Downtown 3Q 2008

Third 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 C space. However, Class A inventory has grown since then, reaching 39% (45.0M sq ft) of total submarket inventory as of 3Q08. 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%	1,929	4.3%	$63.82
B	25,815	23%	1,437	5.6%	$50.49
C	29,365	26%	3,349	11.4%	$50.91
D	14,239	12%	808	5.7%	$41.03
Total	114,395	100%	7,522	6.6%	$53.08

Asking rate growth continued, though at a decelerating pace. The Downtown average asking rate finished the third quarter at $53.08 psf, up $0.17 psf over last quarter and up 13.5% y/y. While Downtown is the only major market to see an asking rate increase over 2Q08, growth still slowed relative to last quarter’s peak growth of 21.6% and 2007’s 15.2% growth. It is worth noting that this is the first period of growth deceleration after a sustained period of growth acceleration in the market over the last two years. Rate growth has accelerated from just 1.0% in 2Q06 to peak growth of 21.6% in 2Q08, representing a $13.15 psf increase in the average asking rate over that time period. While growth in the third quarter remained positive at 13.5%, the market witnessed a significant deceleration that may represent an inflection point in which weakness in the market due to the current economic slowdown is finally becoming apparent in the asking rate trend line. Despite these signs of weakness, we continue to believe market asking rates are artificially high as landlords continue to maintain high published asking rates, but lower net effective lease rates by offering greater rent concessions like free rent and workletters.

The rate increase in the quarter was driven by an increase in the Class B and C asking rates, partially offset by declines in the asking rates for Class A and D properties. The Class B asking rate saw the most significant increase, up $1.44 psf to $50.49 psf, representing 7.2% y/y growth. At the same time, the Class C asking rate increased $0.62 psf to $50.91 psf, representing 20.0% y/y growth. Offsetting these increases was a decrease in the Class D asking rate of $1.61 psf to $41.03 psf, down 1.9% y/y. Additonally, the proportion of Class D availability increased to 11% in the quarter, from 9% last quarter, representing an increase in below average rate space for the market as a whole, representing a further drag on rate growth. The Class A asking rate was also down slightly, with a $0.08 psf reduction to $63.82 psf, though this was still up 14.1% y/y.

From a submarket perspective, three of the five submarkets that make up Downtown saw reductions in their average asking rate in the quarter. City Hall, Hudson Square and the Insurance District all saw meaningful asking rate declines, though these three submarkets combine to account for only 27% of the Downtown market. The two larger submarkets, the Financial District and World Trade/Battery Park, both saw asking rate increases, which essentially offset the declines in the other submarkets. The most noteworthy changes include:

Vacancy remained flat in the quarter, though likely continued to exclude shadow space. Downtown vacancy was flat to last quarter at 7.1%, though this result was still down 69 bps y/y. Downtown was the only of the three major Manhattan markets which did not experience a vacancy increase in the quarter. While this did not result in Downtown vacancy below Midtown South’s 5.3%, it did represent the third quarter that Downtown vacancy was lower than that of Midtown, with Midtown’s vacancy finishing the quarter at 7.9%. 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. Public firms are 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. AIG’s lease of 800K sq ft of space at Goldman Sach’s 180 Maiden Lane is an example of this shadow space. The availability of this space was not publicly known until the sublease was announced. This suggests vacancy in prior quarters was understated and additional shadow space in the market likely continues to result in an under-estimation of Downtown vacancy.

Flat vacancy in the quarter represented a net 17K (or 0.2%) increase in availability that was primarily the result of a 414K sq ft increase in Class A availability, offset by a 460K sq ft decrease in Class C availability. Major increases in Class A availability occurred at 7 Worlld Trade Center (180K sq ft increase in availability), 1 World Financial Center (204K sq ft increase) and 3 World Financial Center (105K sq ft increase). The most meaningful reductions in Class C availability included 26 Broadway (128K sq ft reduction) and 60 Hudson Street (119K sq ft reduction). These shifts in availability resulted in a net 183K sq ft decrease in direct availability and a net 199K sq ft increase in sublease availability, resulting in a slight increase in the proportion of availability attributable to sublease space. Sublease availability increased to 21.4% in the quarter, up from 18.9% last quarter and 16.2% at the end of last year. Sublease availability is currently offered at a 13.0% discount to direct space, so this increase in sublease availability represented a slight drag on rate growth in the quarter.

Market absorption was slightly positive in the quarter for continued low vacancy in the Downtown market. 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 positive 17K sq ft, resulting in the increase in market vacancy of the same size mentioned above. Absorption in the second quarter was the result of 1.7M sq ft of leased space nearly perfectly offset by 1.7M sq ft of newly available space. Downtown absorption has followed a similar trend to Midtown and Midtown South in that all three have seen reductions in y/y leased space, while the pace of newly available space has increased. In the Downtown market, total leased space on a YTD basis reached 6.8M sq ft, down 10.7% y/y, while YTD newly available space of 5.9M sq ft was up 44.5% y/y. This has resulted in positive YTD absorption of 825K sq ft, down 76% from the 3.5M sq ft of positive absorption witnessed over the same three quarter period in 2007.

YTD positive absorption was driven primarily by strong leasing activity in 1Q08, when positive absorption of 1.1M sq ft drove market vacancy to a record low of 6.9%. Despite the past two quarters of negative absorption, market availability has only increased by 225K sq ft (or 2.9%) off that record low, suggesting market fundamentals might still favor landlords. However, overall economic trends strongly suggest otherwise. The most meaningful factor that could impact market supply is the size and availability of “shadow space” currently occupied by financial services firms that have experienced, and continue to experience, meaningful staff reductions. If this space becomes readily available in the market, it could dramatically increase market supply and further slow rate growth in market asking rates. Since the onset of the credit crisis, major banks across Manhattan have already announced layoffs of almost 53K employees. Additionally, the New York City Comptroller’s most recent estimate of total New York City job losses over the next two year is 165K jobs. We estimate that these job losses over the next two years could drive an additional 13.7M sq ft of new availability, driving vacancy in the market as high as 17%, or potentially higher.

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

Class	A	B	C	D	Wtd Avg
Direct	$66.57	50.44	51.21	41.03	52.56
Sublease	48.83	51.88	33.71	0.00	45.70
Wtd Avg	63.82	50.49	50.91	41.03	53.08

3Q 2008 Asking Rates vs. 2Q 2008:

Class	A	B	C	D	Wtd Avg
3Q 2008 Wtd Avg	$63.82	50.49	50.91	41.03	53.08
2Q 2008 Wtd Avg	63.90	49.05	50.30	42.64	52.91
	(0.08)	1.44	0.61	(1.61)	0.17

3Q 2008 Asking Rates vs. 3Q 2007:

Class	A	B	C	D	Wtd Avg
3Q 2008 Wtd Avg	$63.82	50.49	50.91	41.03	53.08
3Q 2007 Wtd Avg	55.91	47.09	42.41	41.81	46.77
	7.91	3.40	8.50	(0.78)	6.31

For further information contact:

M. Myers Mermel Chief Executive Officer (212) 943-7777	Caroline McLain Chief Financial Officer (212) 943-1902