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Changing Market Scuttles Office Sales

Investors plunked down a record $17 billion to acquire Manhattan office properties in the first quarter. But as the credit downturn whipsawed demand for Manhattan skyscrapers, quarterly volume began to decline. Office sales volume during the second and third quarters totaled approximately $8 billion and $5 billion respectively, down sharply from the first quarter.

The wobbly credit market has also triggered thousands of layoffs in the finance sector that could easily dilute occupancy demand in coming months. As the city's key economic engine shifts into lower gear, Manhattan office landlords' winning streak may be nearing an end.

Here are some recent developments behind the growing uncertainty:

  • Through Oct. 19 of this year, roughly 42,205 financial services job cuts were announced in New York City, reports Chicago-based Challenger, Gray & Christmas. Just 8,000 cutbacks were reported during 2006.

  • In mid-October, Manhattan-based investment bank Merrill Lynch posted $7.9 billion in third-quarter writedowns associated with subprime mortgages and asset-backed bonds. It was the bank's first quarterly loss since 2001.

  • Class-A leasing absorption during the first nine months of 2007 totaled 18.3 million sq. ft., down from 20.7 million sq. ft. during the same period in 2006, reports Manhattan-based real estate services firm Cushman & Wakefield.

“The office sales market has really cooled off since the earlier part of the year,” says Bob Stella, senior vice president at Manhattan-based tenant representation firm Cresa Partners.

“And I don't expect the fourth quarter to be very active on the leasing side either. I suspect that many finance firms will drag their feet until the credit markets really improve.”

Fickle finance

Widespread layoffs among finance firms are an ominous sign for office landlords. More than a third of the Manhattan Class-A office market was leased by financial services firms at the end of September, reports Cushman & Wakefield.

Finance firms, for example, signed seven of Manhattan's nine most expensive office leases during the third quarter. How pricey? Tenants who signed those nine leases for Class-A Midtown space paid an average of $150 per sq. ft., or more than three times the national average of just $46 per sq. ft. over the same period.

In recent years, rising headcounts within finance firms justified much of this leasing activity. Merrill Lynch, the third largest investment bank in the U.S., began running out of space at its 3.1 million sq. ft. World Financial Center headquarters last summer and was reportedly mulling over expansion plans earlier this year.

Other companies such as Goldman Sachs and JP Morgan also boosted Manhattan headcounts by as much as 12% between the end of 2003 and 2006. As finance firms bulked up during the boom, so did professional services firms specializing in the legal and accounting fields. Law firms generated roughly 20% of all Class-A leasing activity during the second quarter, reports Cushman & Wakefield.

That's not unusual. Lawyers have consistently accounted for more than 10% of all quarterly Class-A leasing activity since the end of 2005, reports Cushman. Manhattan's financial services companies also support residual industries. Economists estimate that every new Wall Street job creates at least 1.3 other jobs.

But as shrinking third-quarter results poured in from many Wall Street banks in mid-October, the prospect of added layoffs seemed as inevitable as huge daily declines in the stock market. On Friday, Oct. 19, which also happened to be the 20-year anniversary of the Black Monday crash, the Dow Jones Industrial Average plummeted by more than 360 points after investors recoiled from a week's worth of sour earnings reports.

If finance firms continue to pare down their Manhattan headcount, vacancies will most assuredly start climbing.


All Manhattan Class-A office landlords are vulnerable to a sudden decline in leasing demand. Few have benefited from the booming finance sector more than REIT SL Green Realty Corp. Many analysts see SL Green as a barometer on the health of the Midtown office market. Its stock price spiked from nearly $58 in October 2006 to $150 in January 2007. But by Oct. 19, it had declined to $114 per share.

SL Green owns 18.8 million sq. ft. of Class-A and Class-B office buildings in Midtown Manhattan. Roughly 35% of SL Green's Manhattan office tenants hail from the financial services industry. In early October, SL Green managing director Isaac Zion was optimistic about the company's near-term leasing prospects.

“We still see a lot of strength in the Manhattan office market and in our portfolio,” says Zion. “From our perspective, we are in a great position with a well-leased portfolio.”

Even so, occupancy within SL Green's Midtown portfolio fell by 60 basis points to 97% during the third quarter. Another troubling sign: Leasing absorption totaled just 340,000 sq. ft. within SL Green's Manhattan portfolio during the third quarter, a 34% decline over the trailing 12-month average of 590,000 sq. ft.

Lehman Brothers reports that roughly 86% of SL Green's annualized gross rents at midyear were generated by its Midtown Manhattan portfolio. That 98% occupied portfolio largely consists of tenants who work in the so-called FIRE industries (finance, insurance and real estate).

REIT analyst David Harris of Lehman Brothers pegs SL Green's midyear 2007 exposure to this tenant segment — and the legal and professional services firms that work with these tenants — as high as 50% of the SL Green tenant roster.

Harris says that decisions made by financial services firms will have a major impact on occupancy demand within the SL Green office portfolio. Roughly 9.5% of SL Green's Midtown office leases will expire during 2008.

Throttling down

Like other Manhattan office landlords, SL Green's ability to lock in new tenants at attractive rents will hinge on the strength of Manhattan's economy. Yet some economists doubt that the city's prosperous run will carry into 2008.

In mid-October, Moody's cut its regional job growth forecast through mid-year 2008 from 18,700 to 9,500. Two reasons that Moody's halved its job growth estimates were the prospect of a weaker housing market in the suburbs and lower bonus payouts from Wall Street firms.

Despite this gloomy outlook, Manhattan's office market is still reaping the benefits of the buyout boom. While fundamentals appear to be softening, they are far from weak. Overall vacancy dropped from 6% to 5.7% during the 12 months that ended in September.

Occupancy costs also reflect that falling vacancy rate. In Midtown, Class-A effective rents approached $83.74 per sq. ft. at the end of September, up from $77.07 per sq. ft. just 12 months earlier.

Shallow supply pipeline

Another factor that will directly impact occupancy demand is new supply. Manhattan is awaiting several new and speculative office projects, the bulk of which will not be officially completed until 2010 or 2011 at the earliest.

Cushman & Wakefield reports that roughly 3.5 million sq. ft. of new office supply was under construction in the 179.6 million sq. ft. Midtown office market at the end of September. None of the projects that were initiated this year have since been scrapped either.

One developer who is currently building a spec 1.1 million sq. ft. office tower at 11 Times Square is SJP Properties of Parsippany, N.J. Founder and chief executive officer Steven Pozycki broke ground on the $1.2 billion tower this past summer as the credit crunch began to snowball.

Pozycki, however, swapped out his adjustable-rate construction loan for a fixed-rate loan several months ago. “We won't deliver this building to the market until 2009,” says Pozycki. “It's hard to see how much demand there will be by then, but one good sign is that we're already fielding interest from hedge funds and financial services firms for the space.”

That may be because Pozycki began marketing the property located on Eighth Avenue and 42nd Street in the spring early in the credit crunch. “New York City really has a globally diversified base of tenants,” he says. “So we feel that this gives us some insulation against just relying on the financial sector for demand.”

Bellwether sales

Developers like Pozycki may have time on their side. If their projects are developed amid a brief lull in the local economy, their buildings could hit the market as leasing demand builds momentum.

But it's a different story for office landlords attempting to sell into the current market. Five significant Manhattan office towers comprising more than 3.2 million sq. ft. of largely Class-A space hit the market between August and October. None were sold as of mid-October.

One of those offerings, 475 Fifth Avenue, last changed hands in April. But it's far from clear if the owner can effectively flip the property six months later. Joseph Moinian paid $160 million for the building and hired Cushman & Wakefield in late September to market the property.

The Class-B office property was 50% vacant at the end of September. Two Manhattan office brokers say Moinian is seeking at least $200 million for the property. Moinian declined to comment on marketing plans for the building. His spokesman, Eric Gerard, says he might not end up selling the building this quarter since he may just be “testing the waters.”

His indecision speaks volumes about the market. The debt markets were still searching for stability in mid-October as investment banks scrambled to find buyers for more than $300 billion of securitized commercial real estate debt.

In a late September research note, KeyBanc Capital Markets analyst Jordan Sadler wrote that this backlog will continue to undermine demand: “The reduced level of liquidity has driven leveraged buyers from the market, thereby reducing the level of competition for assets and likely previously feverish pricing levels.”

Parke Chapman is senior associate editor.


8.9 million

Source: U.S. Census Bureau

Source: New York City Chamber of Commerce


  1. City of New York
    300,000 employees

  2. New York City Public Schools
    73,774 employees

  3. Merrill Lynch
    50,600 employees

Source: NREI estimates



6.7% vacancy, 2Q 2007

7.8% vacancy, 2Q 2006

$62.91 rent per sq. ft., 2Q 2007

$43.46 rent per sq. ft., 2Q 2006

Source: Cushman & Wakefield


2.8% vacancy, 2Q 2007

2.9% vacancy, 2Q 2006

$2,756 effective rent, 2Q 2007

$2,432 effective rent, 2Q 2006

Source: Reis Inc.


9.1% vacancy, 2Q 2007

7.0% vacancy, 2Q 2006

$39.18 rent per sq. ft., 2Q 2007

$38.73 rent per sq. ft., 2Q 2006

Source: Marcus & Millichap


3.2% vacancy, 2Q 2007

3.3% vacancy, 2Q 2006

$16.48 rent per sq. ft., 2Q 2007

$12.47 rent per sq. ft., 2Q 2006

Source: Marcus & Millichap


86.9% occupancy, 2Q 2007

87.4% occupancy, 2Q 2006

$248.87 average daily rate, 2Q 2007

$241.06 average daily rate, 2Q 2006

Source: Smith Travel Research


11 Times Square — A 40-story office tower under development on Eighth Avenue and 42nd street, will include 55,000 sq. ft. of retail space. While the speculative project has yet to sign a major tenant, the developer plans to keep with the atmosphere of Times Square by placing bold signage on the 1.5 million sq. ft. tower.

Developers: SJP Properties

Completion: 2009

Cost: $1.2 billion

The New York Times Tower — A 52-story tower on the east side of 42nd street and Eighth Avenue, welcomed anchor tenant The New York Times earlier this year. Once its spire was completed in 2006, the tower's height exceeded 1,000 ft. The New York Times occupies roughly 800,000 sq. ft. of the tower in space that it owns.

Developer: Forest City Ratner

Completion: Summer 2007

Cost: $1 billion

Bad timing mars multi-billion dollar office deal

Manhattan office investor Harry Macklowe symbolized New York's booming commercial real estate industry earlier this year. But in recent months, the fickle finance markets have turned against him.

In February, the founder and CEO of Macklowe Properties acquired a portfolio of seven Manhattan office buildings for $6.8 billion. Putting just $50 million, or less than 1% of his own equity into the deal, Macklowe secured the former Equity Office Properties portfolio from The Blackstone Group for roughly $1,000 per sq. ft. — pricey even by Manhattan standards. Macklowe also managed to close the deal less than two weeks after first contacting the seller.

The high-profile investor even borrowed $7.6 billion — nearly $1 billion above the sale price — to cover closing costs. The Wall Street Journal also reports that the $6.8 billion deal would suffer from “negative debt service” until 2012. Negative debt service results when net operating income falls short of covering monthly mortgage payments. As of early October, Macklowe needed to pay back $5.1 billion in debt by next February.

“[Company CEO] Harry Macklowe has one of the highest risk profiles of any investor in New York City,” says office sales broker Woody Heller, executive managing director at Manhattan-based tenant representation firm Studley Inc. “But Harry is also the Harry Houdini of commercial real estate.”

He's clearly worked his magic on massive deals before. In 2003, for example, Macklowe bought the 2 million sq. ft. General Motors Building on Fifth Avenue for $1.4 billion. Some real estate observers have accused Macklowe of overpaying for the building, which fetched a then-record price for a single office asset.

But the value of that tower doubled over the next few years, which allowed Macklowe to use his 49% interest in the tower as collateral on February's $6.8 billion acquisition.

So can Macklowe work his magic this time? He'll need to do something to keep his lenders at bay. Before lenders roundly tightened their underwriting standards last summer, Macklowe could have refinanced the portfolio. And he still could opt to sell pieces of his 11-building Manhattan office portfolio.

If Macklowe can't retire his multi-billion dollar debt by the end of January, lenders could go after the 11-building Macklowe portfolio. Through his spokesman Steve Solomon, Macklowe declined to speak to NREI.

That's not to say that Macklowe is the only risk-taking Manhattan office investor coping with an arduous financing market. In December, for example, New Jersey-based Kushner Cos. agreed to pay $1.8 billion for 666 Fifth Avenue, a trophy Midtown office building located near Rockefeller Center. That deal still stands as the priciest single office asset sale in U.S. history.

“The financing landscape really changed since the first quarter,” says Jared Kushner, principal of the family-owned real estate firm. He agrees that it would be more difficult to engineer the 666 Fifth Avenue deal in mid-October than it was late last year.

That being said, Kushner doesn't believe that his company paid too much for that property. Given the strength of the Midtown office market, Kushner also believes that he can achieve higher rents over the next few years. Approximately 60% of the leases at the property will expire over the next three years.

“Everyone is repricing risk and debt,” Kushner says. “But the Manhattan market remains very strong from a leasing standpoint.”
— Parke M. Chapman

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