Bulls in the office market are about as common on Wall Street as oysters in the desert, owing to the rise of hybrid work and higher interest rates. But in a new report Morgan Stanley, which has $4 billion in exposure to office loans, took a walk on the sunny side of the street. Its thesis: Because new development is all but impossible, existing buildings will become more valuable and the best will gradually fill up again.
“The amount of new supply hitting the market will begin to fall over the next several years,” the report from real estate analyst Ronald Kamdem read, “which would be a positive development for existing higher quality office space.”
To that end, Morgan Stanley upgraded shares in Vornado Realty Trust to “equal weight” — which means buy, but in sensible quantity — from “underweight,” which effectively means sell. Vornado shares have fallen 36% over the last two years, compared to 22% for SL Green, due to a 17% drop in core funds from operations that ranks among the largest in the business. Vornado declined to comment.
However, Morgan Stanley thinks better times are ahead because Vornado is delivering renovated space in buildings that, while not new, are considerably improved. They include Penn 2, the former 2 Penn Plaza. Madison Square Garden leases corporate space in the tower and Morgan Stanley said “we would expect” its rent to jump by 40%, to about $105 per square foot. The bank also said Vornado has had success filling about half the largest spaces soon to be vacated across its large portfolio, which includes 1290 Sixth Ave. and the Farley Office Building.
Vornado’s retail portfolio has rebounded, the bank said, and a building or two might be “opportunistically” sold to pay off debt or raise cash. Office development is off the table at the Hotel Pennsylvania site unless an anchor tenant emerges, but Morgan Stanley said the space “could potentially become a residential play,” meaning an apartment tower.
It’s a similar story for Boston Properties, which owns the General Motors Building and would like to build a 900,000 square foot tower at 343 Madison Ave. to go toe-to-toe with JPMorgan’s new supertall. But the developer won’t develop unless bottom floors are pre-leased at prices exceeding $200 per square foot, Morgan Stanley said.
That’s a tough sell when so much quality space is already available. Office vacancy rates fell along Park Avenue last year but rose elsewhere in Midtown, including on Sixth Avenue, Times Square, along Third and Fifth avenues, Morgan Stanley said. Kastle Systems data shows return-to-office in New York has plateaued; other sources, including banks with lots of skin in the game, tell a more encouraging story.
What’s for sure costs are sure to rise in the months and perhaps years ahead for Manhattan landlords, because mortgages written when interest rates were will have to be refinanced at higher rates. For that reason alone, Morgan Stanley’s enthusiasm for office is actually pretty muted.
“We would need to see more progress on asset sales or lender negotiations before turning more constructive,” Kamdem said.
Aaron Elstein , 2024-03-29 18:46:58
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