Midtown 3Q 2008

Third Quarter, 2008 Analysis

The Midtown market consists of commercial office buildings in the following submarkets: Columbus Circle, Plaza District, Times Square, Midtown Eastside, Sixth Avenue, Rockefeller Plaza, Park Avenue, and Grand Central. We divide the buildings in these submarkets into four classes. Class A consists of buildings built after 1969. Class B are buildings built between 1931 and 1969 possessing older infrastructure. Class C buildings are those built prior to 1931 and over 250,000 sq ft in size. Class D buildings are those built prior to 1931 but are less than 250,000 sq ft in size. In some cases in the Midtown market, Class B buildings are of a similar quality to Class A buildings as a few of these have seen extensive cosmetic upgrades and rehabilitations. These buildings have been added to the Class A property count. The inventory of the Midtown market is primarily comprised of Class A properties as shown in the chart below:

Building Class	Inventory Sq Ft (in ‘000s)	% of Total Inventory	Availability Sq Ft (in ‘000s)	% Vacancy	Avg Asking Rate ($/psf)
A	121,110	63%	8,579	7.1%	$92.98
B	35,353	18%	3,286	9.3%	$75.38
C	15,126	8%	1,059	7.0%	$65.52
D	21,654	11%	2,312	10.7%	$79.12
Total	193,242	100%	15,237	7.9%	$85.22

The average asking rate showed a quarter over quarter decline for the first time since the onset of the credit crisis. 3Q08 is the fourth full quarter since the credit crisis began in 3Q07, and the first quarter that the Midtown market has shown a decline in published average asking rates relative to the prior quarter. The Midtown average asking rate finished the quarter at $85.22 psf, down $1.12 psf, or 1.3% from 2Q08. 3Q08 results represent 9.8% y/y growth, a significant deceleration from the 20.5% y/y growth witnessed last quarter and the first quarter of sub-double-digit growth since 3Q06. We continue to believe that the actual reduction in lease rates exceeds that witnessed in asking rates as landlords continue to lower net effective rents through increased concessions like free rent and landlord work. However, we expect landlords will need to continue to lower asking rates to compete with increased sublease space that we expect will become available at financial services firms that have experienced, and continue to experience, significant staff reductions (see vacancy discussion below). We see the potential for as much as a 15% reduction in average asking rates from 3Q08 levels as a result of shadow space increasing market supply.
The rate reduction in the quarter was spread across all four building classes, driven primarily by dramatic rate reductions and increases in availability in sublease space. Market sublease availability increased 515K sq ft in the quarter, while the average sublease asking rate fell $9.60 psf from last quarter to $65.35 psf. The most significant increase in availability occurred in Class A properties, where sublease availability increased 311K sq ft while the average Class A sublease asking rate fell $9.57 psf to $68.46 psf. This decrease represented a 12% reduction in the average Class A sublease rate in a single quarter.

Asking rate results were more varied by submarket, with asking rate declines in four of the eight submarkets we track with the Midtown market. Rockefeller Center, Midtown Eastside, Grand Central and Sixth Avenue all saw asking rate declines of between $1.95 and $5.86 psf (2.3-6.9%) relative to last quarter. Times Square, Columbus Circle, Plaza and Park Avenue all saw asking rate increases of between $1.19 psf in Times Square to a high of $8.80 psf in the Park Avenue submarket. Interestingly, the most significant increases in sublease space were in Plaza (150K sq ft) and Park Avenue (130K sq ft), despite these submarkets showing increases in average asking rates. While both these submarkets saw declines in their average sublease space, these decreases were more than offset by continued increases in direct asking rates, resulting in net increases in the asking rates for both submarkets.

Vacancy continued to increase driven by new sublease availability. Vacancy continued to increase, reaching 7.9% at the end of 3Q08, up 99 bps y/y. This is the first quarter since 2Q07 to show a y/y bps increase in vacancy. 3Q08’s vacancy level represents a return to the level witnessed in 2Q07, which was just prior to the last period of significant positive absorption and vacancy reduction in the market, which occurred in 3Q07 (see below for more discussion on absorption).

The increase in vacancy in the quarter represented a 579K sq ft increase in availability, driven by a 515K sq ft increase in sublease availability and a 65K sq ft increase in direct availability. An increase in sublease availability was seen across all four building classes, but the most significant were Class A properties (311K sq ft increase), and Class B properties (117K sq ft increase). Some of the properties where we saw the most significant increases in sublease availability include the Park Avenue Atrium at 237 Park Avenue (139K sq ft of new sublease availability, likely former Bear Stearns space), 888 Seventh Avenue (66K sq ft of new sublease availability), and 666 Third Avenue (52K sq ft of new sublease availability).

The pattern of vacancy witnessed for the Midtown market is mirrored by 5 out of 8 of its submarkets. Times Square, Sixth Avenue, Midtown Eastside, Columbus Circle and Park Avenue all showed vacancy increases in the quarter. The most significant were in Park Avenue and Sixth Avenue. Park Avenue availability increased by 225K sq ft (or 23% over last quarter) for an increase to 6.6%. Sixth Avenue availability increased by 265K sq ft (or 19% over last quarter), also resulting in an increase to 6.6%. While Rockefeller Center, Grand Central and Plaza all showed vacancy declines, we continue to expect vacancy in Midtown will increase as financial services firms that occupy space continue to layoff staff as a result of the weakening economy. We have already tracked a total of 53K announced employee layoffs at 13 of the largest financials institutions in the city. Additionally, the New York City Comptroller’s office recently announced an estimate for total expected job losses to reach 165K as a result of the financial crisis. We estimate this could drive as much as 14M additional sq ft of availability in Midtown, and as much as 47M sq ft of new availability across the city as firms look to sublease space they are no longer using. This could drive Midtown vacancy to as high as 14%, and Manhattan vacancy to as high as 17% within the next 12 to 24 months. Also worth noting, this is the first quarter to show an average asking rate decline, despite being the fourth quarter of continued vacancy increases. However, we continue to believe that shadow space exists at financial services firms that have experienced, and continue to experience, significant staff reductions. Companies following GAAP rules of accounting are often hesitant to market available space as FASB 13 and related technical rulings require a balance sheet write off of the value of the space when the firms “cease to use” it. As a result, we believe that this space is not currently fully incorporated into the calculation of market and submarket average asking rates. As this space is likely available at a meaningful discount to direct availability, we believe the currently recorded asking rate may be skewed higher by the omission of this availability.

Absorption was negative for the fourth straight quarter. WWe 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 Midtown market was negative 579K sq ft in the quarter, resulting in the increased availability of the same amount mentioned above. Negative absorption in the quarter was the net result of 2.4M sq of leased space offset by 3.0M sq ft of newly available space. Major lease deals that occurred during the quarter include Bloomberg LP (176K sq ft at 731 Lexington Ave) and BDO Seidman (121K sq ft at 100 Park Ave). Properties that contributed most to newly available space include 475 Fifth Avenue (224K sq ft), 51 West 52nd Street (153K sq ft), 237 Park Avenue (139K sq ft) and 1325 Avenue of the Americas (100K sq ft).

3Q08 leasing results represent a return to the dramatic y/y decreases in leasing that we saw in 1Q08, while the pace of newly available space continued to grow on a y/y basis. Leased space of 2.4M sq ft was down 41.3% y/y, while newly available space of 3.0M sq ft was up 37.1% y/y. The decline in the pace of leased space is at least partially due to timing as 2Q was a relatively strong quarter for leasing in the current year, while 1Q and 3Q were strong leasing quarters last year. A look at the YTD totals evens out some of this discrepancy. YTD leasing of 9.7M sq ft was down only 6.3% y/y. However, YTD newly available space still shows dramatic increases even on a YTD basis. YTD newly available space of 11.3M sq ft was up 42.7% y/y. This dramatic growth in newly available space, while YTD leased space was nearly flat, resulted in a dramatic swing to negative absorption on a YTD basis. YTD absorption was negative 1.5M sq ft in 3Q08, down from positive absorption of 2.5M sq ft for the same period in 2007.

Our analysis of absorption shows that the last meaningful decline in vacancy occurred in 3Q07, when 1.9M sq ft of positive absorption dropped market vacancy to 6.9% from 2Q07’s 7.9%. Over the last four quarters, total negative absorption amounted to 1.9M sq ft, resulting in an increase in availability of the same amount, and essentially returning the market to the 2Q07 vacancy level. However, the full impact of availability at financial services firms has yet to be felt by the market, in our view. We expect to see increasing availability as these firms seek to sublease space left vacant by recent staff reductions. We see potential for these firms to add an additional 14M sq ft of availability to the Midtown market over the next 12 to 24 months, which could drive vacancy has high as 14%.

Summary:

Total Inventory	193.2M sq ft	781 buildings
Class A (1969-current)	121.1M sq ft	194 buildings
Class B (1931-1969)	35.4M sq ft	154 buildings
Class C (before 1931>250,000 sq ft)	15.1M sq ft	34 buildings
Class D (before 1931<250,000 sq ft)	21.7M sq ft	399 buildings

Class	A	B	C	D	Wtd Avg
Direct	$97.87	76.28	65.52	79.90	87.12
Sublease	68.46	53.50	0.00	59.64	65.35
Wtd Avg	92.98	75.58	65.52	79.12	85.22

3Q 2008 Asking Rates vs. 2Q 2008:

Class	A	B	C	D	Wtd Avg
3Q 2008 Wtd Avg	$92.98	75.58	65.52	79.12	85.22
2Q 2008 Wtd Avg	93.63	76.52	66.72	80.50	86.33
	(0.65)	(0.94)	(1.20)	(1.38)	(1.11)

3Q 2008 Asking Rates vs. 3Q 2007:

Class	A	B	C	D	Wtd Avg
3Q 2008 Wtd Avg	$92.98	75.58	65.52	79.12	85.22
3Q 2007 Wtd Avg	86.96	71.52	58.54	59.34	77.59
	6.02	4.06	6.98	19.78	7.63

For further information contact:

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