By Dr. Peter Kozel
Senior Managing Director
FirstService Williams
New York City

Mounting evidence suggests that the New York City office sector is scraping along the bottom of its cycle and laying the foundation for an improvement in operating performance. The property market itself is offering some of this evidence. Additionally, data from the economy and business sector are providing greater clarity about the dimensions of the contraction in business activity plus what are likely to be the contours of the eventual economic recovery.

Demand for office space evaporated during the first four months of 2009, with leasing volume declining to a monthly rate of just one million square feet, and much of this activity involved 5,000 square foot and 10,000 square foot transactions.

In June and July, however, leasing volume escalated to 2 million square feet in each month, roughly equal to the average monthly total in 2007. An important part of this increase stems from the substantial number of leases signed in those two months for over 50,000 square feet. From approximately mid-June to the end of July, FirstService Williams counted twenty-two lease transactions for 50,000 square feet or more including ten for 100,000 square feet or more. Undoubtedly, there were additional confidential transactions that were not reported.

Some of these large deals were completed by tenants that had been in the market looking for space since 2007. In a few cases, they were close to a deal. But, as rental rates started to decline, they decided to wait. With the average effective rent now down by close to 40% from the peak – and more in some submarkets – these firms must have decided that rents were close enough to a bottom so that a deal struck at this time will not prove to be overpriced six months from now. Additionally, their own business situations must have stabilized to the point that they can gauge how much space they would likely need and what they can carry in occupancy costs.

Since mid-May, net additions to the amount of available space has also slowed from the pace in the previous nine months, down by nearly 50%. The amount of space that is listed as available continues to increase; but what is less clear is whether or not these new listings are really newly available space. The stock of shadow space began to grow in 2008, and some of it has now been shifted to open listing.

In the Midtown North market, availability registered 14.8% at the end of the second quarter of 2009. Our reading of the data points to a peak of 16.8% by the end of 2009 and about the same at the end of 2010. Even though the New York City economy should be on the mend by early 2010 – with modest additions to employment – a little over three million square feet of newly constructed office space will be added to the inventory, keeping the availability high.

So what is the broader economy telling us? The average unemployment rate for the first six months of 2009 in New York at 8.3% remains below the national average of 8.7%. Moreover, the labor force continues to increase in New York City, while it is trending downwards for the nation as a whole.

For the past 24 months, office sector employment is down a total of 5.8% for the U.S. but only 3% for New York City. By contrast, in the 2002/2003 cycle, New York City suffered a 9% cumulative decline but just a 2.4% reduction for the nation. The consensus forecast now looks for the U.S. economy to grow by 2.5% to 3% during the third and fourth quarters of 2009. Since New York City has consistently outperformed the nation during this recession, the city should enjoy a solid bounce in the second half of 2009.

There are plenty of credit problems yet to be worked-out during the next several years. So the recovery will be bumpy. But as the partial sale of 485 Lexington Avenue by SL Green for a 6.2% cap rate indicates, confidence in the New York City office market is beginning to return.

Hedge funds, private equity funds and top-tier investment banks that inhabit or inhabited Midtown offices along the premier Avenues were the first companies in New York City to experience the tumult of the current recession. Of course, the declines in their respective businesses that began in the second quarter of 2008 were preceded by the burgeoning collapse of the residential housing market that began a year earlier in the rest of the country.

When New York City’s financial sector started to contract in 2008, demand for office space in the Midtown market shriveled. As a result, the availability rate escalated dramatically within key Midtown submarkets such as the Plaza and Rockefeller Center/Fifth Avenue districts

By the end of the first quarter of 2009, the office availability rate in Midtown was 13.3%; substantially higher than the availability rate in both Midtown South and Downtown, which ended the quarter with availability rates of 9.8% and 10.8% respectively. The financial sector is the lead horse that pulls the New York City economy, so the other major sub-markets in Manhattan were expected to follow the downward trend and show weakness in subsequent months.

This projection has in fact been borne out by the very preliminary numbers for the second quarter of 2009, which indicate that the degree of weakness among the major Manhattan markets is beginning to equalize. In the second quarter, for example, the overall Midtown availability rate likely increased to about 15%, or 1.7 percentage points higher than the end of the first quarter in 2009. Both the Downtown and Midtown South markets, however, will see substantially larger percentage gains. For Downtown, it probably jumped into the 12.5% area; and for Midtown South, the move was to 13%.

Manhattan’s office property market likely sustained further deterioration in the second quarter. But the more pressing concern centers on how long the decline will continue and how far it will drive availability rates up.

In recent weeks there have been some references to green shoots [meaning the beginnings of economic growth towards the end of a recession] when talking about the national economy’s incipient recovery. Virtually all of these instances were supported by observations that the rate of economic decline was slowing. The recent uptrend in the stock market, for the moment, confirms that upbeat assessment. While it is important to avoid getting caught up in overly optimistic scenarios based on a few positive developments, it’s important to note that our preliminary data for the Manhattan office market during the second quarter also shows some green shoots springing up among the rubble.

In May, the total amount of office space that was added to the total supply available for leasing did increase. But the total amount of space added during May was about 60% less than the amount added during each of the previous six months. The deluge of new space into the Midtown market slowed even more, with 70% less space hitting the market in May versus the preceding six months.

With net absorption of office space negative, the amount of available space continues to increase. But the pace of deterioration has slowed. All of this data indicates that Manhattan office market fundamentals are still weakening, but at a much slower pace. Again, one month of data does not prove a solid trend, but there is additional fundamental data that may lend credence to the property level statistics.

Again, based on the preliminary data, the employment situation in New York City does not seem to be weakening as fast as it was during late 2008 and early 2009. The year-over-year job loss in total employment is about 100,000, or 2.4%.
In the financial sector, employment levels seem to be holding steady, and the business fundamentals in that industry are improving. The unemployment rate for residents of New York City has been steady over the last few months, and the labor force number has continued to rise. These are additional positive signs.

While we have only a few indicators and observations from those measures of business activity, the incoming observations over the last month have turned more positive.

Dr. Peter P. Kozel,
Senior Managing Director,
FirstService Williams