Fallout From Sept. 11 Still Affects New York Office Market, Hotels
By DEAN STARKMAN, PETER GRANT, MOTOKO RICH and SHEILA MUTO
Staff Reporters of THE WALL STREET JOURNAL
January 02, 2002
As 2001 began, all signs pointed toward an unusual and difficult year
for the U.S. real-estate market. A year later, the signs are still there --
and there are more of them.
During the past year's economic slowdown, vacancy rates rose, market rents
fell and, for the first time since such records were kept, tenants leased
less office space than they did the year before. Then the attacks of Sept.
11 hit the real-estate industry at the center of its third-largest office
market -- downtown Manhattan -- and the damage radiated outward across the
In whipsaw fashion, New York City vacancies immediately shrank under the
weight of frantic new demand as tenants scrambled to find new quarters. But
as the dire economic reality took hold, New York vacancies climbed back up
and markets elsewhere further deteriorated.
Jacques Gordon, research director at the investment-management unit of Jones
Lang LaSalle, a Chicago real-estate services and investment firm, says the
national office vacancy rate was expected to settle at about 13.3% at year's
end, up from 7.4% a year earlier and 12.3% at the end of the third quarter.
The deteriorating conditions for landlords created modest opportunities for
tenants. Cushman & Wakefield Inc., a New York real-estate services firm,
says Manhattan asking rents slipped to about $47 a square foot at the end of
2001 from about $51 a year earlier. Rents in San Francisco fell to about $46
a square foot from a peak of about $69.50 a year earlier.
The year was marked by two unusual trends. The slowdown in the economy
forced corporations to put excess office space back on the market in
unprecedented numbers: 266 million square feet, or 3.5% of the nation's 7.6
billion square feet of inventory, was put on the market as sublease space in
2001, says Steve Coyle, senior strategist for Property & Portfolio Research
Inc., a Boston research firm. The sublease space made a meaningful
contribution to rising vacancies, in contrast to the big real-estate bust of
the early 1990s, when vacancies were caused mostly by overbuilding.
For property owners, a related -- and equally worrisome -- phenomenon was
negative absorption. That means tenants occupied fewer square feet of office
space in the first quarter of 2001 than in the fourth quarter of 2000, a
first for the industry. Office demand shrank a few million square feet in
the first quarter, then shrank at an accelerating pace through the next
three quarters, leaving 48 million fewer square feet occupied in 2001 than
in 2000, Mr. Coyle says. Compared with the 7.6 billion feet of total
inventory, the number is small. But remember: Developers add supply all the
time -- about 142 million square feet in 2001 -- never expecting that demand
would ever actually diminish.
With those worrisome notes, here are areas that had an impact on the past
year and seem poised to do so again in 2002.
New York's Woes
Most experts predicted earlier last year that the downturn for New York real
estate would be relatively mild compared with the severe busts of the past.
But crystal balls were shattered by the collapse of the World Trade Center.
Hotel vacancies skyrocketed, and Manhattan's perpetually high apartment
rents began to fall. Huge questions were raised over whether the downtown
financial district will ever fully recover from the devastation.
Shortly after the attacks, many expected the Manhattan office market to
benefit from the destruction or damage to more than 30 million square feet
of office space, a dramatic reduction in supply. But the opposite occurred.
Available space in midtown Manhattan swelled to 16 million square feet in
December from 12.8 million square feet in August, according to Insignia/ESG,
a New York brokerage firm. Many corporations that lost offices had a surplus
of space elsewhere in the region. Meantime, the recession and the fallout
from Sept. 11 put pressure on other firms to cut back.
"The real-estate industry didn't recognize there was a tremendous overhang
of softness within the larger financial-services firms," says M. Myers
Mermel, chief executive of TenantWise.com, an online real-estate
brokerage firm in New York.
Manhattan vacancies ultimately settled at 9.1% at the end of November, up
from 8% on Sept. 11, according to a Merrill Lynch & Co. report.
The uncertainty has forced developers to shelve a wide range of plans. New
York developer Douglas Durst says that before the attacks he was bullish
enough on the city to move forward with a 50-story office tower on 42nd
Street between Sixth and Seventh avenues without any preleasing. But now Mr.
Durst says he won't start unless one-third of the building is leased.
Long range, much will depend on how quickly downtown can recover -- a
political and financial challenge unparalleled in the city's history. City
officials have been hoping for federal money to provide incentives to keep
tenants from leaving and lure World Trade Center refugees back downtown. A
comprehensive program has taken months to emerge, much to the distress of
Hotels were already suffering the most by the end of the summer, as
companies sharply cut back on employee travel. Hotel fortunes then
nose-dived after the attacks.
Compared with 2000, a very strong year for hotels, 2001 was dismal: The
revenue-per-available-room rate, a main industry indicator, fell 8% for the
hotel business overall, says Steve Kent, an analyst at Goldman Sachs Group
Inc. The average industry occupancy rate fell to 59.4% from 63.7% in 2000.
With so much uncertainty, the market for hotels slowed dramatically. In the
first half, some 67 hotels worth $10 million or more were acquired for a
total price of $2.7 billion, up from sales of $2.3 billion in the first half
of 2000, according to Hospitality Valuation Services Inc. of Mineola, N.Y.
But in the second half, only 29 hotels were bought for a total of $1.1
billion, down from 69 for $2.4 billion a year earlier. Wyndham International
Inc. had set a goal of disposing of $500 million in nonstrategic assets in
2001. But the Dallas-based hotel company is likely to sell less than half
that, says Chief Investment Officer Joseph Champ. "After Sept. 11," he says,
"it was too difficult to value the properties."
Tom McConnell, a senior managing director at Insignia/ESG, says 2002 will
see more forced selling, with weakened hotel owners offering their
properties at discount prices. Meanwhile, Bjorn Hanson, an analyst at
PricewaterhouseCoopers in New York, says 8% to 15% of hotels won't generate
enough cash to make their debt-service payments.
The silver lining: This downturn won't be as deep as that of the early
1990s, when hotels were saddled with high levels of debt, Mr. Hanson says.
In 1990, he says, the average hotel was spending 14.1 cents of every dollar
of revenue on debt service. Today, it's four cents on the dollar.
The year provided a bit of revenge for tenants in high-tech markets who
suffered during the boom years of the late 1990s, when vacancy rates shrank
to below 3% and rents rose above $80 a square foot in some markets. With the
dot-com implosion and severely curtailed technology spending by big
companies, these same areas closed out 2001 with office vacancy rates as
much as seven times higher, asking rents cut in half and concessions galore,
including several months' free rent. Owners and investors of so-called
telecom hotels -- buildings that house the equipment of telecommunications
concerns -- were hit the hardest, with a nearly 40% overall vacancy rate,
according to Grubb & Ellis Co., a New York real-estate services firm.
About one-third of the nearly two million layoffs announced by companies
through November of last year were in the dot-com, telecom, computer and
electronics sectors, according to Challenger, Gray & Christmas Inc., a
Chicago outplacement firm.
"It was like a car hitting a brick wall at 100 miles an hour," says Rob
Aigner, executive managing director at Colliers International Inc.'s Seattle
office, describing what happened in Seattle's eastern suburbs and other
markets dominated by dot-com, telecom and other technology firms.
Markets with a more-diversified tenant base, such as New York and even the
Washington, D.C., area, didn't crash as hard as Austin, Boston, Denver, San
Francisco, San Jose and Seattle.
Vulture investors circled these markets looking for deals, but the gap
between offering and asking prices was wide, curtailing widespread sale
activity. "Tenants who leased space in 2000 in high-profile technology
markets and gave back space in 2001 continued to pay landlords rent," says
Raymond Torto, managing director of Torto Wheaton Research in Boston, "and
landlords continue to pay their debt" on properties.
Even after it became clear that tenants in tech markets ruled the day, many
remained on the sidelines, speculating -- with good reason -- that even
better deals are on the horizon for 2002. "The recovery will take a while,"
says Kenneth Rosen, chairman of Rosen Consulting Group LLC, a Berkeley,
Calif., economic and real-estate advisory concern. But he predicts the
technology-dominated real-estate markets should be the strongest markets by
late 2003 or early 2004, with defense-related technology and biotech likely
Searching for a Haven
As the year opens, the area below Canal Street in downtown Manhattan is the
most uncertain market in the U.S., and it will remain so for some time.
Merrill Lynch's study forecasts vacancies there to reach 17% to 18% in 2002,
well above the 8% to 9% rate expected for midtown Manhattan.
Bruce Mosler, Cushman & Wakefield's president of U.S. operations, doesn't
believe downtown vacancies will go quite that high but says much depends on
whether the government steps in to stabilize the area with subsidies for
tenants or developers. "The city and state have failed to come up with a
competitive incentive plan," he says, "and that failure will have a larger
impact down the road."
Overall, U.S. real estate will be a reasonable haven for investors, with
in-place leases protecting income through the current downturn, provided
that it's short, forecasters say. Mr. Gordon, research director at the Jones
Lang LaSalle unit, forecasts that major classes of real estate -- office,
industrial, suburban and retail -- will provide returns of 7% to 9% a year
as a group through 2003, compared with flat or negative growth widely
predicted for the rest of the economy. Leasing is expected to be slow until
the white-collar economy begins to turn around and companies use up the
space they already have under lease.
Which sector will provide the safest of havens for owners is a matter of
debate. Steve Sakwa, a top Merrill Lynch analyst, says the office sector is
potentially the most problematic, adding that supply-and-demand data could
be more unfavorable than expected when firms release annual results in
February and March. He picks regional retail malls as best suited to provide
strongest returns in a weak economy, saying the sector isn't as prone to
overbuilding and stocks of retail companies appear undervalued relative to
projected 2002 earnings.
Mike Kirby, an analyst at Green Street Advisors Inc., a Newport Beach,
Calif., real-estate research firm, says retail is more likely to suffer
later in a downturn as interest rates tick up and store closings accelerate
in 2002. He and Mr. Gordon pick office properties as the safest bet,
reasoning that the sector will be quicker than retail to respond too good
economic news, such as rising employment.
Overall, real-estate professionals say, the industry should return from
years of high growth from rising property values to its more traditional
role of providing relatively safe income from leases. "It's a good defensive
place to weather the storm," Mr. Gordon says.
Copyright © 2002 Dow Jones & Company, Inc. All Rights