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Sept. 11's Shadow Darkening Outlook

Attack, economy take toll as rents fall across the city; could be at least 10 years before downtown recovers

Crain's New York Business

By Lore Croghan

September 02, 2002

The terrorist attack on the World Trade Center tore a 16-acre hole in the city's heart. A year later, the aftershocks of that aggression continue to reverberate in the office market.

The outlook is darkest for downtown, whose wounded landscape will take years to heal. But Sept. 11's damage is lingering throughout Manhattan.

"This is a tsunami that has not even begun to show its impact," says Gregg Lorberbaum, a managing principal at brokerage firm The Staubach Co.

The market is weakening and will get worse before it gets better. Rents will erode and vacancies will increase through autumn, as more sublets become available due to continuing layoffs.

Contingency plans

The problems of the market are likely to be exacerbated over the next year. Businesses are just starting to confront the issue of what to do to improve their chances for survival if another disaster strikes. Their need to disperse their personnel threatens to shift jobs out of town.

Some companies have opted for Brooklyn, but it's only one place to pit against well-established alternatives all over the tristate area.

"We will see companies taking multiple locations with excess office capacity," says Barry Gosin, chief executive of brokerage Newmark & Co. Real Estate Inc. "That will spell trouble for New York City unless companies can be persuaded to take Brooklyn and Queens seriously."

Opposite reaction

The effects of Sept. 11 have been so profound, and so long-lasting, in part because the attack came when the market was already beginning to face recessionary pressures. In the weeks right after the disaster, businesses rushed to offer millions of square feet of unused offices for sublet. They thought that tenants displaced by the disaster would rent it in no time. They were wrong.

Many displaced tenants backfilled into their own office space. With companies throughout New York, especially Wall Street firms, consolidating, there have been no other renters to take the space. Much of it is still sitting unused, glutting the market.

As additional space comes on line this fall, even midtown's prices will begin to drop. Offices that went for $60 per square foot in 2000 will reprice at $40, predicts Staubach's Mr. Lorberbaum. Rents in up-and-coming areas such as the garment district, the Penn Station area and Hudson Square will fall to the $20s per square foot. They were in the $40s and $50s two years ago.

The problems across most of Manhattan are economic. Downtown's run much deeper, and even a partial recovery is proving more elusive than was initially hoped.

"The towers were the defining structure for the skyline," says Ric Clark, chief executive of Brookfield Properties Corp., downtown's largest landlord.

The trade center's 11 million square feet of offices are gone, 3.5 million square feet of damaged buildings remain uninhabitable, yet the vacancy rate in the surviving real estate is rising. It has nearly tripled to 20% since Sept. 11, and it is expected to rise another 2 to 4 percentage points by year's end, according to TenantWise.com Inc., a brokerage that tracks post-Sept. 11 real estate trends.

Nowhere are the pressures more evident than at the World Financial Center, Brookfield's newly repaired office and retail complex on the western edge of Ground Zero.

Its office space is almost fully leased, but some tenants are paying rent for locations they have decided not to reoccupy. Their departures from the complex have cut the number of people working there to 25,000, from 36,000 pre-disaster. They've left one tower half-empty and another one-quarter empty.

Half of the one World Financial Center building that Brookfield doesn't own is vacant. Lehman Brothers, which owns the space, is negotiating to sell it to Brookfield for a bargain rate of $160 per square foot.

Deep discounting

Due to sparse demand by big tenants and continuing concerns about transportation, environmental safety and quality of life, the area's rents are decreasing dramatically.

The prices that landlords and sublessors will accept have fallen to $34 per square foot for Class A space during the first seven months of this year, says TenantWise.com. In the same period of 2001, these taking rents were $50. Class B taking rents have dropped to $31 per square foot from $38, and Class C rates have fallen to $22 per square foot from $29.

In the near term, the neighborhood's downward slide will continue.

"The downtown market has not yet hit its bottom," says Bruce Surry, an executive managing director at brokerage Insignia/ESG Inc., who expects to see at least a half-million square feet of new sublets come on line in the area in the fourth quarter. There's already 4.8 million square feet available there now.

There is a growing conviction that downtown will require at least a decade of government funding to recover.

"It will be like the Hoover Dam, a huge federal project," says M. Myers Mermel, TenantWise.com's chief executive. "Backing downtown is a national imperative, because the continued dispersion of financial services from their core market could allow someplace like Singapore or Brussels to take the lead as the world's foremost financial market."

Both downtown and midtown face further damage from anticipated corporate relocations that threaten to drain jobs from the city.

Businesses all over Manhattan are just now grappling with the problem of disaster planning, which for many will entail renting new offices and facilities to enable them to keep functioning in an emergency. Insurers, investors and federal regulators are pressuring them to get going.

Some companies are looking to rent additional locations on different power grids from their current offices, and split up their personnel. They're considering New Jersey, Westchester County, Connecticut, and even far-flung cities such as Omaha.

The ones that want to keep their staff under a single roof are shopping for office space to rent but leave unpopulated. They will furnish it and install phones and computers so it's ready to move into immediately if necessary. Others are planning to build backup data facilities. Some are looking to rent one emergency site nearby, and one on the other side of the country.

The decision process is forcing them to contemplate appalling contingencies.

"Before Sept. 11, no one ever asked, `What will happen if our colleagues are dead?"' says Jeff Hipschman, a senior vice president at brokerage CB Richard Ellis Inc., who advises companies about disaster recovery.

Knowing that companies are looking to decentralize, real estate executives are trying to keep them in New York City. They're hoping some midtown firms will sign deals for big downtown spaces and break the logjam in lower Manhattan leasing. But Brooklyn is where they're having the most success in their marketing. The Bank of New York is one of their big scores.

BONY loyalty

Since its 18th-century founding, the bank has been located downtown, but federal regulators told it to decentralize. So it's moving 1,400 employees to a Forest City Ratner Cos. development at Atlantic Terminal in Brooklyn. The bank shopped for space across the Hudson River, but ultimately remained loyal to New York City.

Mary Anne Tighe, chief executive of CB Richard Ellis's New York region, served as Ratner's broker in the recent 316,000-square-foot lease deal.

"The fatal duel that felled bank founder Alexander Hamilton took place in Weehawken. Why go to Jersey?" says Ms. Tighe, only half-joking.

Copyright 2002 Crain Communications, Inc
 

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