estate commercial landlord based on the size of his portfolio. In 1999, Swig — principal of real estate development and investment firm Swig Equities — decided to renovate landmark office tower 48 Wall Street. Like most old office buildings in lower Manhattan, the 32-story office tower was limited by small floor plates that didn't appeal to large office tenants. With the conversion movement already showing signs of life, Swig decided to divide the office building into apartments.
But Swig abruptly changed course after office rents in lower Manhattan showed signs of spiking in late 1999 and early 2000. Data from Colliers ABR shows that Class-A asking rents hit $47 per sq. ft. in September 2000, their highest level on record. Swig also realized that a wave of residential conversions was helping thin the office inventory, making a renovated office building that much more attractive to tenants.
“The one thing I did correctly was to recognize that there was substantial upside in lower Manhattan. This shows that the residential conversions can only help the office market,” says Swig. He adds that even in the late 1990s, he was aware that a large residential population would be entering lower Manhattan.
After the renovation of 48 Wall Street was completed in 2000, Swig marketed the space to smaller firms seeking roughly 5,000 to 15,000 sq. ft.. The strategy took hold, and it's kept the building afloat ever since. Vacancy at 48 Wall Street stands at 2%. That's exceptional given lower Manhattan's 16% office vacancy rate.
Swig's fortunes may be tied to the future of lower Manhattan, but he appears anything but worried. He cites the creation of a large-scale transit hub in lower Manhattan, the creation of dozens of new parks, a thriving residential population and heavy tourist traffic as good omens. “When the transit hub is completed in three years, lower Manhattan will have the best train stations in Manhattan that will feed people into the area from all over. This isn't about what may happen in the future — it is happening now,” says Swig.
With office demand in the doldrums and 7 World Trade Center on the verge of delivering nearly 2 million sq. ft. to the market early next year, it appears that the future of residential real estate may be safer than office. After all, people are willing to live in lower Manhattan, but it's unclear if enough are that determined to relocate their staffs into this area. Some are even saying that lower Manhattan is better suited to develop into a residential neighborhood rather than hold onto its identity as an office concentration.
“The conversion trend will continue because residential is the highest and best use right now,” says Carl Schwartz, chairman of real estate at Manhattan-based law firm Herrick, Feinstein. Schwartz has represented several lower Manhattan developers seeking Liberty Bond financing for residential conversions.
“Office demand has stagnated over the past few months. This has become an accepted place to live, and you'll see more population growth down here over the next ten years.”
Parke Chapman is NREI's Senior Editor
New York - BY THE NUMBERS
POPULATION OF METRO AREA:
8.09 million
Source: Census Bureau
UNEMPLOYMENT RATE: 7%
Source: NY Dept. of Labor
LARGEST EMPLOYERS:
-
Columbia University
15,000 employees -
Merrill Lynch
15,000 employees -
Mount Sinai Medical Center
13,000 employees
METRO AREA VACANCY STATS Office:
6.8%, 2Q 2005
7.8%, 2Q 2004
Rent per sq. ft.: $42.14, 2Q 2005
Source: CoStar Group
Multifamily:
3.1%, 2Q 2005
3.2%, 2Q 2004
Average asking rent per unit: $2,316
Source: Reis Inc.
Retail:
6.0% 2Q 2005
6.2% 2Q 2004
Rent per sq. ft.: $100, 2Q 2005
Source: Marcus & Millichap
Industrial:
6.0% 2Q 2005
5.5% 2Q 2004
Rent per sq. ft.: $9.56/yr*, 2Q 2004
* triple-net basis
Source: CB Richard Ellis
Hotel:
81.7%, 2Q 2005
78.6%, 2Q 2004
$191.42, Average Daily Rate, 2Q 2005
Source: Smith Travel Research
MAJOR PROJECTS UNDER CONSTRUCTION:
7 World Trade Center, a 1.7 million sq. ft. office tower in lower Manhattan
Cost: $540 million
Developer: Silverstein Co.
Completion: January 2006
Anchor: none signed
New York Times Tower (620 Eighth Avenue), a 1.5 million sq. ft. office tower on the West Side of Manhattan
Cost: $850 million
Developer: Forest City Ratner Cos.
Completion: Summer 2006
Anchor: New York Times Co.
One Beacon Court (731 Lexington Avenue), a 1.8 million sq. ft. mixed-use tower in Midtown Manhattan
Cost: $630 million
Developer: Vornado Realty Trust
Completion: fall 2005
Anchor: Bloomberg
Defraying Expensive Conversion Costs
Converting office buildings into abodes may be popular, but it's not cheap. For one thing, office buildings typically house batches of shared bathrooms on each floor. Apartments require at least one bathroom per unit, plus a kitchen, and that's a serious plumbing project. Elevator shafts may also be re-routed, and large commercial lobbies might need to be reconfigured for residents rather than office workers. All of this work can add up to a small fortune, even before any units are sold or rented.
Investment sales broker Scott Latham, an executive managing director at New York-based Cushman & Wakefield, says the cost of converting a building from office to residential can run as high as $150 per sq. ft. By comparison, the same building could be upgraded as an office property for as little as $35 per sq. ft.
With government incentives reducing the cost of financing these conversions, however, many developers are spending far less than $150 per sq. ft. to convert these properties. Thousands of lower Manhattan rental units were financed by more than $1 billion worth of tax-exempt Liberty Bonds since the 9/11 attacks.
“There have been a fair amount of deals that didn't need Liberty Bond financing,” says Carl Schwartz, director of the real estate practice at New York-based law firm Herrick, Feinstein. Adds Schwartz: “That shows that many lenders are very positive about residential uses in lower Manhattan, too.”
— Parke Chapman