Return to Office: Rob Martin on the Present and Future State of Commercial Real Estate

As a Vice Chairman of JLL, Rob Martin’s experience as a commercial real estate broker, advisor, and strategist has helped hundreds of clients sell, lease, and buy commercial spaces across New York City.

I had the chance to chat with Rob, an LP in Primary, on the upcoming trends of the office market in New York, the long-tail impact of WeWork across the city, and why leveraging climate tech to make smart, sustainable buildings is emerging as an exciting opportunity for building owners.

What the heck is going on in the office market today?

From a leasing perspective, there's a lot of uncertainty from tenants and occupiers trying to figure out the economy. Are we going into a recession or not? When there's uncertainty, it's never good for the office market. People will delay decisions. It's already had a significant impact on leasing activities, because leasing activity for the first quarter this year was down significantly. It's going to be probably down for the foreseeable future until there is some certainty on the direction of the economy. I've been doing this for almost 40 years. I can tell you that when there's uncertainty, there's lower leasing activity. That’s why the office market is tough right now, with vacancy rates in New York and other cities approaching highs.

The amount of sublet space on the market compared to direct space is also approaching all-time highs. Typically, when the amount of sublet space goes over 20% of all space on the market, you see pressure on pricing. And net effective rents—rents that back out concessions, tenant improvement allowance, and free rent—often drop too. And that's what's going on now. It's a tough time for everybody, but in tough times, I think that’s often the best time to take advantage of an opportunity, go out there, create great relationships, and add a lot of value for your clients.

Are the challenges across the board? It seems like the Class A spaces, like Hudson Yards, are still getting pretty good rent at the top end of the market.

The top end of the market is the one bright spot. People are paying record rents for high quality, best-of-the-best spaces. But we’re always going to find winners and losers.

Now, from a capital markets perspective, interest rates have obviously had a significant, negative impact on real estate values. Valuations are down. There’s a lot of restock. Vornado, for example, is close to 52 weeks of lows—25 years of gains wiped out. For a lot of these building owners, if the first evaluations are down and they have to refinance in the near-term, they’ll have to put up more equity just to keep it. They’re not able to borrow what they were able to borrow before.

Banks are also not lending as much. They're a little more cautious because it's hard to figure out what the valuations are based on what their buildings are renting for. If they can't peg the rents, they don't know the certainty of where rents will be, which tells them the value of the building. That means people aren't selling buildings, and the volume of available buildings to buy is significantly down.

So should people be buying now, or is there concern that they might be catching a falling knife?

For me, the big concern about the office market is what the next driver for job growth will be. We’ve had tech, which has grown significantly in New York. But there have also been a lot of tech layoffs. And while FANG stocks are back—Facebook, Amazon, Netflix, and Google—valuations are down significantly for a lot of other private companies and some public ones. They're looking to cut their burn rate to survive and increase their runway. They're not buying spaces and growing as much as they once were. Law firms are using space more efficiently today than they have in the past. Financial service firms, obviously private equity and venture capital, have only been leading a very small percentage of the market. So the question remains: what is that next industry that will grow and lead the comeback of the office market?

As it relates to catching a falling knife, I think of a couple things. One, when interest rates come down at some point, real estate valuations will pick up again. So if you have a long-term horizon and you believe in certain cities, buying now means you can't ever hit the bottom. Even if you try to hit the bottom, you'll actually buy a depressed asset. You hope that you have a long-term horizon that will make a lot of money.

Office conversion is a big topic, but it requires significant capital expenditures in order to convert an office to something else (i.e., multi-family apartments). Those owners might end up taking a harder hit because building prices are going to have to come down even more for the economics of those conversions to even make sense.

Well, there are certain buildings that work well for conversion and others that don't. You have to look at it on a building-by-building basis. Then you have to ask what you’re converting it to. Will it be hospitality, residential, or some other use? You look at what and where the demand is. Right now, there is a lot of demand for hotels in New York. But what is the cost to convert a building from an office to a hotel? Is it cost prohibitive, or can you buy it at such a price that it makes economic sense?

The same thing goes for residential. What happened in Lower Manhattan is interesting. Over the years, we’ve had a lot of downtown buildings converted from office to residential. Some of those buildings had no value as an office building. That was the perfect site for conversion.

Let's talk about NYC prices. What is the cost these days of really high end, Class A office space? And what is that compared to the small startups renting in, say, Union Square?

Well, there are some good quality buildings in Union Square. But I would say a new product today can go anywhere from 150 to 250 dollars per RSF depending upon where you want to be. For example, smaller spaces on higher floors in 425 Park and One Vanderbilt are the ones seeing the highest rents--not because of their size, but because they’re up in the tapered part of the towers. The tenants are betting on getting people back in the office, because these spaces have great light, great air, great amenities, and all the bells and whistles to attract them back.

I haven't heard a lot of conversation on the demand for space artificially influenced by the growth of WeWork. During those three or four years, WeWork literally had an insatiable appetite for space. And because they had an insatiable appetite, it had an impact on rent growth. We had tenants compete for space just south of Midtown. Rent went from 40 dollars a foot to 60 dollars a foot. The valuation of those buildings went well north of a thousand dollars a foot, and a lot of them traded. All of a sudden, WeWork and all these sort of flexible office space providers sort of took a more cautious approach. I wonder what would happen to office market stats if we took out the WeWork impact. Would they have performed so well?

So you're saying we can blame WeWork for helping create the bubble in both the startup and the real estate markets in New York City?

The flex office space provider just had an insatiable appetite for space.

It's an interesting point because not only did WeWork scoop up a ton of product, but there were still a lot of companies that didn’t want space. He was forcing prices up in his own product. It shot up the remaining part of the total available market in the city.

Yep, exactly. No one's really talking about it.

Is it taboo to have that point of view? Back in WeWork’s heyday, none of my friends in real estate thought positively about WeWork.

JLL came out years ago and said that 30% of all space should be flexible. You can manage growth and loss in a single building quickly instead of locking yourself into long-term leases. But for WeWork, the economy shifted, interest rates went up, venture capital dried up, and startups stopped growing. So all the things that were growing flipped on them.

What advice would you provide to an owner in a situation where they're looking down the barrel and imagining handing back the keys back to their building? What can they do to avoid that unfortunate reality?

Every situation is different, but if they're facing handing the keys back, it's probably because either they don't want to have to put up additional equity, or, they're unable to refinance. We might not be able to help that person. But for the person that is not there yet, and, say, maturing at some point in the next couple years, they could reduce their cost of operating the building before then. They could also attract tenants with property technology to improve the experience. This can be focused on making an efficient building, reducing costs, focusing on clean air, and providing a better and accessible workspace environment.

Let's talk about energy for a second. Do owners actually care? Or will the upcoming laws in New York make them move the needle and change?

Oh yes, they care. They need to reduce their carbon footprint. One of my clients literally runs all of their HVAC systems and infrastructure on electricity now. A lot of landlords are facing negative consequences soon if they don’t do something soon. That’s why climate tech is hot right now in property technology. Building sustainable offices is a huge opportunity. If you can find a way to reduce costs for landlords, reduce time for tenants, and make their experience more enjoyable, you’re in good shape.

With your job as Vice Chairman at JLL, are you making technology-based recommendations to owners thinking about reducing their operating costs?

We always think about technology. I mean, I think JLL's CEO went on record saying that JLL is a technology company in the real estate services business. We even have an internal group called JLL Technologies that invests in technology solutions.

If you look at the life cycle of a real estate transaction, there are three main phases: the planning phase, the transacting phase, and the managing phase. We have technology for all different phases of that process no matter what asset class it is. So for instance, let’s say you're in that first phase of, “What should I do?” Whether it's a needs assessment, a location analysis, or where to place distribution centers and your headquarters, we’ve built technology around that. How much space do you need? What is it going to cost you? What's going to work? What if you want to have a hybrid work environment to have a work environment? We have technology to help people and companies make these decisions.

And then in the managing phase, whether you want to manage your lease portfolio and make rental payments, proactively engage your portfolio, or measure where your lease is versus the market, we have the bright technology to think through these decisions. If I'm having a meeting with a potential prospect or new client, there's typically a follow-up with a separate technology demo. It’s often just to figure out how technology can help them in some way. It happens a lot more today than it did three or four years ago.

We end up in an advisory role to figure out how we can add value, whether it's helping companies streamline decision making or helping them look at their portfolio to save money. That's been a big change to really viewing us as your trusted advisor, like you do with a lawyer or an accountant. We're not just here when you need a transaction, but we're here all the time. You have to provide value and answer questions.

What do you believe is going to happen regarding the return to work at this point in time?

There's definitely a positive trend of getting people back to the office more frequently. I've never seen something like today where employees have so much power. Will we head to a full five-day week environment, or even a four-day week environment? I definitely think it's going to eventually come back.

Have you seen any use cases for generative AI in real estate that are popping off the page for you?

Not at the moment, but I do think the best ideas will improve processes that take multiple steps and a long period of time like invoicing, accounts payable, and accounts receivable. I’m thinking of some app for business development where they’re looking to find out who might be looking to grow their office space. You could use LinkedIn and figure out how to get connected, or look at lease documents. Could AI negotiate a lease and not have to spend that much money on lawyers? We need a brainstorming session to go through this. But yes, there will definitely be some applications.