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Market Analysis

Downtown Major Market Analysis:

Battery to Canal Street
River to River:

Second Quarter, 2008 Analysis

Lower Manhattan consists of the following submarkets: Hudson Square, City Hall, World Trade/Battery Park, Financial District, and Insurance District. Prior to 9/11/01, the inventory of Lower Manhattan was predominately Class B and Class C space. However, Class A inventory has grown since then, reaching 39% (45.0M sq ft) of total submarket inventory as of 2Q08. The market as a whole totals 114.4M sq ft of office space. Residential conversion, as well as demolition and development of new buildings in and around Ground Zero, are all starting to change the mix of inventory in the market.

Building Class Inventory Sq Ft
(in ‘000s)
% of Total
Vacancy
Availability Sq Ft
(in ‘000s)
% Vacancy Avg Asking Rate ($/psf)
A 44,976 39% 2,084 4.6% $63.90
B 25,815 23% 1,479 5.7% $49.05
C 29,365 26% 3,809 13.0% $50.30
D 14,239 12% 702 4.9% $42.64
Total 114,395 100% 8,075 7.1% $52.91

Key takeaways of our second quarter analysis include:

Asking rate growth continued at an accelerating pace.  The Downtown market saw record growth in its average asking rate of 21.6% y/y, to $52.91 psf at quarter end. The quarter’s result represented an acceleration from 16.2% y/y growth last quarter, and an increase of $2.18 psf over last quarter’s average asking rate. The quarter’s continued acceleration in rate growth represents the ninth straight quarter of growth acceleration, from a low of just 1.0% in 2Q06. Over the same time period, the asking rate has increased $13.15 psf from $39.76 psf. Also of note, this is the first quarter since 2001 with rate growth for the Downtown market that surpassed that of the Midtown market.

The primary driver of y/y growth was Class C properties, which have growth 26.3% y/y to $50.30 psf. This growth represented a $10.47 psf increase in the Class C rate over the last 12 months, and accounted for $5.58 of the total market asking rate increase. Class B rate growth was also a significant driver, though to a lesser extent, with 20.2% y/y to $49.05 psf, an acceleration from 13.4% y/y growth last quarter. Class A rate growth amounted to an $8.90 psf increase in the Class A rate over the last 12 months, and contributed $3.87 to the total market rate increase. We continue to believe market asking rates are artificially high as landlords continue to maintain high published asking rates, but lower the net effective lease rates by offering greater rent concessions like free rent and work letters. This trend is likely lending support to the current record lease rate levels we are witnessing across Manhattan. Additionally, the Downtown market continues to offer an attractive discount to Midtown space for price conscious tenants. In 2Q08, the discount to Midtown space offered by Downtown space remained at 39%, up from 36% in 1Q07.

From a submarket perspective, all five submarkets saw an increase in the 2Q08 average asking rate relative to last quarter. However, the most significant increases were in the Financial District and Hudson Square submarkets, which saw $4.24 psf and $5.71 psf increases over last quarter respectively. The Financial District finished the quarter with an average asking rate of $52.64 psf (up 21.6% y/y) while the Hudson Square submarket finished with an average asking rate of $50.87 psf (up 29.1% y/y). The City Hall submarket also saw a meaningful asking rate increase of $3.08 psf to $47.55 psf (up 6.9% y/y), though this submarket accounts for only 1.1% of total market availability, so the impact of this increase on the total market was minimal.

Results for the Downtown market by building class include:
 

  • Class A buildings saw asking rate growth of 16.2% y/y to $63.90 psf, up $1.02 psf from 1Q08 and representing a slight deceleration from 17.9% y/y growth last quarter.
  • Class B buildings saw asking rate growth of 20.2% y/y to $49.05 psf, up $0.27 psf from 1Q08 and representing an acceleration from 13.4% y/y growth last quarter.
  • Class C buildings saw asking rate growth of 26.3% y/y to $50.30 psf, up $2.13 psf from 1Q08 and representing an acceleration from 22.2% y/y growth last quarter.
  • Class D buildings saw asking rate growth of 10.2% y/y to $42.64 psf, up $0.48 psf from 1Q08 and representing a deceleration from 14.5% y/y growth last quarter.

Vacancy increased slightly from last quarter’s record low, though likely continued to exclude shadow space.  Downtown vacancy increased slightly to 7.1% in the quarter, up 18.2 bps over last quarter, but still down 233 bps y/y. The increase in vacancy represented a fairly minor increase over last quarter’s record low for the market and the y/y decrease suggests this quarter’s level is still low relative to historical levels. It is also worth noting that this is only the second quarter that Downtown vacancy is not the highest of the three major Manhattan markets. Downtown vacancy continues to exceed Midtown South vacancy of only 4.6%, but is still less than Midtown’s 7.6%. However, we continue to believe Downtown’s vacancy likely excludes “shadow space” from financial services firms with unused space in the wake of recent layoffs over the last two quarters. Large public firms that account for their office leases as capital leases are often reluctant to market available space as FASB 13 and related technical rulings require a balance sheet write-off of the value of these spaces at the time the firms “cease to use” the space. As a result, the market is often unaware of these vacancies until the space is publicly marketed or a new lease on the space is publicly reported.

The 18.2 bps vacancy increase in the quarter represented a 208K sq ft increase in availability driven primarily by a 473K sq ft increase in Class A availability. The increase was offset by a 185K sq ft decrease in Class B availability and smaller 32K sq ft and 48K sq ft declines in Class C and D availability respectively. The primary driver of the increase in Class A availability was the net 581K sq ft increase in sublease availability at 77 Water St, driven by Goldman Sach’s decision to sublease 517K sq ft of its space at the property. The investment bank will no longer need this space once it moves to its new headquarters next year. The 185K sq ft decrease in Class B availability was spread across several properties, with no single property accounted for a significant majority. The decline was also spread across sublease and direct availability, with direct space accounting for 47K sq ft of the reduction and sublease space accounting for 138K sq ft. The reduction in sublease availability reduced the proportion of Class B availability attributable to sublease space to 6.9%, down from 14.4% last quarter. Class B sublease space is currently offered at a 25.2% discount to direct space, so the reduction in sublease availability was a further driver of Class B rate growth in the quarter.

Market vacancy results by building class include:
 

  • Class A vacancy increased to 4.6%, up 105 bps from last quarter, but down 85 bps y/y. This reduction represented a 473K sq ft increase in availability from last quarter, to 2.1M sq ft.
  • Class B vacancy fell to 5.7%, down 72 bps from last quarter and down 508 bps y/y. This reduction represented a 185K sq ft reduction in availability from last quarter, to 1.5M sq ft.
  • Class C vacancy decreased slightly to 13.0%, down 11 bps from last quarter and down 369 bps y/y. This reduction represented a 32K sq ft reduction in availability from last quarter, to 3.8M sq ft. Class C vacancy continues to be impacted by high vacancy at 205 West St (95.6% vacancy), 40 Worth St (64% vacancy), 330 Hudson St (67.2% vacancy), 205 Hudson St (60.6% vacancy) and 200 Hudson St (69.2% vacancy).
  • Class D vacancy decreased to 4.9%, down 48 bps from last quarter, but up 78 bps y/y. This reduction represented only a 48K sq ft reduction in Class D availability from last quarter, to 702K sq ft. Class D availability represented only 9% of total market availability at quarter end, so this decrease was not a substantial driver of the total market vacancy change in the quarter.

Market absorption was negative in the quarter, and down significantly y/y as vacancy continued at near record lows.  We analyze net absorption (leased space less newly available space) in the market as a measure of the relative strength of demand relative to new supply. Net absorption for the Downtown market in the quarter was negative 208K sq ft, resulting in the increase in market vacancy of the same size mentioned above. Absorption in the second quarter of negative 208K sq ft was the result of 2.9M sq ft of leased space offset by 3.1M sq ft of newly available space. While net absorption was roughly equivalent to the 167K sq ft of negative absorption witnessed in 2Q07, it is worth noting that market activity was up significantly on both the supply and demand side in 2Q08. Leased space of 2.9M sq ft was up 102% y/y, while newly available space of 3.1M sq ft was up 94% y/y.

Absorption results for the first two quarters appear to be following historical seasonal trends with stronger periods of positive absorption in the first and third quarter of the year and near-zero or slightly negative periods of absorption in the second and fourth quarters. However, on a YTD basis, newly available space grew at a faster pace than leased space. YTD leased space of 5.0M sq ft was up 10.6% y/y, while newly available space of 4.2M sq ft was up 41.7% y/y. While this would indicate that growth in supply outpaced growth in demand in the market, we would argue this result should be somewhat expected given record low vacancy in the market in 1Q08. Despite the slight up-tick in vacancy in 2Q08, market vacancy was still at a low point relative to historical levels, suggesting the market for asking rates still favors landlords, at least in the short-term. The most meaningful factor that could impact the strength of landlord’s negotiating position is the size and availability of “shadow space” currently occupied by financial services firms. If this space becomes readily available in the market, it could dramatically increase market supply and slow rate growth in market asking rates.
 
 Summary:
 

Total Inventory 114.4 M sq ft 431 buildings
Class A (1969-current) 45.0 M sq ft 55 buildings
Class B (1931-1969) 25.8 M sq ft 68 buildings
Class C
(before 1931>250,000 sq ft)
29.4 M sq ft 61 buildings
Class D
(before 1931<250,000 sq ft)
14.2 M sq ft 247 buildings

2Q 2008 Asking Rates:

Class A B C D Wtd Avg
Direct $65.25 49.35 50.75 43.22 51.96
Sublease 47.97 36.89 38.50 20.00 44.70
Wtd Avg 63.90 49.05 50.30 42.64 52.91

2Q 2008 Asking Rates vs. 1Q 2008:
 
Class A B C D Wtd Avg
2Q 2008 Wtd Avg $63.90 49.05 50.30 42.64 52.91
1Q 2008 Wtd Avg 62.88 48.78 48.17 42.16 50.74
  1.02 0.27 2.13 0.48 2.16

2Q 2008 Asking Rates vs. 2Q 2007:
 
Class A B C D Wtd Avg
2Q 2007 Wtd Avg $63.90 49.05 50.30 42.64 52.91
2Q 2006 Wtd Avg 55.00 40.82 39.82 38.69 43.50
  8.90 8.23 10.48 3.95 9.41

Completed transactions.  The fifteen largest lease transactions completed in the Downtown market in the second quarter of 2008 are as follows:

 

Address

Tenant

Square Feet
1 26 Broadway SpeechCycle 28,000
2 One Exchange Plaza Teliris 17,000
3 33 Whitehall Street Cognet Communications 16,564
4 20 Broad Street FriendFinder Networks, Inc. 16,000
5 17 Battery Place South CSA Group 14,000
6 14 Wall Street Kable Distribution Services 12,486
7 One Exchange Plaza Fog Creek Software 10,000
8 22 Cortlandt Street DB/URS 8,650
9 61 Broadway Fidelity Brokerage Services 8,629
10 40 Wall Street Euroclear Bank 8,313
11 130 William Street The U.S. Census Bureau 8,000
12 61 Broadway NY Artnet Worldwide Corporation 7,630
13 14 Wall Street BATS Trading, Inc. 6,000
14 14 Wall Street Deutsche Telekom 5,658
15 90 Broad Street Rick Steiner Fell & Benowitz, LLP 5,310


 


Charts
 [click to enlarge]

 


Absorption
[click to enlarge]

 


Supporting Market Detail
[click to enlarge]

 
For further information contact:
M. Myers Mermel
Chief Executive Officer
(212) 943-7777
Caroline McLain
Chief Financial Officer
(212) 943-1902

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