MARKET HIGHLIGHT, DECEMBER 2005

NEW YORK CITY MARKET HIGHLIGHT

New York City Retail Market

Back in the mid-1990s, when many bank branches were closing and national retailers looked to take over locations left empty by the banks, all it took was patience for the right space to come along. A spate of bank mergers and attendant branch consolidations created a surfeit of vacant ground floors that were promptly snapped up by high-gloss retailers and theme restaurants. Typical was Chemical Bank, which gobbled up Manufacturers Hanover, and within the same 12-month period, Chase Manhattan. Assuming the Chase brand name, Chemical then shuttered 34 of the consolidated branches, prompting rival Citibank to close some of its smaller units in a cost-cutting move.

Now, a decade and 10-year lease later, the banking establishment is roaring back to meet the demand for consumer financial services. They covet the space they willingly abandoned in the 1990s, this time competing with such new upstarts as Seattle-based Washington Mutual, New Jersey-based Commerce Bank, Long Island's North Fork and Valley National and San Francisco's First Republic as well as comparatively tiny City & Suburban, Independence and the behemoth Bank of America (nee Boston's Fleet).

Naturally, they all want prime vacant retail corners, both in Midtown and in residential neighborhoods. Competition is so keen that mid-block locations, never before considered, are now seriously in play. Two banks are currently competing for a 3,300-square-foot mid-block space at one of MHP Retail Services' agencies (16 West 46th Street).

Interestingly, banks are not only competing against each other, they have the wherewithal to edge out well-heeled national retail chains and specialty shops coveting the same spaces. What landlord would pass on the prospect of a bank tenant that will pay upwards of $300 per square foot, about $100 more than a retailer? And it isn't just about money. Isn't a staid, if somewhat sterile, banking image preferable to a street-level display of baubles, bangles and boots in a Class A residential or office tower? As choices go, even when the rent dollars match, its a no-brainer.

It is not only banks that are responsible for fueling the momentum of escalating rents. With supply diminishing and demand increasing, brand-conscious retailers with strong balance sheets are willing to pay 20 percent occupancy costs-to-sales ratio, to launch a flagship store in New York.

According to the Real Estate Board of New York (REBNY), in the Spring of 2003, rents on prime retail strips like 34th Street between Fifth and Sixth avenues jumped to $299 per square foot, up 82 percent from the year before, West 42nd Street between Sixth and Eighth avenues surged 54 percent to $243 per square foot for the same period, and in the Third Avenue corridor between 60th and 72nd streets, the median rent increased 17 percent to $326 per square foot.

It is well-documented that New York rental rates are the highest in the world, with East 57th Street being the top of the heap, and no signs of leveling off in sight. In 2001, according to a survey by Cushman & Wakefield, annual asking rents averaged $700 per square foot. Today it is $1,000 per square foot. Current average asking rents for the Fifth Avenue corridor north of 50th Street (still in second place) in the last 5 years have risen from $560 per square foot to $800 per square foot, and the luxury corridor of Madison Avenue between 57th and 72nd streets has increased from $520 to more than $700 per square foot. Overall average asking rents, for all space in all areas of Manhattan have increased 6 percent, to $103 per square foot since last year, according to REBNY's retail report. The west side saw a 14 percent average increase to $127 per square foot, the east side, a 4 percent average increase to $160 per square foot, and downtown, the average asking rent rose 14 percent, to $82 per square foot.

Some chains like Gap are downsizing, and others are exploring alternative markets like NoHo, The Fashion District, Chelsea, and the Meatpacking District, which have attracted Madison Avenue-type tenants like Stella McCartney, Carlos Mieli, and Diane von Furstenberg, and the rising rents reflect how rapidly retail space is being absorbed.

SoHo has almost recaptured pre-9/11 rents, with designers like Kate Spade, Reis, Mexx and Intermix opening on Wooster, Spring and Broome streets. Broadway, which is SoHo's main street and is anchored by Crate & Barrel, H&M and Bloomingdale's, has more than rebounded. From Houston Street to Broome Street the median asking rent rose 46 percent to $226 per square foot.

Lower Manhattan has benefited significantly from the leasing activity uptown. Retailers like DSW with large space requirements, have settled into affordable spaces. Recovery will be accelerated further when the Port Authority unveils its redevelopment plans for the World Trade Center site and General Growth reveals its plans for South Street Seaport development.

Soaring rents and low interest rates have spurred increased interest in retail condominiums. Europeans, who are accustomed to “buying the walls” are seriously exploring purchasing property for their own retail use. In February 2003 LVMH acquired the former Warner Bros. Studio Store at One East 57th Street for Louis Vuitton, one of its top brands. Custo Barcelona recently closed on 240 Columbus Avenue, a residential building with a 1,500 square foot store, and Valley National Bank operates nine bank-owned branches in Manhattan and is aggressively pursuing additional condominium sites.

In all sectors, the New York real estate market appears to be in excellent health. Demand is strong and growing in the commercial sector and retail activity is brisk. Residential sales prices have never been higher, although there is evidence of a softening in the top sector of the market.

Though there are clouds on the national economic horizon — the looming deficit, inflation, the war in Iraq, the high cost of energy, rebuilding the Gulf coast after Katrina and Rita — New York has proven it has the resiliency and energy to counter a downturn in the economy.

We're back to banks — it's 2006 and a new cycle has begun.

— Alyne Model is an executive managing director of MHP Retail Services.

New York City Industrial Market

New York's evolving industrial real estate sector continues to remain viable, even as it shifts to meet the changing demands of the market and adjusts to recent zoning changes that may remove a considerable amount of the current supply.

Recently enacted zoning changes in the Williamsburg and Greenpoint sections of Brooklyn have resulted in the conversion of a significant amount of industrial space for residential use. However, rather than hurt the market, these changes have made East Williamsburg more viable for industrial users, as well as creating increased demand for spaces within long-established industrial complexes such as the Brooklyn Army Terminal and Bush Terminal in Brooklyn. Within these self-contained industrial communities, small-user tenants seek the advantages of networking and gaining new business from their industrial neighbors. In addition, space expansion and contraction is relatively easy at these locations. Enterprising tenants have boosted occupancy at the metro industrial terminals to above 90 percent.

This shifting of availability has also attracted industrial tenants to the East New York and Bedford-Stuyvesant areas of Brooklyn, as well as Maspeth and Long Island City in Queens, and various areas of The Bronx, including Hunts Point and Port Morris. Still other areas within the Outer Boroughs will be considered for re-zoning for industrial use, simply because these tenants have nowhere else to go.

The Asian population has become the backbone of this sector, especially among smaller, antiquated buildings that are being used by a variety of small companies, particularly in service-related industries.

Multi-story buildings with large floorplates such as the Falci Building in Long Island City are attracting formerly Manhattan-based companies priced out of that market and attracted to the lower production costs, tax benefits and other incentives being offered in the Outer Boroughs.

Investors seeking industrial properties for acquisition are investigating opportunities in the Outer Boroughs, in communities across the Hudson River, and in western Nassau County within areas that are on the verge of gentrification. For example, southern Newark is an up-and-coming industrial zone. Investors with excellent local market knowledge have capitalized on Newark's recently approved plans for a new sports arena for the N.J. Devils. Conversely, these investors have fled inner city areas that have already become gentrified because of unrealistically high prices. An example of this is Downtown Brooklyn, where Forest City Ratner is finalizing plans for multiple mixed-use towers anchored by a new sports arena for the Nets. As an alternative to Downtown Brooklyn, industrial buyers are looking at neighborhoods like East New York and Brownsville.

The adaptive re-use of existing industrial inventory, combined with emerging communities embracing light manufacturing, warehouse and distribution users forced out of other areas, continue to change the face of New York City's industrial real estate market.

— Neil A. Dolgin is principal and partner of Kalmon Dolgin Affiliates.

New York City Multifamily Market

The New York real estate market appears to be normalizing as mortgage interests rise and sale prices remain steady. Apartments take a longer time to sell in the market but are still in demand. Government reports show that there is a 35 percent increase in the average number of units within new developments. The prospect of large profits and significant return on investments has attracted many new developers to make their mark within this market. For instance, developments on Astor Place sell at $2,000 per square foot.

There has been a rise in residential condominium conversions over the past 18 months. The number of condominiums hitting the market has steadily increased since 2000 and continues to climb. To build condominiums, developers pay higher and higher prices for parcels of land or convert office spaces and existing buildings. Though these conversions are prevalent throughout New York City, certain areas such as Wall Street, Lower East Side, Upper West Side Harlem and Brooklyn have been more active. Condominium buyers are attracted by the promise of luxury in the world's premier city. Trendier amenities within units include floor-to-ceiling windows, gyms, roof deck pools, private gardens, and even wine storage and stainless steel appliances.

The average sale price of a Manhattan condominium in October 2005 ranges from $1,000 to $2,000 per square foot. Since sale prices remain high, more foreign than local buyers seem to buy condos because they see the purchase as an investment opportunity. Prices for large apartment units have decreased by 15 percent to 20 percent. However, prices for studios and smaller apartment units have increased by 13 percent to 15 percent. Last quarter's reports indicate that local buyers unable to afford condos or large apartments now focus on acquiring small apartments.

Development projects follow suit as they construct small apartment buildings to accommodate this need for affordable housing. Non-traditional areas are restored and offer alternative solutions for families. Manhattan's Lower East Side and Wall Street; and Brooklyn's Dumbo and Greenpoint are a few examples. As always, timing and evaluating trend shifts are crucial in this market. Developers may need to assess whether profits generated from condominium sales would offset the purchase price and construction costs. At this point, condominium sales still offer high yields.

— Roni Abudi is a broker with GFI Realty Services.

New York City Office Market

The strength of Manhattan's office market in 2005 has been both welcomed and potentially very misleading. Vacancy factors have decreased and rentals have increased throughout Manhattan this year.

The continuous strength of the market's staying power is questionable. Law firms and hedge funds have led the upsurge of leasing in the high end of Midtown space. Undoubtedly every major law firm in the United States is now represented in Manhattan either by opening an office, or via a merger with a New York City firm. The increasing size of older hedge funds and the ease of raising substantial amounts of money by new funds have increased the upward pressure on rentals in the prime buildings. The “blowup” of several small hedge funds together with the dwindling return that most funds are currently earning will act as a damper on the ease with which new funds will be able to commence operations with unbelievable sums of money and will result in less expansion space being leased by this industry.

The Class A office market has an average asking rental of $54.50 per square foot and a vacancy factor of 7.1 percent, which is down from 8.7 percent at the beginning of the year.

The average asking rental for all classes of available space in Manhattan is $40.53 per square foot and the overall vacancy rate is 7.6 percent, which is a reduction from 9.3 percent at the beginning of the year.

At a time when many investors are paying what appears to be outlandish prices for buildings, many in the real estate industry are dispensing the conventional wisdom that the market is not only going to continue this moderate strength but that rents will increase at an accelerated rate in the coming year.

If you believe in dreams rather than reality, one may well come to this assumption. Reality often deals bluntly with assumptions. Perhaps it is too much to expect realistic thinking since the market has seen a long period of exceptionally low interest rates together with a very low rate of inflation. This economic period is rapidly coming to a conclusion.

One must be a visionary with an eye on the future to understand the implications of change. Put bluntly, I expect the Federal Reserve to continue pushing up short-term rates to a level well above the rate that many economists are projecting, which will cause an upsurge in long-term rates. This measure, together with a substantial uptick in the inflation rate means there is no denying that the compelling evidence, which you cannot be impervious to, is the probability of a slowing of the rental market, and that a return to past sizzling markets is not in the offing.

Apparently it has not occurred to many that from time immemorial rising interest rates together with an increase in inflation — and now adding in a drastic increase in the cost of oil — will slow economic growth. The staying power of today's market strength is questionable at best.

I anticipate a slight rise in rentals in 2006 at best and there is no denying that there is a distinct possibility of economic factors working in enough of a negative fashion to weigh heavily on the market causing a downturn.

— Stuart Lilien is an executive vice president with Lansco Corporation/CORFAC International.


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