Chris Balestra, President and Chief Investment Officer at Taconic Partners, joined the Real Estate Daily Beat for an interview. We discussed the implications of the hybrid work model, the life sciences sector, challenges in the affordable housing market, and other interesting topics.
Daily Beat: Many large companies announced plans to delay their return to the office to October because of the Delta variant. What are your thoughts on the future of the office sector and work from home trends?
Chris Balestra: In the long-term, I think companies will ultimately revert back to something closer to the previous norm. But until people take that first step back, tenants do not know what they're going to need space wise. We've been in this situation for too long now.
Our firm has been in the office for a while now with some flexibility, but you really need those big companies to come back, and see how they're using space. I don't think we're going to really know for another year or two.
Assuming that people do come back in greater quantities in the fall, there will be more clarity at that point as to what the long term really brings. Selfishly, as an office landlord, we're definitely betting on a more full return to work and that work from home doesn't work for everyone. It certainly doesn't work for our industry.
Daily Beat: One thing that frequently gets lost in this conversation is that the hybrid work model doesn’t necessarily mean less office space. Let’s take a firm that allows employees to work remotely one to two days per week. How much less space can those firms really get away with?
Chris Balestra: I think if you're looking at a 3-4 day per week scenario, I agree with you that it would be hard to operate with less space. People don’t like the touchdown desk scenario. In recent years – even pre-pandemic – we were moving away from those super tight office spaces. So that's why I think people really have to wait and see, but the collaboration that takes place within the office, even if it's three or four days a week, you still need the same sorts of spaces that we've had in the past.
People forget about the fact that employees are sometimes traveling on vacation and get sick. Even before Covid, everyone didn't come to the office five days a week necessarily anyway. You have to take that into account in the overall formula.
Daily Beat: Taconic has been active in the life sciences sector for a while now with projects like 125 West End Avenue and Hudson Research Center. The space is certainly heating up post-pandemic. What attracted you to the sector?
Chris Balestra: Life sciences is a sector that we're highly invested in and have a lot of faith in. Even pre pandemic – three or four years ago – we saw that interest in some early tenancies that we had at the Hudson Research Center and trying to understand the space and the needs of those tenants better.
The sector presents a crazy supply demand imbalance in New York City compared to other major cities with lots of life science space. A lot of it stems from having alternatives to build over the years like high price condos and other office space, which led to lab space not really being built.
New York has the medical research institutions and the funding and unfortunately a lot of the great ideas that happened in those institutions have been forced to leave to grow their businesses. It’s been our experience so far that if you can provide great lab space, tenants will rent it. As soon as we pre-build a space, tenants are leasing it and paying phenomenal rents. New York is currently that type of market and I think they're really happy with the product that we're creating.
Daily Beat: I’m always surprised by the lack of supply.
Chris Balestra: The space doesn't exist and these companies that are rapidly growing can't sit around and wait for a three-year conversion to get lab space. They have to move and be nimble. The other thing to note is that most NYCbuildings can't be converted. It's really hard to build new product given the land basis for most areas in the city.You have to find vacant assets that have floor loads that can handle it and ceiling heights that work, so that you can do the infrastructure projects that are required to attract the tenants. We've been successful in finding some of those opportunities and that's also why the sector can't quadruple overnight here because most assets aren't really capable without massive retrofits.
Daily Beat: Let's say you're looking at a new office development. How are you pricing the costs of a life sciences project on a square foot basis versus a traditional new Class A building?
Chris Balestra: The space building premium we apply compared to a new office development is probably 40%. And then the TI’s on top of that, which is probably 2x what traditional office leasing is today – perhaps even more depending on the location. So it's more expensive, but the rents are higher and they have to be justified. If you have a tenant that wants to stay in New York, you're getting into some fairly high rent premiums, but our thesis across the board is always about talent. New York attracts and retains talent and those companies want to grow here. That's what you've seen in the tech and banking sectors, and I think it's the same thing in the healthcare and the life science industry.
Daily Beat: What are some of the discrepancies between different types of lab space and how does that impact development?
Chris Balestra: Because the New York market is still maturing, our approach is to put in robust infrastructure at the base building level that can support a variety of different types of user needs. If they want to build their own space or they come to us early enough and can help design their space, we've got the infrastructure to accommodate it.
In a scenario where we pre-build space and aren't sure what type of tenant exactly might take it, we build the most flexible space possible where we can move the lab benches around. Modular construction is very helpful with that.
Daily Beat: What are you seeing in the affordable housing space? It’s obviously a very challenging political environment.
Chris Balestra: We try not to get too political, but the reason that a lot of the incentive programs were put into place initially was to incentivize developers to invest in properties. When the rent laws changed two years ago, it turned that upside down. You can't raise rents and there hasn't been a true acknowledgement that operating expenses are higher. In order to continue to improve properties, it takes rent.
So we hope that in the future – perhaps five to eights years – the pendulum will swing back a little bit. And at that point, the government will put some of those programs back into place to help incentivize the reinvestment into rent stabilized properties.
Daily Beat: The new 421-a program (Affordable Housing New York Program) is set to expire next year and many developers fear what happens next.
Chris Balestra: 421-a is a hot potato. Although it sounds politically great to not give tax incentives to developers, the reality in New York City is that with land, construction costs, and taxes so high – these residential buildings won't get built without them.
The unfortunate outcome is there won't be the affordable units delivered, in addition to the market rate units that come along with them. And then the only true affordable housing development will be based on more highly subsidized government funding through HPD and the state. But those projects won't be in the same places that those 421-a buildings would have been. So the policy is detracting from the overall creation of affordable housing and the general housing market.
Daily Beat: I think what many miss is that we aren’t operating on a fully capitalist playing field in the first place. With the high cost of land and taxes, the alternative is developers not building new affordable housing. The deals just don’t pencil out.
Chris Balestra: Exactly. If you look at the rent guidelines board increases, there was a small increase this year, but it's been basically nothing for years. And I'd love to find a building whose operational costs haven't gone up, but they don't exist.
We own 2,000 units in the Bronx where costs to operate the properties have risen. These buildings deserve to be improved, but landlords won't necessarily do that without the ability to raise rents as well, even on the margin.
Daily Beat: Do you have any WeWork or co-working exposure in the portfolio?
Chris Balestra: We do not. That's one thing that looking back we intentionally avoided. It wasn't because we don't think it's a trend that will stick around – it's certainly useful in certain settings, but we were skeptical of the crazy growth the sector went through and shied away from it.
Daily Beat: You guys recently did a deal with Trader Joes for a new grocery store at 121 West 125th Street in Harlem. Interestingly, the sector has remained strong despite secular headwinds in the broader retail sector. What are your thoughts on the future of the space?
Chris Balestra: Personally I like going to the grocery store and there are many people that like to shop for their own groceries. If you look at certain areas of New York City, they're very underserved by retail, including grocery. The first deal that we did with Trader Joe's was at Essex Crossing. There are hundreds of thousands of people who live right around that area without a real major grocery store.
If you find pockets of the city that are really underserved by retail, it can be very successful. If you look at 125th Street, there's a Whole Foods, but Trader Joe's goes well with it. In that area, there's enough demand to satisfy the additional need in grocery.
Daily Beat: Are you looking at the e-commerce / industrial sector at all for new acquisitions?
Chris Balestra: We're looking at deals in the industrial sector. It’s very intriguing and clearly has legs. Our team is looking at deals that would cater to the likes of Amazon and others that are more locally focused.
Daily Beat: Do you think developers are too focused on the larger industrial leases when last-mile delivery will necessitate micro-fulfillment centers?
Chris Balestra: We're still underserved from the logistics standpoint in the New York Metro area. That's what you still see those big leases getting signed. That's why development sites in New Jersey are so expensive, but I totally agree that the sector as a whole has a long way to go in the neighborhood level. It's probably not as efficient as it could be on the delivery side and I think that's why you're seeing even the likes of Amazon taking smaller spaces that they can bike delivery from. I think that as we adapt to the world that has overnight packages, there's going to have to be adaption in the city.
As an example, if you look at residential buildings, nobody designed package rooms to be warehouses. If you take a 400-unit residential building and everybody's got Amazon package or two showing up every day, you've got major problems. So I think the change in that sector in general is already having a ripple effect throughout other asset classes in the city.
If you're designing a new building today, you're doing it completely differently and there's probably room in the space to get your package picked up at somewhere local versus having it delivered right to your home and maybe that's cheaper.
Daily Beat: Where do you think is a better place to be in the office market right now? Smaller (5,000-10,000 SF tenants) or larger (100,000 SF) ones?
Chris Balestra: I think you're still going to play in all of it. We're definitely seeing a much greater increase in tenant traffic and deals on the smaller side. I think that the big tenants will come out of the shadows soon enough. But I think that goes back to one of our earlier discussion points of getting back to the office.
Those big guys who either have a little bit of term left or who maybe did some shorter term extensions, I think they're just reluctant today to make long-term large space decisions without fully knowing how they're going to continue to use their space. Maybe they use the space no differently than they do today, but they don't know yet because their workforce isn't here.
So today, if you have smaller tenant type space available, you're probably very happy about that. If you have truly unique product for larger tenants, you have seen some of those deals get done, but I think you're going to see a pickup in the larger tenant space three to twelve months after everybody actually gets back to the office.
Daily Beat: Congrats on your recent promotion!
Chris Balestra: Thanks Joe. I joined Taconic back in 2005. I started my career at M&T bank as a commercial real estate lender. I was an econ major and knew I wanted to try to work for a bank and kind of fell into the real estate side of it and really enjoyed it.
The other thing that I figured out pretty quickly into my tenure at the bank was that it seemed like a lot more fun and more interesting to be on the developer and operator side. I left the bank in 2005 and then started at Taconic, which at the time was really just a handful of people – maybe less than 10. We've grown tremendously over those years and I think that today we're closer to 50 people in our office.
I came in as an analyst and worked my way up to CIO a couple of years ago, and then the recent promotion this year. Some of that I'd like to think was skill and some of it's a little bit lucky because most people in order to move up off have to go somewhere else with people in the way. Being at a smaller, entrepreneurial company to start and that has grown over the years, gave me the opportunity to be able to step up as I was ready, so I'm fortunate in that way.
Daily Beat: And I’m glad the firm enjoys our premium newsletter!
Chris Balestra: It’s one of the first emails I read every day. I've been a reader for a few years and when you converted to premium content, we signed up because it’s a great synthesis of the real estate world and very helpful.
*The interview has been edited and condensed for clarity.