The commercial real estate market in Manhattan has demonstrated its resiliency over the past 3 years by staving off a recession, overcoming the impact of terrorist attacks in 2001 and avoiding sweeping job losses. In fact, throughout the down cycle, office vacancies in New York remained in far better shape than the national average for central business districts. And while vacancies did rise significantly, relative to the late 1990s, the investment sales market stayed strong and set records for prices achieved. All the while, the retail market remained attractive to both domestic and international retailers.

OFFICE

After Manhattan vacancies leveled off and held steady for the last three quarters in 2003 at 12.5 percent, vacancies fell to 12.2 percent at the end of the first quarter 2004, led by the strongest new leasing activity in more than 2 years and a significant reduction in sublease space throughout Manhattan. This is the most significant demonstration of Manhattan’s resiliency, and the clearest sign to date that the office market is recovering and even improving. Overall vacancies declined 0.1 percent from the end of the first quarter of 2003 to first quarter 2004.

The improvements can be attributed to an improving economy and a perceived bottom in the market from prospective tenants. There has been moderate economic growth from a variety of industry sectors. Add that to an equation in New York City where a tremendous opportunity exists in the sublease market, and it becomes clear that decision-makers are using a positive economic outlook to take advantage of sublease opportunities while they can.

New leasing activity for the first quarter of 2004, which represented the most square footage leased during any 3-month period over the last 2 years, totaled 7.7 million square feet compared to 5.8 million square feet during the first quarter of 2003. Leasing has been led by legal, financial services, accounting and insurance firms.

The most significant vacancy declines continued to occur in the sublease market. Overall sublease vacancies declined to 3.1 percent at the end of the first quarter of 2004, from 4.1 at the end of first quarter 2003. Some of the biggest factors in the recovery have been a reduction in sublease space availabilities and improved business confidence and profitability, which have in turn resulted in significant gains in leasing activity.

In 2001, sublease space comprised 37 percent of all available space in Manhattan and as much as 45 percent of all available space Downtown. It now represents 25 percent of available space in Manhattan and only 18 percent Downtown. Major sublease transactions closed this year have included PricewaterhouseCoopers for 789,248 square feet at 300 Madison Avenue, Cadwalader Wickersham & Taft for 364,742 square feet at One World Financial Center, and Kramer Levin Naftalis & Frankel for 231,395 square feet at 1177 Avenue of the Americas.

For the quarter ending March 31, all three Manhattan markets experienced declines in overall vacancy rates. Downtown’s vacancy decline was most significant, falling from 13.5 percent to 12.9 percent. Midtown South dropped from 13.3 percent to 13 percent, and Midtown declined from 11.9 percent to 11.8 percent.

The average asking rental rate continued to decline in Manhattan overall, to $40.06 per square foot at the end of the quarter from $40.53 at the end of 2003, due largely to a significant decline in Downtown Manhattan’s rents. Downtown rents dropped from $36.92 per square foot to an average of $33.68 during the quarter. Rents in Midtown and Midtown South experienced increases, from $30.37 per square foot to $31.04 in Midtown South, and from $45.37 to $45.61 in Midtown — helping further to fuel the perception that the market has bottomed.

One important caveat to keep in mind is that the increase in leasing activity was due in part to a significant number of large leasing transactions in the first quarter that had been in the works since 2003.

In addition to the large subleases mentioned for PricewaterhouseCoopers, Cadwalader Wickersham & Taft and Kramer Levin Naftalis & Frankel, other large transactions included Fairchild Publications at 750 Third Avenue (234,006 square feet), Gulf Insurance at One State Street Plaza (108,120 square feet) and Morgan & Finnegan at Three World Financial Center (104,226 square feet).

INVESTMENT SALES

On the investment side of the market, available product is limited but investor appetite remains voracious. A premium is being paid for well-stabilized class-A buildings where average prices are now approaching $400 per square foot.

Almost $10 billion in investment sales activity occurred in Manhattan in 2003, driven mainly by historic lows in interest rates and aggressive loan-to-value ratios. The pace has continued so far in 2004. Even incremental interest rate increases, which are projected for sometime in 2004, are not expected to hold back demand as the prospects for improvements in the leasing market are starting to take shape.

Another area of interest in the investment sales market, particularly in Lower Manhattan, is the growing number of office building purchases made with the intention for residential conversions.

Completed conversions downtown in 2003 totaled approximately 500,000 square feet and other buildings slated for conversion Downtown total more than 2 million square feet. Almost 5,500 residential units have been completed with another 15,000 scheduled to be completed by 2008.

As more older office inventory is removed from the market and is converted to residential, several important things will happen. Vacancy rates will be kept in check. Newer, more efficient office space will be developed and have better prospects for leasing. And the area will move towards a more sustainable 24/7 community, which is necessary for the long-term vibrancy of the Downtown office market.

In addition to demand for existing product, real estate developers are busy implementing plans for new projects in Manhattan. In 2004 alone, the market is expected to add 4.3 million square feet of new office inventory. The properties, some completed and some expected to be completed by year’s end, include Times Square Tower at 7 Times Square, Columbus Center, 731 Lexington Avenue and 300 Madison. Even this new delivery of office inventory has not tipped the vacancy forecast scales into negative territory. The reason is because of a substantial amount of pre-leasing. Of the four projects just mentioned, nearly 75 percent of the space is pre-leased. An additional 25 percent of that space is close to being leased within the next quarter.

That’s a strong start for these projects. Given the lack of new, large blocks of available space, and overall economic improvement, the market is expected to handle the added inventory. On the horizon, new projects expected to be completed over the next few years include 8 Times Square, One Bryant Park, Seven World Trade Center and 959 Eighth Avenue. These buildings will constitute about 6 million square feet, of which about half is already pre-leased.

RETAIL

Another segment of the market that has continued to have its hot spots is retail real estate. New York City is home to the “retail capital of the world,” 57th Street and Fifth Avenue, where retailers take on the most expensive rents anywhere in the world in order to have a presence.

This allure is a major factor in New York City’s continued retail success. While the luxury market continues to remain strong from both domestic and international retailers, one of the biggest new trends is the proliferation of retail bank branches throughout Manhattan.

In a race to aggregate assets, every corner of Manhattan retail space has been deemed a prime location for banks. In fact, even some luxury brands are closing their doors and making room for banks. Rolls-Royce, for one, recently relocated a Madison Avenue location where banking powerhouse Wachovia is about to open a large branch.

Another trend, with perhaps more potentially significant implications for the long term, is the entrance of big box retailers into the Manhattan market. The Home Depot has announced plans for multiple locations, and its anticipated success has many retail brokerage professionals expecting leasing activity and interest from other big boxes in Manhattan and the other boroughs.

If this trend materializes, it will mean much larger retail leases, and retail space will play a much more significant role in Manhattan’s buildings from an investment perspective, as landlords make room to accommodate the needs of the larger retailers.

Ken Krasnow is executive managing director and New York area leader with Cushman & Wakefield.

NYC Apartment Investment Market Remains Hot Prior to 2001, apartment concessions were unheard of in Manhattan. Now, however, concessions are prevalent throughout the borough. Effective rents are currently 4.5 percent below asking rents, as compared with 4.8 percent nationwide, 4.1 percent in Los Angeles and 4.6 percent in both Washington, D.C., and Philadelphia. Within Manhattan, concessions are highest in Midtown West, where new construction has been centered over the past few years and vacancy has increased as a result. Building managers in more-established neighborhoods where construction has been limited, such as Stuyvesant and the West Village, are holding the line on concessions. Owners can expect concessions to persist into 2005. Over the next 12 to 24 months, however, rental market fundamentals will recover as job creation accelerates and interest rates rise, putting a damper on new construction and the flight to homeownership. Manhattan’s apartment fundamentals will register limited improvement in 2004 as a result of a recent buildup in construction and lackluster employment growth. While developers will complete 3,190 units in 2004, a 20 percent decline from the previous year and the lowest total in many years, there is still a high number of vacant units on the market. Half of the new units coming on line will be in the Midtown West submarket. This area is attractive to investors due to high rents and burgeoning employment growth as financial firms, such as Lehman Brothers, relocate from the Wall Street financial district. Vacancy in Manhattan will inch up 20 basis points to reach 4.7 percent by year-end 2004. While this level is considerably lower than the national mean of 6.7 percent, it is high by Manhattan standards, where vacancy averaged 1.8 percent for two decades prior to 2001. Since then, employment loss and a fervent tempo of construction have pushed vacancy rates to new heights. We expect vacancy to remain relatively flat for at least the foreseeable future. At an average of $2,900 per month, Manhattan’s asking rents are the highest in the country. Average asking rents on the Upper West Side are more than $3,400 and are nearly $3,100 on the Upper East Side. Morningside Heights/Washington Heights is the only submarket in the city with rents below $2,700. New York rents are still below what they were in 2000 and 2001. Citywide, effective rents are now 4.5 percent less than asking rents. The offering of concessions is an unusual scenario and very different from the late 1990s when they were rarely, if ever, given. The value of concessions in Midtown West and the Upper East Side has now reached 1 month to 2 months of free rent. Strong investor demand will continue to support price appreciation in the Manhattan apartment market. The median price per unit increased 9 percent, to $119,000, in 2003, surpassing peaks last seen in 2000. Values are projected to rise another 5 percent to 8 percent in 2004. Sellers are taking advantage of strong demand due to current low interest rates to engage in profit taking. Investors who already own apartment properties tend to purchase additional multifamily units in Manhattan. Small to medium-sized properties in prime locations are expected to continue posting cap rates at or below 6.5 percent. — Mitchell R. LaBar is a managing director at Marcus & Millichap and regional manager of the firm’s Northeast operations.

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