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Does Manhattan Office Space Face a Reckoning?

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Does Manhattan Office Space Face a Reckoning?

May 18, 2020

In every crisis we ask the question, for about five minutes, is New York finished? But this time could be different because the movement of office-based employees to working from home has created an uncertain outlook for Manhattan’s vast stock of office space. A recent New York Times article suggests that even as the emergency eases, companies will liberalize work-at-home restrictions, allowing employees to come into the office only part of the day, or on some days of the week. Employees that can work productively at home will be permitted to do so, traveling to the office only when it’s necessary for meetings. While in the office, they will be able to share work stations with people who come to work on different days. Businesses will be able to reduce their costly office “footprints,” taking advantage of remote-working technology to cut costs.

So far, so true.  Where the article errs is in viewing these changes as a cause for alarm. The article states that businesses allowing more workers to stay home “would affect an entire ecosystem, from transit to restaurants to shops. Not to mention the tax base.”  In reality, however, it's simply a continuation of a long-standing trend which has not had any such effects, and shouldn’t in the future.

Office-based businesses have long been cutting back on expensive space, as employees switched from offices to cubicles and space once devoted to storing paper files is no longer needed. The Times reported in 2015 that, according to the commercial real estate firm CoreNet Global, the average square feet of office space per worker in North America had dropped from 225 per worker in 2010 to 176 in 2012. The same firm reported that the average dropped further to 151 square feet in 2017. The trend was led by startups that were squeezing the amount of space they used in expensive cities like New York, by cutting down the size of workstations or by having employees work at long tables.

But while all of this was happening, Manhattan office vacancy rates went down and space became more, not less, expensive. By the third quarter of 2019, asking rents for the highest-quality Manhattan office space exceeded $100/square foot, and office vacancy rates were declining from already-low levels. 

In order to understand the future of commercial real estate we must draw a distinction between companies’ shrinking demand for office space per employee and the market’s demand for office space. Companies take advantage of technological improvements to cut costs and reduce the amount of office space each worker occupies. As they cut costs, they become more productive; that is, the amount of value each worker adds to the enterprise goes up. More productive firms can increase profits while expanding their market share by lowering the price they charge customers. These lower overall prices expand the market and existing businesses add employees. Because there are profits to be had, new businesses start up and office space remains strongly in demand even though the space per worker at individual firms goes down. 

This is exactly what happened in New York City. Annual average employment in Professional and Business Services, the largest category of office-using businesses, rose from 603,500 at the peak of the last business cycle in 2008 to 794,100 in 2019, the peak of the current cycle. These large job increases occured despite relatively small amounts of new construction over the past decade as compared to the existing stock of office space, and rising office rental prices, because existing space was used more intensively.

The linkage between business productivity and economic growth is what the Times article misses. Economists are familiar with the “lump-of-labor fallacy,” the idea that there is a fixed demand for work, so that, if workers become more productive, total employment must fall. (In fact, as workers become more productive, new kinds of work emerge to keep the labor force employed.)  The Times article invents a similar “lump-of-office-demand” fallacy, according to which if some big companies need less Manhattan office space, the space will just sit empty, and there will be fewer people to eat in restaurants or ride transit. 

These fears are misguided. New York is the nation’s largest and most diverse labor market. Businesses providing advanced services (the primary users of office space) want to be here because the highly qualified labor force is here, and the labor force remains because the businesses are here. It’s a virtuous circle that has served the city well for decades, and even with advances in technology, person-to-person interaction provides a strong attraction for locating a business in New York. If some big companies lease less space, there will be (for a time) more vacant space, and asking rents will fall to the point where it makes sense for other businesses to expand or new businesses to start up. More people, not fewer, will be working in Manhattan offices in the future, at least some of the time. This is how the economy grows.

Eric Kober is an adjunct fellow at the Manhattan Institute. He retired in 2017 as director of housing, economic and infrastructure planning at the New York City Department of City Planning.

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