For the past 14 months, news outlets have been gripped by Amazon.com Inc.’s (Amazon) selection process for its second headquarters (HQ2). For cities in the running, the prospect of a major tech company like Amazon expanding into their areas would mean a significant economic boost with analysts forecasting as many as 50,000 new jobs and $3.0 billion in new wages following the company’s expansion, according to Morgan Stanley. In addition, Amazon reportedly planned to bring a total of $5.0 billion in investments into the local economy for the city of its choosing. After a massive campaign that began in September 2017, including 238 proposals from cities and regions including 54 states, provinces, districts and territories, Amazon decided to split HQ2 between two locations: Long Island City, New York, and Crystal City, Virginia. These locations are expected to be affected by improvements in vacancy rates, development prospects and overall real estate fundamentals for the foreseeable future. DBRS, Inc. (DBRS) is already monitoring assets backing loans included in its rated commercial mortgage-backed securities (CMBS) transactions to determine immediate effects of Amazon’s expansion.
When Amazon announced its plans to take root in Long Island City, CMBS implications were immediate. The company reportedly signed for space at One Court Square, which backs a $315.0 million pari passu loan with pieces securitized in the DBRS-rated Wells Fargo Commercial Mortgage Trust 2015-NXS3 transaction as well as the non DBRS-rated Wells Fargo Commercial Mortgage Trust 2015-NXS4, Wells Fargo Commercial Mortgage Trust 2016-NXS5 and Citigroup Commercial Mortgage Trust 2016-P3 transactions. One Court Square is a 1.4 million-square foot (sf ) Class A office building that is fully leased to Citibank Inc. (Citi) on a lease through May 2020; however, Citi recently announced plans to vacate approximately 1.0 million sf at lease expiration and expects to move 1,100 employees out of the building by Q2 2019. The property’s appeal to Amazon is no surprise with its prominent structure, standing at 52 stories — the tallest building in New York State outside Manhattan. One Court Square is one of 22 Class A office properties within the Long Island City submarket with a superior location within one block of five public parking garages and direct access to One Court station, part of the New York City subway system, beneath the building.
Amazon is expected to fill the 1.0 million sf to be vacated by Citi over two phases. The first phase will involve the initial move into 500,000 sf (35.7% of the net rentable area (NRA)) to accommodate the company’s initial hiring efforts while the second phase will include the construction of the corporate campus, slated to house 25,000 employees in the New York area once complete. That property will be located approximately one mile west of One Court Square on the East River waterfront. Ultimately, the HQ2 footprint in New York will include the development, construction and renovation of approximately 4.0 million sf, resulting in the creation of 25,000 new jobs with an average annual wage over $150,000 by November 2028. The company is also forecasting additional expansion plans for a total of 6.0 million to 8.0 million sf of commercial space as well as the creation of up to 40,000 additional jobs prior to November 2033.
DBRS has been monitoring One Court Square since Citi’s announcement earlier this year that it planned to vacate; however, as noted in the loan commentary on the DBRS Viewpoint platform, the loan and property benefit from a booming market with significant population growth and development in the area over the past few years as well as preferred equity and common equity positions of $200 million and $65 million, respectively, for the loan sponsors at issuance.
The office market dynamics have been in a recent downward trend with an overall 15.7% vacancy rate and 21.1% availability rate, according to a Q3 2018 CoStar Group (CoStar) report. Class A office product has been driving higher vacancy and availability rates as these properties feature a 21.1% vacancy rate and 34.7% availability rate with a negative net-absorption trend. Submarket vacancy increased in Q3 2018 when over 90,000 sf of the Falchi Building became vacant. Furthermore, the rising vacancy rate can also be attributed to the number of former warehouses that were converted into creative office space as nearly 500,000 sf of new office supply has been delivered since YE2013. Two large developments, known as One Jackson and Three Jackson, encompassing 1.1 million sf are scheduled to be delivered to the submarket in January 2019, which will be located less than one mile northeast of One Court Square. CoStar projects that the vacancy rate will decrease down to 13.7% at YE2022, slightly above the five-year average of 9.7% as these properties are absorbed.
Long Island City has experienced a multifamily development boom with over 11,000 units delivered since 2010, according to CoStar, as a result of its affordability and close proximity to Manhattan. Vacancy rates have varied from 2.4% to 6.6% since 2013 with a five-year average of 4.5% and average rents increasing almost 15% in that time. CoStar projects that over 5,600 additional units will be delivered prior to YE2022 with vacancy increasing to 7.5%. The additional supply will primarily feature Class A properties that will command top-tier rents; however, projected average rents of $3,668 per unit at YE2022 will still be less than average rents across the river in the Upper East Side, Upper West Side, West Village/Downtown and Midtown West submarkets.
Resulting from demand pressure within the submarket, industrial properties have been demolished or repurposed as existing inventory was viewed as obsolete. In several cases, the developable land was worth more than the industrial improvements, which has led to over one million sf of industrial supply permanently taken offline since YE2013. The decreased supply has resulted in compressed vacancy rates with a current vacancy rate of 5.2%, according to a Q3 2018 CoStar report. CoStar forecasts two large industrial developments (encompassing 250,000 sf ) to be completed by January 2019 and the industrial stock to increase 9.1% by YE2022. Overall, vacancy rates are expected to hover around 6.0% and rents are projected to increase almost 8.0% by YE2022.
The area’s desirability and functionality are expected to drastically improve with the Amazon development package’s new amenities, set to be delivered in exchange for significant tax incentives offered to Amazon as part of the deal. Amazon is required to develop a primary/intermediate public school, 149,650 sf of total public open space and 25,000 sf of community facility use/artist workspace.
Given the high number of employees to be hired by the company as well as the need for a well-connected geographic location, it is not surprising that Amazon chose very high-density areas like those surrounding Long Island City and Crystal City, both of which offer young, educated population bases from which the company can draw. DBRS anticipates continued demolishing or repurposing of existing commercial real estate (CRE) properties as Amazon HQ2 is constructed. Amazon will also redevelop several underutilized areas within the Long Island City submarket, which will then be opened to the community for public use. The proposed development plans will fuel the continuous growth of Long Island City and benefit a majority of CRE owners for generations to come.
(All figures are in U.S. dollars unless otherwise noted)
A copy of this report is available on the DBRS website or by contacting info@dbrs.com.
Stephanie Hughes 