Real Estate According to New York Times

¶ … Real Estate

According to New York Times reporter Leslie Eaton, the Sept. 11 terrorist attacks "inflicted deep and lasting wounds on New York City's already-teetering economy; devastated both big companies and small businesses in and around twin towers; brought business across city to halt for days, weeks and in some cases months, slashing workers' earnings and tax revenues alike; made many employers determined to spread their workers over wider swath of geography, which has ominous implications for Manhattan."

As a result of Sept. 11, an enormous amount of space was added to the market and there was a short-term damaging effect on the U.S. economy. U.S. businesses suddenly became resistant to change or expansion and surviving World Trade Center businesses had no place to go.

The terrorist attacks took 13.5 million square feet of office space from the market indefinitely and temporarily removed an additional 12.1 million square feet. New York City's commercial real estate market was in a state of chaos for months as reality sunk in and displaced tenants scrambled to find new space. Still, despite the plethora of lost space, the market did not tighten. Instead, New York bounced back.

An estimated 10.1 million square feet was offered on the sublease market within three months of the attack, as companies who had too much space realized that they could easily attract tenants who had lost their space. By the fourth quarter of 2001, despite the huge hole in the market, vacancy rates in New York's downtown area shot up to nearly 14%, with net absorption rates in the red and rental rates showing significant decreases.

The Aftermath

Over a year after the attacks, according to NY Times reporter John Holusha, "the underlying fundamentals of the commercial real estate market in Manhattan are behaving in the mirror image of expected patterns."

The overall pace of activity still looks soft," the New York bank reported in the "beige book," which is the Federal Reserve's periodic assessment of economic conditions around the country. "Real estate markets continue to cool off, and there is downward pressure on goods and service prices." (Eaton)

One of the main reasons for the continued downturn in New York's commercial real estate market is the enormous cutbacks by leading financial companies. In addition to the shrinkage of the dot-com and telecommunications companies in size, financial companies are rapidly downsizing, as well.

As the workforces grow smaller and smaller, so does the need for office space. As a result, companies are placing massive amounts of sublease space on the market at discounted rates, contributing to the depression of rental rates in New York.

According to Holusha's article, brokerage Julien J. Studley reports that the average asking rent for prime buildings in Midtown has fallen to an average of $67.55 per square foot opposed to $75.48 per square foot before Sept. 11. In addition, landlords are competing for tenants; often lowering rents to as much as $60 per square foot.

Traditionally, high occupancy levels and low rental rates create a chain effect with property values in the area. These factors are the backbone of cash flows that underwrite the value of properties. Therefore, if occupancy is high and rents are low, sale prices will decline, as well.

However, Sept. 11's effect on the overall economy has made the commercial real estate market an unpredictable phenomenon. Investors pulled their money out of stocks and looked to new investment vehicles. Real estate offers a comparatively safe and stable option for investment, so investors have been buying New York buildings. This means that Manhattan real estate is selling at record prices.

Boston Properties, a real estate investment trust, recently paid $1.06 billion, or $630 a square foot, for an office building at 399 Park Avenue -- a decision that real estate experts say is example of the exceptional demand for Manhattan properties.

Still, the commercial real estate rental market is not expected to recover until the majority of the sublease space is absorbed and the leasing market resumes normalcy. Experts say this may occur sometime next year.

Holusha's article quotes Stephen B. Siegel, chairman of Insignia/ESG, the brokerage and services company as saying: "The wave of sublet space creates uncertainty about rents because 75% of it has no asking price."

Sublet space is a good alternative for companies that do not want to make a large capital expenditure in uncertain economic times, due to the fact that the space is usually fully built out and equipped for use.

If a company needs 60,000 square feet of space, it could make a deal directly with the landlord in the high $30's or low $40's, and pay the capital expenditure for the buildout. Or it could sublease space from a company with too much space for about $25 per square foot that is fully built. While these deals may be short-term, they will definitely save the company some money.

Some dot-com firms spent millions of dollars to build out space, only to find that they would not need it. As a result, thousands of square feet of highly improved dot-com space is on the sublease market.

According to Halusha's article, there was approximately 13.2 million square feet of vacant Class A space in Manhattan in September 2002. This space is divided almost equally between Midtown (6.86 million square feet) and downtown (6.34 million square feet.) Much of the recent increase has been concentrated in Midtown. Prior to Sept. 11, there was 3.64 million square feet of Class A space available in Midtown before Sept. 11, 2001. This number increased to 4.82 million square feet in the second quarter of 2002.

However, these Class A spaces are likely to be rented before the older and cheaper Class B and C. properties, say experts. The Holusha article quotes Mitchell Steir, vice chairman of Studley as saying: "The best quality product will always lease first, even if the number is a little lower than the owner would like."

Many brokers share the opinion that companies should take advantage of low lease rates while they are still at record low. According to Michael T. Cohen, president of Williams Real Estate, the buildings of the World Financial Center, which were close to the World Trade Center and damaged in the terrorist attack, are great bargains.