Optimists have been suggesting that despite ongoing weakness in residential and commercial property markets around the country, values in New York would be relatively unaffected.
On the face of it, that seemed ridiculous. Even though there has likely been some buying/leasing interest by foreigners on the back of a slip-sliding dollar, the City's fortunes nonetheless remain closely tied to those of the financial services industry.
Given the writedowns and upheavals that have been occurring lately, is it any surprise, then, that things are beginning to ease up in the Big Apple? In "Large Firms Start to Dump Office Space," Crain's New York Business gives us the latest.
Rise in sublease market could lead to lower rents; tenants cautious
As the economy cools, tenants are starting to shed Manhattan office space—a development that could lead to lower rents and signify the end of the robust leasing market that landlords have enjoyed over the past few years.
The amount of space represents only a fraction of the 350 million-square-foot market. But the activity is causing a stir in real estate circles, because some fear that what is now a trickle could turn into a flood. Ominous indicators of a possible recession—such as imploding hedge funds, faltering investment banks and wild stock market gyrations—lead some to believe that increasing amounts of space will hit the market in coming months.
"There is absolutely more space out there now," says Mark S. Friedman, a vice chairman at GVA Williams. "[And] we are [only] on the 20-yard line. We've got 80 more to go. Everyone sees what is going on in the economy. You can't ignore it."
Rents have fallen during previous recessions, and Mr. Friedman thinks they will drop 15% by early next year—factoring in tenant concessions, which have already become more popular. A decline in rents would fly in the face of the conventional wisdom that a lack of inventory in the real estate market will enable landlords to keep lease prices steady.
The supply-and-demand ratio still favors landlords, so rents remain high. But that could change as more space comes on the market.
The Royal Bank of Scotland is ready to market about 140,000 square feet at 7 World Trade Center that it inherited when it bought ABN Amro.
Troubled financial firms, including Citigroup, iStar Financial and Bear Stearns, are preparing to unload about 610,000 square feet. Earlier this month, Lehman Brothers announced that it is laying off 5% of its global workforce, and real estate brokers speculate that it will soon dump 400,000 square feet of space. A Lehman spokesman wouldn't comment.
Another factor adding inventory to the market is the completion of new buildings. Goldman Sachs is preparing to sublease about 500,000 square feet at 77 Water St. that it won't need when it moves into its new world headquarters next year. Bank of America is expected to shed a significant portion of the roughly 500,000 square feet it has at 114 W. 47th St. once its new tower opens.
Market still strong
However, New York remains a landlord's market. The vacancy rate in February was 5.8%. A lack of space drove rents up 29% in the 12 months ended in February, to an average of $66.95 a square foot in Manhattan, according to Cushman & Wakefield Inc. And leasing activity remains brisk.
Experts say there is a balance between supply and demand when the vacancy rate is 8%. To spur a surge of sublease space, experts say, companies would have to eliminate about 40,000 jobs. In the 2001-02 recession, about 187,000 jobs were lost in Manhattan.
Some brokers are speculating that the market is already slipping. Deals take months to close; some of the recent leases now being reported actually originated last year. Financial firms, which account for one-third of the leases in Manhattan and which have been driving up rents, are beginning to relinquish space as the economy weakens. Some brokers say that their phones are ringing less often, and that tenants are skittish about committing to space.
Tenants reluctant
Landlords are already sweetening deals to entice tenants. GVA says that in January, landlords in midtown were offering three to six months of free rent, up from zero to six months a year earlier. Construction allowances rose to between $40 and $50 per square foot, from $35 to $45 a year before.
But tenants aren't necessarily taking the bait.
"Many tenants that do not have a compelling reason to make a leasing decision are putting off such decisions," says Bill Montana, a managing director at Studley. "They are concerned that the market may fall, and they do not want to sign new leases now if they suspect the market might be turning in their favor."
It is still unclear what rents the space coming on the market will fetch. Subleased space is typically less expensive than offices rented directly. This can put enormous pressure on direct leases, driving prices down.
However, some landlords have strict policies putting limits on subleases. For example, sources say, leases at 7 WTC have firm rules that would prevent a tenant from subleasing space at rents lower than those the building's landlord is asking. That's critical for 7 WTC, since it still has 10 stories to lease, and three and a half more floors from RBS are now coming on the market.
Dire economic predictions have caused some prospective tenants to have unrealistic expectations about where rents might go, brokers say.
Ben Friedland represents numerous hedge funds, which he has placed in trophy properties such as 512 Fifth Ave. Lately, Mr. Friedland, a senior vice president at CB Richard Ellis Inc., says he is getting calls from prospective tenants asking to sublease space in such buildings for $90 a square foot, whereas rents are typically around $125 a square foot. He says space in such buildings is tight, and rents remain steady.
"Rents haven't fallen in these buildings, at least not yet," Mr. Friedland says.
(Hat tap to Prudentbear.com)
New York City is far more dependent on financial firms for its economic survival today than it was in early 1970's. Gone are companies like Shell Oil, Texaco, Mobil and Exxon. As the financial business contracts, there will be more office space to rent, more high paying jobs eliminated, more vacant stores etc. I remember when Olympia and York was able to become the largest commercial landlord in Manhattan around 1977 for a rather modest sum of money, $320 million, less than the current value of the Bear Stearns building in Manhattan. The mid-1970's recession and the city's insolvency were very bad for the local real estate market.
Posted by: rocky | March 16, 2008 at 10:11 PM
At the end of February I wrote about the Manhattan residential real estate market, which is beginning to show signs of weakness. It looks like overseas interest in Manhattan properties is starting to cool as well.
"Tide Turning On Manhattan Real Estate?"
http://www.boom2bust.com/2008/02/27/tide-turning-on-manhattan-real-estate/
Posted by: Boom2Bust.com | March 17, 2008 at 10:04 AM