2023 Real Estate Review: Office landlords feel the pinch

Tue, Jan 9th 2024 01:52pm

Jacob Tierney
Buffalo Business First

Buffalo Business First

Businesses are fleeing sprawling offices, and experts say the market has plenty of room to fall before it hits bottom. You don’t have to look far to see how the shrinking market for office space has affected Western New York.

“The list goes on, and on and on and on,” said Robert Schell, president of Cushman & Wakefield/Pyramid Brokerage Co. “Every significant office building in town either has vacancy or space for sublease.”

The most dramatic example is the HIghmark Blue Cross Blue Shield building at 257 W. Genesee St., a 440,000-square-foot structure that will be completely vacant next year once Highmark completes its move to 100,000 square feet at Seneca One. There are many smaller examples, and local real estate experts agree the fall is far from finished.

“We’re hoping a lot of leasing gets done in the next few months, but we’re not optimistic,” said Kyle Ciminelli, executive vice president of Ciminelli Real Estate Corp. “We have not yet bottomed out. The reason for that is there are still companies with leases that are going to expire in the next few years that are likely to be rightsizing.”

Exact measurements of office vacancy rates vary. Newmark Ciminelli — Ciminelli Real Estate’s brokerage business — estimated city vacancy rates at about 12% as of the second quarter. CBRE Upstate NY’s estimate is similar. Pyramid Brokerage’s estimate is significantly higher, at 17% in the third quarter. Pyramid’s estimate includes vacant subleased space. It’s been clear since the pandemic that people’s attitudes toward office work have changed, with hybrid schedules and work-from-home options becoming far more common. However, experts weren’t sure how long this shift would last. Now, they expect reduced demand for office space will last for years.

“We’re just starting,” said Sarah Cashimere-Warren, licensed real estate salesperson with CBRE Upstate NY. “Last year was the first year we saw the effect of Covid on the numbers.”

Musical chairs

Despite the downsizing trend, there have been some notable local outliers. Fidelis Care recently left an 88,000-square-foot space at 3920 Main St., Amherst, but Charter Communications will fill that space. Odoo acquired seven mostly vacant floors at 40 Fountain Plaza downtown for $2 from the state, and pledged to bring 350 full-time employees to the space over the next five years.

Cashimere-Warren said she’s still seeing plenty of activity on the office real estate market, though it’s mostly from tenants seeking smaller space. Tenants are really just shifting from one space to another,” she said. “I think we’ll see a lot of reflective downsizing or rightsizing.” Once the dust settles, there likely will be many large office spaces left looking for tenants. “Anything over 10,000 square feet gets pretty tough in our market, because our bread and butter is that 3,000 to 5,000 square-foot user,” Cashimere-Warren said.

Most market activity involves existing companies shuffling their space. It would take new companies bringing large numbers of employees into the region to fill all open space in Western New York, she said. Other than Odoo, there are few signs of that happening.

Flight to quality

As businesses decide they need less space, many have grown increasingly willing to shell out more per square foot for extra perks such as more amenities and a prime location, Schell said. “People, especially the younger generation, don’t want to go into some old, beat-up circa-1980 space,” he said.

He cited M&T Bank as an example. The company this year decided to pull out of suburban offices to focus on its core downtown properties. It’s recently invested heavily in creating two tech hubs at Seneca One and 465 Main St. — trendy workspaces with plenty of amenities to lure young workers back to the office. “It has to do with location, it has to do with amenities, it has to do with quality of the buildout,” Schell said.

All office properties have taken a hit, but Class A buildings, those with the best amenities, have lower vacancy rates than their Class B counterparts. Not every landlord can afford a top-of-the-line office building, and even if they could, there’s still more space available than demand to fill it. “The endgame is, I think there’s going to be a flight to quality, and the landlords stuck in the middle are going to have to evaluate what they do with the space,” he said.

Getting creative

So what’s a landlord to do? Get creative, Ciminelli said. He predicts office space will play a smaller role in the local real estate market for the foreseeable future, particularly in downtown Buffalo. “It’s got to be a small piece of a big puzzle,” he said. “Even if we fill a lot of these buildings with office tenants downtown, remember a lot of these companies only have employees coming in two or three days a week.”

For a landlord who owns a Class B building that has partial vacancy and retains steady tenants, it might be worth investing in improvements, Ciminelli said. For those facing near-total vacancy, a complete change of use may be the wiser option. “That’s where this region needs to get creative,” Ciminelli said.

In other cities, office-to-residential conversions have been popular, and suburban offices have been converted to research and development spaces. Ciminelli Real Estate is considering several residential conversions, though nothing the company is ready to announce, Ciminelli said. Finding the money to make these renovations happen won’t be easy.

“We were anticipating interest rates were going to change by now, and they haven’t,” Ciminelli said. He said government incentives may be necessary to spur the extensive renovations necessary to make Buffalo’s real estate meet demands of the changing economy.

Western New York’s office vacancy rates weren’t particularly rosy before the pandemic. Schell said it could take a decade or more before the oversupply of office space works itself out. Landlords should expect difficult years ahead, he said. “There’s still a lot of vacancy there that companies are paying rent on until their lease expires,” he said. “Once those leases expire, and once landlords start feeling the pain, that’s when they’re really going to see it.”

A Moody Analytics Inc. report showed that 76% of commercial mortgage-backed securities loans for office buildings maturing in 2024 are at high risk of not being able to refinance.

Schell expects some will be unable to pay their mortgages, and foreclosures could be coming. “My guess is people will be handing the keys back to the bank,” he said.