Westchester Office Leasing Activity Improves in Third Quarter; Industrial, Multifamily Sectors Remain Strong

Real Estate In-Depth | October 2020

The Westchester County office market is “experiencing the inevitable friction that comes with economic turmoil and above average unemployment.”

 

RYE BROOK—Despite impacts of COVID-19, office leasing activity in Westchester County improved in the third quarter as New York City companies look to relocate or establish new offices in the county, according to the Houlihan Lawrence Third Quarter Commercial Market Report for Westchester County.

Meanwhile, the report showed demand remains strong for industrial space and the inventory of multi-family under construction continues at a high level. The report also noted that the retail sector continues to struggle and investors are sitting on the sidelines for the near term.

The following are some of the highlights of the Houlihan Lawrence Third Quarter report:

Westchester Office Vacancy Trends Upwards Intensifying Adaptation

Office space released to the market in the third quarter hit a high as vacancy increased 1.5% according to COSTAR. Space was made available in the both the direct and sublet markets with close to a quarter of the availability coming in the form of sublets.

Despite these headwinds, leasing activity improved during the third quarter, the Houlihan Lawrence report stated. Leasing deals doubled and inquiries from New York City businesses relocating or establishing a new beachhead in Westchester are increasing.

“In the office sector we are experiencing the inevitable friction that comes with economic turmoil and above average unemployment. New office tenants are looking for possibilities in Westchester, however, their search is hesitant, and many are seeking shorter term commitments because economic trends are so uncertain.,” the report stated. Landlords are demonstrating flexibility, trying to mitigate vacancies and maintain the vibrancy of their office buildings. In smaller, B and C buildings, some potential tenants, still leery of elevators, are voicing a preference for ground and first floors, where use of stairs is possible.

Large building owners, especially those catering to national clients and commanding top market rents, continue to focus on ways to monitor indoor air quality and HVAC systems. The CDC has recommended a meaningful increase in fresh air circulation, but many HVAC systems are not designed to heat, cool and filter large amounts of fresh air. Increases in air recirculation are costly as the air needs to be treated to adjust to desired internal conditions. In addition, new air filtration systems may need to be installed to ensure desired air quality outcomes.

New approaches in purchasing electricity and energy contracts may be helpful in controlling heating and cooling costs but, indisputably, office landlords are facing higher operating costs, related to COVID-19, at a time that cash flows are likely at risk from rising vacancies, the report conclude.

Industrial Space Continues to be in High Demand

Industrial real estate continues to outpace other property sectors. The sustained rise of e-commerce boosted by the COVID-19 pandemic has accelerated consumption trends that rely on last mile distribution.

Consumers are increasingly comfortable with on-line fulfillment of an ever-increasing array of products. This acceptance is partly driven by constraints created by COVID and by inventory shortages that many retailers are experiencing.

The breakdown of retail channels and distribution chains is, however, creating friction in the tenancy of Westchester industrial assets, the Houlihan Lawrence report noted. Occupancy and rents remain stable. Some industrial space has been released into the market and leasing deals have declined. This segment of the market has not been immune to the pandemic, but the strong underlying demand is expected to help with absorption of available space that may come to market, as long as the space is priced appropriately. Westchester industrial vacancies have remained under 4% during 2020 and we expect this healthy environment to continue for the foreseeable future.

The Nuts and Bolts: Westchester’s Multifamily Plateaus

Effective rents for multifamily rental units in Westchester appear to have settled at a healthy level, in line with the last four quarters. This represents a stellar performance in the face of COVID-19 headwinds. In contrast, New York City’s residential rent reductions are widespread with the luxury product suffering the most.

In Westchester, multifamily occupancy weakened by approximately 1%, however, the brokerage firm stated that it would not be surprised to see vacancy to trend modestly higher as the economic headwinds persist. Newer units, targeted to millennials and commanding top-of-market per square foot rents, appear vulnerable in the near term.

Inventory of units under construction remains at a high level, with an equivalent of 6.3% of the current multifamily stock under construction according to COSTAR data. New deliveries over the next few months may face lower traffic and steeper competition as established projects will also be seeking to maintain their occupancy. However, weaker demand in Westchester multifamily may not materialize. There is an observable trend of households leaving the urban core of New York City and seeking more space. A rental apartment in Westchester may be the obvious choice for some of them, the report concluded.

Construction costs have continued to escalate higher, and the pandemic is fueling additional increases by raising havoc in production lines and raw material supply chains. Raising costs and weakening demand are likely to result in new projects being delayed or permanently shelved. The market will have to absorb delivery of projects already started and the pricing environment will reflect new demand dynamics.

Retail Vacancies Statistics and Observable Offerings

Retail vacancy statistics continue to be behind the observable retail space offerings so prominent at the street level all across the county. Many well-established retail brands, such as Soul Cycle and California Pizza, among others, have closed shop in Westchester locations where they had built a very successful client following and had established businesses. COVID-19’s impact has been most severe in restaurants, sit-down food chains and physical fitness business and all of these have been important tenants for Westchester’s retail landscape. Many long-time restauranteurs appear to be discouraged and their business are now for sale, along with the real estate.

COSTAR data suggests that retail vacancies have trended upwards and the square footage of space offered increased during the quarter. Pricing appears stable—for now. Leasing deals have been at low levels, a reflection of the market uncertainty. Among the many hurdles that the current retail leasing environment presents is that “plug and play” site opportunities are difficult to find, and hefty customization costs can only be justified and financed if the tenants and landlords have confidence in the business and a long-term horizon. Those horizons are not visible from here as the nation and world wait for a vaccine to tackle COVID-19.

Uncertain Cash Flows Impact Investor Appetite in the Near Term

Tenant’s businesses are in flux and near-term uncertainty is keeping investors on the sidelines. Underwriting asset values is nearly impossible when cash flows are uncertain. Houlihan Lawrence said it is no surprise that owner occupiers are leading property purchases—as these buyers can be more confident in their own business. This temporary pause in investor activity will subside and pent-up investor demand will be unleashed as stretched property owners begin to sell, the brokerage firm predicted.

Credit markets are functioning relatively well, but debt providers are, for the time being, avoiding retail and hospitality assets. In general, transaction volume is at low levels, in Westchester and other regions of the U.S. Median transaction prices have held up in Westchester, but pricing trends will not become crystal clear until there is some rebound in transaction volumes.