MANHATTAN REAL ESTATE: bursting at the seams

New York's real estate industry is getting decked out in style for the new millennium. Powered by an expanding economy and a booming Wall Street, vacancy rates are declining, prices are soaring and developments are rising from Harlem to the Battery. With tourism and job growth enjoying banner years, all asset classes - office, residential, retail and hotel - are prospering.

The numbers don't lie: Office rents in prime Midtown locations have hit $60, $70 and in some cases even $80 per sq. ft. Average hotel room rates are $211 a night. Fifth Avenue landlords are asking an average of $200 per sq. ft. for retail space. Homebuyers are paying an average of $611,000 for a two-bedroom apartment. If they balk at paying those prices they can always rent - for more than $50 per sq. ft.

Just as encouraging, New York's end-of-the-century prosperity, so far, seems to be marked by a remarkable realism. Unlike booms in the 1970s and 1980s, developers and investors have not taken leave of their senses in bidding up property prices and launching wildly speculative projects. It's not that human nature has changed, rather, a confluence of forces has acted as a moderating influence.

Exuberance in the office and hotel markets has been reigned in by 1999 statistics that indicate demand has begun to taper off. Meanwhile, capital markets have still not recovered from the impact of last year's Asian Flu on commercial mortgage-backed securities (CMBS) and real estate investment trusts (REITs). And in investment sales, price hikes have been held back by the large number of assets that are up for sale by owners eager to cash out while the going is good.

But many real estate professionals view these trends as positive. "In my quarter century in the business, this is probably the best market environment I've experienced," says Thomas P. Falus, president of New York-based Cushman & Wakefield. "It's not characterized by excess on either the upside or the downside. It's just fundamentally very, very strong."

Bird's-eye view Care for a quick tour? Let's start Downtown at Battery Park City where eight apartment buildings, a hotel, two public schools, four ferry slips and a multiplex cinema were recently finished, under construction or being planned. Move over to the financial district where office vacancy has declined by five percentage points in the past year, numerous obsolete commercial properties are being converted into apartment buildings and the New York Stock Exchange is planning a new $1 billion trading floor and office tower.

Take the Broadway local train to Midtown south, an office submarket that has become so tight that service companies and new-media businesses have begun to spill over into industrial areas to the west, driving up rents and forcing out printers, manufacturers and other traditional tenants. A few subway stops to the north, investors like Vornado Realty Trust have been snapping up property in the Penn Station and Madison Square Garden area, anticipating that development will begin picking up there soon. It's not a bad bet, given the $484 million combined federal, state and city plan to convert the historic General Post Office building on Eighth Avenue into the grand railroad portal The Big Apple has so desperately needed since the razing of the original Penn Station 36 years ago.

Then there's Midtown, once again the city's leader in new development. Developer Douglas Durst just finished the 1.6 million sq. ft. Conde Nast Building, and work is either under way or about to begin on skyscrapers for Reuters, Bertelsmann, Bear Stearns, Morgan Stanley Dean Witter, and Ernst & Young. Donald Trump is building what he says will be the largest apartment building in the world near the United Nations (although he has predictably stirred up local community groups which are suing to have it shortened).

A half-dozen hotels are being developed or renovated, including a 400-room Sofitel on West 44th Street and a 455-room Doubletree in Times Square.

And that brings us to Times Square, ground zero for the upcoming New Year's Eve millennium bash and thus a fitting place to end our tour. The district that was just a few years ago pockmarked by porn shops has been transformed into an urban amusement park. When the ball drops on New Year's Eve it will be surrounded by attractions by Warner Brothers, Disney, Madame Tussaud's, AMC, Sony and a wide range of other global retailers, restaurants and entertainment companies rushing to Times Square for the occasion.

Behind this success story is an economy that is firing on all cylinders. The city's financial and business services, publishing, communications, advertising, and tourism sectors are raking in profits, adding staff and expanding offices. Thousands of jobs also are being added by the city's fledgling new-media businesses as well as its growing film and television production industry.

Overall, the private sector has added 314,000 jobs since December 1993, including 74,300 in the past year for a total of more than 3 million new jobs, according to the city's Office of Management and Budget. Employment is now at its pre-recession peak in 1987. "The New York City economy has never been better," says Deputy Mayor Randy Levine. "We're producing jobs at a faster rate than any entity today, including the U.S. economy."

Office is hot property The expansion has most directly affected the office market. In Midtown north, vacancy has plummeted to about 3% from 11.7% in third-quarter 1994, while average asking rents have soared to more than $45 from $32.94, according to Los Angeles-based CB Richard Ellis. Midtown south has fared just as well, with vacancy dropping to about 5% from 13.1% and asking rents rising to more than $28 from $21 in the same period.

Downtown is no longer the basket case of the office market, as it was for much of the 1990s. Vacancies Downtown are now below 8% compared to more than 22% in late 1994. Asking rents are more than $31, up from $26, reports CB Richard Ellis.

To be sure, short-term leasing trends have been less sensational. For the first six months of 1999, leasing volume and absorption were down in Midtown, Downtown and Midtown south, compared with the first half of 1998, according to New York-based Insignia/ESG. In fact, absorption was minus-130,000 sq. ft. Downtown and minus-60,000 sq. ft. in Midtown south, compared with positive 1.5 million sq. ft. and 1.2 million sq. ft., respectively, last year. First-half 1999 absorption was positive in Midtown, but only to the tune of 810,000 sq. ft. - down from 900,000 sq. ft. in 1998. (See p. 121 for Cushman & Wakefield's Manhattan office-vacancy predictions.)

But few real estate professionals are concerned that the market may be turning. They are buoyed by the steady rent rise, even with the slowdown in leasing and absorption. They also see enough activity in the pipeline to assuage any worries of a downturn. "Leasing was off 15% to 20% in the first six months of the year, but most of that was attributable to the first three or four months," says Stephen B. Siegel, CEO of Insignia/ESG. "In May and June, we saw a significant pick-up in activity. I don't thing we're going to equal the frenzied pace of 1997 and the first three quarters of 1998. What we're returning to is something more evenly paced."

Indeed, most brokers are more concerned about space drying up than any impending glut. Tenants are getting increasingly frustrated over high prices, few options, restrictive lease clauses and losing deals by failing to make quick decisions. "It's a great market for landlords, but it's creating a lot of issues for tenants," says Barry Gosin, CEO of Newmark & Co. "For large users there are not a lot of choices. And many service businesses are now finding it hard to find $20 to $25 space."

These issues are generating a lot of movement within the market. Increasingly Midtown tenants are gravitating toward the lower rents and greater options offered by Downtown. Midtown south tenants are pioneering such non-traditional areas as Hudson Square and the mammoth Starrett-Lehigh Building. And more businesses are being lured across the Hudson River to Jersey City, where rents are low and speculative development is possible. Major tenants that have moved operations there in the past year include American Express, U.S. Trust and Cigna Insurance. "In the past, tenants would threaten to move as a ploy (to get incentives from the city)," Gosin says. "But it's a reality right now."

Until now, New York has more than held its own in the perennial cross-border tug-of-war over office tenants. Many businesses are recognizing that paying a premium to stay in New York is well worth it becausemoving out can mean huge personnel headaches.

"The space may be cheaper and the parking may be free, but at the end of the day what these companies need to do is recruit people," says William S. Elder, eastern regional leasing director for Shorenstein Realty Services. "And to do that, especially with young people, you need access to great restaurants and other after-hour amenities."

The administration of Mayor Rudolph Giuliani also has made New York appealing by lavishing tens of millions of dollars worth of tax breaks and other incentives on corporate giants like Time Inc., Home Box Office and even new-media firms like DoubleClick. While Giuliani's critics denounce the deals as corporate welfare, his aides contend they are well worth it. "What they do is make us competitive," says Levine. "And the city gets paid back in a very short period of time."

But even this assistance has its limitations as space has become tighter and tighter. More creativity also is demanded of real estate professionals, especially to accommodate larger tenants. For example, to keep Time Inc. in Manhattan and meet its growth needs, executives figured how to restack the publisher's existing space in 1271 Sixth Avenue and expand into the building next door at 135 W. 50th Street. Time will be able to occupy 1.7 million sq. ft. initially and ultimately expand into 2.6 million sq. ft. "We created the necessary swing space for the building retrofit and put Sports Illustrated's brand on the new building, all the while satisfying Time's economic, location and image considerations," says Mitchell Steir, executive vice president of Julien J. Studley Inc., which brokered the deal.

But no amount of creativity has made it possible for New York to compete with New Jersey on one important front - speculative development. Almost all the office developments that have moved forward have had major advance leasing commitments. The numbers just don't work for speculative projects given the cost of a major Manhattan skyscraper and the reluctance of lenders to finance construction without huge equity contributions.

"To finance a speculative office building that costs $500 million, someone has to write a check for $100 million to $150 million," says Robert B. Horowitz, principal of Cooper-Horowitz Real Estate Financing. "That's a lot of money to put into a deal when you don't have a tenant."

So far, one of the few exceptions to this rule has been The Durst Organization. Durst was prepared to move forward with the Conde Nast Building on 42nd St. and Seventh Avenue even before the publisher and the law firm Skadden Arps Slate Meagher and Flom leased the majority of its space. Now developer Douglas Durst says his company is moving forward with another tower next door on 42nd and Sixth Avenue, also on speculation. "We're fortunate to have a large capital reserve which allows us to start the project with our own money," he says.

Durst predicted he will have little difficulty getting the $65 per sq. ft. he will need when the tower is completed in mid-2003.

"We think that the market will continue to tighten and that rents, while not growing at double-digit rates, will continue to climb," he says, adding that the recent decline in leasing and absorption volume does not disturb him. "It's largely because there's so little space available."

Residential/hotel on the up If Durst were a residential or hotel developer, he'd have a lot more competition. About 5,000 new apartments and 1,400 new hotel rooms are under construction in different parts of the city. Conversion and renovation projects are adding thousands of other units. In Downtown alone, some 3,800 apartments have been created by the renovation of about 40 buildings, transforming the financial district into a 24-hour-a-day community. PKF Consulting estimates that 6,000 to 7,000 new hotel rooms will be developed between now and 2002.

The reason for this development surge is easier financing for hotel and residential projects as opposed to speculative office development. Rental buildings qualify for attractive subsidies and tax-exempt borrowing if they set aside 20% of the units for moderate-income families in the so-called 80-20 program. Residential projects also tend to be smaller, requiring less of an equity contribution. "Very few of the super-luxury condos are being built," says Andrew Gerringer, senior vice president at Douglas Elliman. "A big building today is 100 units."

It's also difficult for lenders to argue with the enormous demand for residential and hotel product. Thanks to near-record tourism and business travel, hotel occupancy was 78.1% for the first six months of 1999. The New York housing market, especially in Manhattan, has once again turned into a nightmare for buyers and renters but a bonanza for owners. "Right now it's zero risk to do condominiums," says Aby Rosen, a principal of RFR Holding, which has finished or is under construction on 11 apartment buildings. "The demand is tremendous."

But the voice of moderation is beginning to be heard in this market as well. Land prices and construction costs have escalated to the point that some developers are questioning the feasibility of moving forward with anything but the most ultra-luxury apartment buildings.

"There's been extreme upward pressure on land and construction costs in the past year," says Jeff Blau, executive vice president of Related Cos. in New York. "That's creating a situation where you have limited supply and increasing demand and increasing costs. That only yields one thing - higher rents. The question is, 'How much higher can rents go in New York City?' The answer is that you have to tread carefully on new development projects."

Buyers in the investment sales market also are treading cautiously, but for different reasons. For one thing, a more conservative cast of characters has emerged as the lead players in real estate finance since the upheaval in the world financial markets in the summer and fall of 1998. REITs and CMBS issuers are generally taking a back seat these days to pension funds, commercial banks, insurance companies and other more traditional lenders. "When firms like Nomura were in their heyday, they were able to offer terms more aggressive than what traditional lenders were willing to do," says Paul M. Stern, managing director of Sonnenblick-Goldman Co. "But after the problems last year, they were no longer able to do so. That opened opportunity for insurance companies again."

Most of these lenders still remember the pain caused by the uninhibited lending of the 1980s. As a result, they are sticking to conservative underwriting assumptions, basing their loans on cash flow rather than the potential for asset appreciation. "Primary lenders in the 1980s were following the prices up," says Sam Giarusso, senior vice president of M&T Bank. "But what's happening now is that most primary lenders are staying pretty conservative. I don't see a lot of craziness going on."

Prices also are being held in check by the large number of assets being put up for sale by owners eager to cash in before the next downturn. About 10 hotels are on the block, including three being offered by Loews Corp. - The Lexington Avenue Loews New York along with the Howard Johnson and Days Inn on Eighth Avenue. The result is that prices have not yet returned to the highs they hit in 1998. In March, for example, the Lai Sun Group sold the Four Seasons hotel on East 57th Street for $275 million, or $750,000 a room, to Ty Warner, the bean-bag toy guru. Last summer, experts were predicting the Hong Kong investment group would get $850,000 to $1 million a room for the property.

The rush to sell is even greater in the office market. In the first five months of 1999, 27 buildings with 14.6 million sq. ft. of GLA changed hands for $2.7 billion, according to Insignia/ESG Capital Advisors. That far exceeds the 23 office buildings with 12.6 million sq. ft. that were sold for $1.7 billion in the first five months of 1998.

Meanwhile, new "for-sale" signs have appeared on about 40 other properties, including four skyscrapers on Sixth Avenue alone - 1301 Sixth, 1211 Sixth, 1350 Sixth and CBS's headquarters building at Sixth Avenue and 52nd St., better known as "Black Rock."

"There are many who want to take advantage of selling into a market where there is a lot of capital, liquidity is good and the horizon is telling us that interest rates could be rising," says Richard B. Baxter, senior managing director at Insignia/ESG.

But there also are a lot of buyers in the market. Demand from foreign investors, pension funds, Wall Street opportunity funds and New York real estate dynasties has been strong enough to maintain prices at roughly 5% to 10% lower than they were before last year's credit crunch. Recent deals include TrizecHahn's purchase of One New York Plaza for $162 per sq. ft.; the sale of 1325 Sixth Avenue to German investment firm Paramount Group for $390 per sq. ft.; and Teachers Insurance and Annuity Association's acquisition of 780 Third Avenue for $330 per sq. ft.

Even REITs, which were blown out of the market when REIT stocks tanked in 1998, are making a comeback. SL Green Realty Corp. agreed in July to buy the 39-story building at 1250 Broadway for $93 million. Even more impressive, Reckson Associates Realty Corp. muscled its way into Manhattan by buying Tower Realty Trust for $690 million, as well as individual assets including the mortgage on 919 Third Avenue.

Reckson had little choice. Until recently the company's assets primarily were in the New York suburban markets. But company officials increasingly recognized they needed to own Manhattan real estate to serve the needs of their tenants. "We did not recognize until later in the execution of our suburban strategy how much interaction there was between the city and suburbs," says Reckson's president Scott Rechler. "We're now able to serve tenants better with more flexibility. Also the decision-makers in the region are based in the city. Having a relationship with them adds value."

Retailers pushing boundaries High demand also is the driving force behind the retail real estate market. So many retailers want to open flagship stores on Madison Avenue that the tony strip has virtually no vacancy in its most desirable locations between 57th and 70th streets. As a result, retailers are beginning to push the boundaries of the luxury shopping district north. Rents above 70th Street are up to $250 per sq. ft., compared with $175 per sq. ft. one year ago, according to Faith Hope Consolo, executive managing director of Garrick-Aug Associates.

The 'spillover effect' also is creating new shopping districts Downtown. Ever hear of Nolita? That's the new trendy retail district "north of little Italy" that was started by galleries, craft stores and restaurants that could not afford space in Soho. Suddenly it's as hot as a pistol and rents have more than doubled to $75 per sq. ft., says Beth R. Greenwald, a broker with New Spectrum Realty Services Inc. "It's got a left-bank-of-Paris feel to it," she says. "The chains couldn't go down there even if they wanted to because the stores are too small."

And, of course, everyone wants to be in Times Square for the millennium party and beyond. The sidewalks are getting so packed with tourists and office workers on even average days that city officials are beginning to study new methods of crowd control. Conditions are expected to get worse in September when ABC-TV's "Good Morning America" opens at the northeast corner of 43rd and Broadway.

Meanwhile, retail demand has moved all the way down 42nd Street from Broadway to Eighth Avenue, where Tishman Realty & Construction is putting the final touches on E Walk, a 200,000 sq. ft. entertainment, restaurant and retail complex. The development is already about 80% leased to Loews Cineplex Entertainment, The Museum Co., a host of restaurants and a virtual-reality arcade based on the theme of old New York. Tishman is moving to finance a $300 million, 860-room Westin hotel that will rise above the complex.

"Better and better tenants are becoming interested in 42nd Street," says Frank W. Gallo, executive vice president of Tishman Real Estate Services, the company's leasing arm. "Tenants who just expressed an interest in the area one and a half years ago are now realizing that they have to get in now or they're going to be shut out."

Retail experts say, however, that the jury is still out on whether Times Square stores, restaurants and entertainment attractions can generate the sales to justify the hype as well as the high rents, which are north of $200 per sq. ft. for some street-level space.

"We have to look six months from now after we get past thi millennium," says Consolo. "All the office buildings have to open as well as E Walk and Madame Tussaud's. Then we can see who's doing well and who's a flash in the pan.

"We've had five years of hype and almost no one has opened their doors yet," she adds. "Right now it's like the wild, wild west."

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