Houlihan Lawrence Q1 2023 Commercial Report - Westchester County

Writer: Teresa Marziano, Real Estate Salesperson

Executive Summary

The business community is experiencing a waiting game. The most anticipated recession in half a century is expected to arrive any day. Yet, for commercial real estate owners in Westchester, there is an eerie feeling of disparity between the tangible energy present in the local markets and the anxiety of realizing that inflation headwinds are not yet subsiding, and higher interest rates will impact economic activity and real estate valuations. The fragility experienced by certain middle market banks in recent weeks and the inevitability of more restrictive lending have added to the sobering economic landscape that commercial real estate owners are now facing.

Despite headwinds and a cloudy economic picture, the feared visitor may never arrive. Should health in the labor markets persist and be able to coexist with declining inflation, a recession may be averted. This would give commercial real estate owners time to adapt to a more challenging financing environment.

Private sector hiring rose during March underscoring the still strong employment environment. Financial activities and business services lost positions while leisure and hospitality continued to add jobs. New jobs were evenly split between goods producing activities and services. The wider employment measure compiled by the Bureau of Labor Statistics (BLS) confirmed that March hiring was strong and nonfarm payrolls increased by 236,000 positions. The unemployment rate declined to 3.5% and labor participation increased, suggesting that workers on the sidelines are seeking and finding jobs. Robust employment continues to delay a widely expected economic slowdown.

The Purchasing Managers Index (PMI) published in the first week of April indicates that the economy is indeed losing strength. Inflation, although sticky in some areas, is responding to the steep rise in interest rates over the last twelve months. The manufacturing PMI for March was 46.3 indicating a contraction in activity. The services PMI, at 51.6, has declined meaningfully over the last month, but still indicates an expansion in the service economy. Prices paid, reported along PMIs suggest the battle against inflation is bearing fruit, albeit at a slow pace. A contraction in both PMI indices would signal a deepening slowdown and it appears that this outcome may be hard to avoid given the restrictive environment created by higher interest rates.

The recent collapse of Silicon Valley Bank (SVB) and other banking failures had a particularly negative impact on the value of publicly traded banks and REITs (commercial real estate companies structured as real estate investment trusts). The message, from investors, is that lack of confidence in the banking system, and financial intermediation, is immediately detrimental for those segments of the economy that rely on leverage. Equally, lack of confidence in regional banks is also detrimental for a myriad of small to medium size companiesfrom all industries- that value and rely on services that regional banks can uniquely provide. Despite decisive action taken by the US Treasury and Federal Reserve to restore confidence in the banking system, regional banks will face higher funding costs for a period, and commercial real estate owners will find it more difficult to obtain lending from their local banks.

Overall, a decline in lending activity is never good for growth. A tighter lending environment, exacerbated by greater caution from financial institutions and non-bank lenders, is still playing out in the local economies. Winners will be investors with cash resources, patience and a savvy understanding of real estate and financial markets.

OFFICES FACE CHALLENGES

Nationwide, office buildings continue to face occupancy challenges rooted in hybrid work. Technology companies have been more lenient toward employee demands for flexibility, but financial companies continue to try to lure employees back to the office in a meaningful way. JP Morgan, for example, has resorted to a blank mandate for Managing Directors. They are now expected in the office five days per week. We will see if this announcement by JPM results in a wave of similar actions by other companies and good compliance by employees. The mandate underscores how difficult it has been to return to “pre-covid ways” when it comes to office attendance.

Data reported by Costar indicates that in Q1, Westchester office vacancies inched upwards as supply demand was unfavorable. Pricing has held up after a steep drop in the previous quarter. Sublet space has shed occupancy and leasing activity is down in terms of square footage. It appears that deals have been concentrated in small footprint spaces. In Westchester, Class A buildings tend to be well occupied and rising vacancies mainly impact Class B and C offices. Yet, high vacancies have a negative impact on net pricing across the entire stock of buildings in proximate geographies. Longer term, some of the smaller obsolete office buildings in Westchester could be candidates for re-positioning. The speed and efficacy of such a process will depend on municipal zoning authorities, availability of risk capital and asset pricing that is attractive enough to encourage developers to engage in a relatively high risk development project.

RETAIL ATTEMPTS A REBOUND

After two challenging quarters, Westchester retail shops saw an uptick in demand during Q1. Supply-demand balance was favorable and occupancy rate increased by 0.3%, a nice improvement after a six-month period of occupancy declines. New retail square footage was delivered to the market primarily at the ground level of new multifamily developments. Retail demand was strong enough to absorb this square footage and, at the same time, cause an increase in the occupancy rate. Pricing was slightly weaker as landlords were more flexible and sought to lock-in deals even if at a slight discount.

The influx of households into Westchester, during and after the Pandemic, has created incremental demand for services and an incentive for entrepreneurs and well-established companies to “follow” those households. New retailers are seeking to establish a beachhead in the area, and successful companies are increasing their already existing footprint. This trend is encouraging for retail landlords in Westchester and for the local economy.

INDUSTRIAL OCCUPANCY WEAKENS BUT RENTS REMAIN STABLE

Industrial space in Westchester has not been immune to the economic volatility that we are experiencing. Vacancies have increased, but pricing has remained remarkably stable. We anticipate industrial fundamentals will remain robust, despite inevitable occupancy fluctuations that reflect tenant turnover in a turbulent economy. In addition, refurbishment of dated space creates an artificial “vacancy” as such space remains in the available inventory data despite being unavailable due to renovations. Overall, supportive trends such as online purchases and rapid fulfillment of orders bode well for the continued expansion of industrial demand.

WESTCHESTER TRANSACTION AT LOW LEVELS

Investment sales transaction volumes declined as uncertainty related to asset valuation and the path of interest rates continues. Reduced lending availability, after the bank turmoil of recent weeks, will likely impact transaction funding and we expect to see further declines in investment sales volumes over the next couple of quarters. Median prices held firm suggesting that no deeply distressed sales took place during the quarter.

HOULIHAN LAWRENCE COMMERCIAL TEAM

During an economic slowdown, interesting commercial real estate investment opportunities may become available. In addition, during times when liquidity is restricted, poorly capitalized owners seek to sell. During such times, there are numerous market and economic risks that add to the complexities of acquiring commercial real estate. Understanding the market forces that are shaping the fundamentals for each property, requires a deep knowledge of the property, local and regional insights, and close contacts with the right financial partners. Our Team is highly skilled in all these areas.

Reach out to HOULIHAN LAWRENCE COMMERCIAL for a complementary assessment of your real estate, an evaluation of a purchase target, and to receive an in-depth perspective on the dynamic Westchester commercial real estate market.

Unemployment Rate in Westchester – Below Pre-Pandemic levels

WESTCHESTER’S RATE OF UNEMPLOYMENT CONTINUES TO REACH NEW LOWS

Westchester’s rate of unemployment is at the lowest level of recent history.

Sources: COSTAR, Trepp, US. Bureau of Labor Statistics, Unemployment Westchester County (Not Seasonally Adjusted) , NY. Real Estate Employees Data is Seasonally Adjusted. All data retrieved from FRED, Federal Reserve Bank of St. Louis; April 2023

Multifamily Projects Resilient Even as New Unit Delivery Continues

WESTCHESTER, SOUTH OF I- ���

Rents and occupancy rebounded during Q1 even though the economy is slowing.

Developers were confident enough to add units to the pipeline of new apartments. Westchester offers an attractive lifestyle and value proposition for apartment dwellers, compared to NYC.

STRONG OCCUPANCY AND RESILIENT PRICING FOR WESTCHESTER APARTMENTS

Sources: COSTAR, Trepp, US Bureau of Labor Statistics, Data Reflects Fundamentals for Westchester County Area South of I-287. Price Index for Westchester retrieved from FRED, Federal Reserve Bank of St. Louis; April 2023 HOULIHANLAWRENCE.COM/COMMERCIAL

Westchester Office and Retail – Office Departures Accelerate, Retail Fundamentals Rebound

SOUTH OF I- ���

Office rental pricing has stabilized at a lower-level while occupancy continues to decline.

Demand for retail shops has seen a rebound and rents are holding steady

Sources: COSTAR, Trepp, US Bureau of Labor Statistics, Data Reflects Fundamentals for Westchester County Area South of I-287. Price Index for Westchester retrieved from FRED, Federal Reserve Bank of St. Louis; April 2023

Industrial Properties – Stable Pricing despite some occupancy volatility

SOUTH OF I- ���

Industrial space data suggests that supply-demand fundamentals - occupancy and asking rents - will continue to be favorable

Sources: COSTAR, Trepp, US Bureau of Labor Statistics, Data Reflects Fundamentals for Westchester County Area South of I-287. Price Index for Westchester retrieved from FRED, Federal Reserve Bank of St. Louis; April 2023

Investment Activity Weakens as Price Discovery Becomes Difficult

SOUTH OF I- ���

Investment sales weakened meaningfully during the Quarter, but median transaction prices rebounded modestly.

Going forward, headwinds from higher financing rates and a slowing economy will continue, and we expect transaction volume to remain subdued. MEDIAN

Sources: COSTAR, Trepp, US Bureau of Labor Statistics, Data Reflects Fundamentals for Westchester County Area South of I-287. Price Index for Westchester retrieved from FRED, Federal Reserve Bank of St. Louis; April 2023