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After Brief Rush, Midtown Market Weakens.

Displaced tenants backfill space; 6.1 million sq. ft. of sublets available.

Crain's New York Business

By Lore Croghan

December 09, 2001

On Sept. 11, the terrorist attack on the World Trade Center blasted businesses out of more than 30 million square feet of property downtown. They needed new offices right away.

Real estate executives expected the mass-scale destruction to translate into a mass-scale migration to midtown, which would sop up all the empty space and jump-start construction.

Instead, the vacancy rate in midtown has climbed, reaching 8.6% at the end of October, compared with 7% at the end of August, according to brokerage firm Insignia/ESG Inc.

Rents, which had been expected to firm up with the infusion of former downtown tenants, are weakening. While midtown asking rents are down only about $1 a square foot, an analysis by TenantWise.com Inc. of 50 small available offices shows that people would be willing to take an average of $48 a square foot, 18% lower than the price they are asking.

No rebound is expected until spring at the earliest and then only if the economy improves. Real estate experts anticipate that vacancy rates and rents will stagnate.

"Immediately after the disaster, there was talk of a mad rush," says Doug Winshall, senior vice president of landlord Trizec Hahn Office Properties' Eastern region. "Expectations were higher than perhaps they should have been."

Less than expected

The migration of companies to midtown did result in a short-lived boost. Some buildings benefited, such as 11 W. 42nd St., which picked up tenants Thacher Proffitt & Wood and Empire Blue Cross Blue Shield. A few big leases got done, such as Lehman Brothers' 400,000-square-foot deal at 399 Park Ave.

Displaced downtown tenants leased a total of 3.6 million square feet in midtown, according to brokerage TenantWise.com. It wasn't nearly as much as was anticipated.

The leasing boom failed to materialize for a number of reasons, including the movement of some companies to New Jersey and Connecticut. But the primary reason was the surprising amount of underused office space that surfaced.

Companies that weren't directly involved in the disaster rushed to put idle ready-built space up for sublet. Meanwhile, many disaster-striken firms found they had underused space of their own. Rather than renting new offices, they sent downtown personnel to backfill midtown facilities. Many businesses wound up occupying less space in metro New York than they had before Sept. 11.

Unloading space

Had the attack occurred last year, when the economy was strong, Manhattan office vacancy would have fallen to its lowest level since the late 1960s, when it was less than 3%, says Justin Stein, regional director of the client services group at Grubb & Ellis New York Inc.

But many midtown businesses, already feeling the pinch of recession, saw an opportunity to unload unwanted space and be helpful to refugee firms from downtown at the same time. In short order, 3.3 million square feet of sublets were added to the midtown market.

"What emerged was pent-up supply," says Mr. Stein. "It came out of left field."

Despite the post-Sept. 11 leasing activity, about 6.1 million square feet of midtown sublet space was available at the end of October, he says, the same amount as at the end of August. Hundreds of the new locations are small, but some big blocks are unclaimed as well, such as Vivendi Universal's quarter-million square feet at 800 Third Ave.

Lowering sights

The first evidence of midtown price erosion is surfacing, as firms that came onto the market expecting to move space quickly and profitably have second thoughts.

Andrew Roos is aiming for a rent of $60 per square foot for a Plaza district sublet he's marketing, with furniture, phones and high-speed wiring. At that rate, says Mr. Roos, an executive vice president at brokerage GVA Williams, the tenant offering the space will lose a total of $1.5 million, the equivalent of more than two years' rent for the 8,000-square-foot office. The landlord is owed $75 per square foot now and $90 as the lease term progresses.

"I can think of at least a dozen instances where transactions closed at rents that would not have been considered acceptable prior to Sept. 11," says Barrett Stern, executive managing director at brokerage Murray Hill Properties/TCN.

While midtown's average asking rent of $59.49 per square foot is only about $1 lower than it was last summer, the spread between ask and take is starting to widen.

A recent TenantWise survey of 50 small midtown offices of less than 20,000 square feet found that companies offering sublets and landlords are willing to take rents averaging 18% lower than their asking prices. Plus, they're ready to give concessions such as rent-free periods to further cut the cost of occupancy to 24% below asking rents.

While the average asking rent for the spaces surveyed is $58 per square foot, the average taking rent is $48 per square foot, and the equivalent lease rate is $44 per square foot when concessions are factored in.

M. Myers Mermel, TenantWise's chief executive, had expected midtown spaces to rent for their asking rates or at discounts of no more than 5%, because of post disaster demand.

Instead, he found that bargains could be had for offices all over the neighborhood. For instance, a ready-built Madison Avenue location with an asking rent of $65 per square foot has a taking rent in the mid-$40s. With concessions, the equivalent lease rate would be $39.97 per square foot-38% below ask.

Gloomy outlook

Real estate executives predict the midtown market will be soft at least through the first quarter of next year, or until the economy recovers. Demand will remain weak, though tenants will still find the neighborhood a more attractive alternative to downtown, at least until promised government incentives to keep businesses in lower Manhattan assume their final shape.

It will take a minimum of six months to a year to work through midtown's sublet inventory. And additional offerings of more than 1 million square feet are expected in the next quarter, as the most recent layoffs kick in.

"Sublets will drive the market," says David W. Levinson, vice chairman of Insignia/ESG.

Copyright 2001 Crain Communications, Inc

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