Space squeeze gets serious as vacancy nudges 8%

Real Estate Weekly, April 12, 2006 by Tiffany Razzano

Manhattan office rents have seen significant spikes across the board in the first quarter of 2006, as space continues to tighten in midtown and midtown south.

The overall average asking rent for office space in Manhattan has reached $43.20 per s/f, Joseph Harbert, COO at Cushman & Wakefield, told an audience at Cushman & Wakefield's First Quarter Review Breakfast. That's up from $40.58 at the end of 2005.

"There was a reduction in office space in 2005. The amount of available office space went down 25%," Harbert said. "Now we're starting to feel the effects of that." Breaking down the three major office markets in Manhattan, midtown saw a dramatic spike in overall average asking rent, with rent jumping to $55.3 per s/f in the first quarter of 2006, after ending 2005 at only $47.41. The rental spikes in downtown and midtown south were similarly dramatic. Downtown jumped to $36.34 per s/f from $30.89 at the end of 2005, while midtown south went from $33.63 per s/f to $39.48.

There's also been an increase in tenants willing to pay top dollar for higher quality office space in Manhattan. In the first quarter of 2006, there were 15 deals that were completed with rents of $100 per s/f or more. There were only 10 such deals in all of 2005. According to Harbert, these are the highest rents he's ever seen, with some deals starting at $135 and some even going up to $150.

The waning supply of high quality, Class A space and the competition for this limited space are the main factors that have helped to drive up rents. Also, many newer buildings being brought to market are starting off at much higher rents. Downtown, though 7 World Trade Center coming onto the market has been a factor contributing to the increase in the overall average asking rents there, said Harbert, adjustments are now being made in all office buildings in that market.

The jump in rental cost has coincided with a decline in overall leasing activity in Manhattan. Only 5.4 million s/f were leased in Manhattan in the first quarter of 2006, down 19% from the 6.7 million s/f leased in the first quarter of 2005. Midtown took a 14% dip, leasing only 3.8 million s/f this past quarter. Midtown south and downtown saw declines in leasing activity as well. Midtown south saw a 28% drop, while Downtown saw 751,700 s/f leased in the first quarter of 2006, compared to 1.1017 million s/f in the first quarter of 2005.

Vacancy rates throughout the city have also dropped. The vacancy rate closed the first quarter of 2006 at 8.4%. This time last year, it was at 10.84%. With the lowest vacancy rate in the country, midtown south has closed the first quarter with a vacancy rate of 6.2%. "It's an extremely tight, but popular market with the lowest vacancy rate in the country," Harbert said. "There's nowhere to go. You're better off in midtown."

At the beginning of 2005, the vacancy rate in that market was 9.9%. Midtown, with the fourth lowest vacancy rate in the country, went down to 7.8% from 9.8% in the first quarter of 2005. The vacancy rate in downtown closed the first quarter at 11.6%, down from 10.6% at the end of 2005, but up from 12.3% during the first quarter of 2005.

As rents increase and space tightens up in midtown and midtown south, more tenants will be forced to look downtown for space. But really, said Harbert, this could be the better deal for office tenants. There's a $46 gap between the most expensive submarket in midtown (Madison-Fifth Avenue, with an average asking rent of $74.78 per s/f) and the least expensive submarket downtown (Financial West, with an average asking rent of $28.86). According to Harbert, a 10,000 s/f office tenant could save $500,000 per year if they sought space downtown rather than midtown.

With Manhattan projected to see modest job growth of 1% to 1.4% each year for the next 10 years, the demand for office space could reach 28 million s/f by 2016. Over this same period, the total inventory for Manhattan office space is expected to rise by 18 million s/f, which will result in a vacancy rate of 4.4%.

"What happens in a tight market with prices going up?" asked Harbert. "We could run out of space. There's a lack of new supply and it's a serious issue."

During the 1980s, nearly 60 million s/f of office space was added to the Manhattan market, dropping dramatically to 14.2 million s/f in the 1990s. According to a special construction report put out by Cushman & Wakefield, "current projections do not begin to reach previous levels for new construction." Of the 8 million s/f recently completed, under construction or recently announced for Manhattan, the majority of this is either pre-leased or designated for residential use.

The majority of expected commercial office space to be built in Manhattan by 2016 will be downtown, with 13.7 million s/f to be constructed at the already completed 7 World Trade Center, the World Trade Center Complex, the Freedom Tower and the Goldman Sachs Headquarters.

This means the recent squabbling over plans for the World Trade Center site could be harmful to the city. If the World Trade Center site, as well as West Side development, doesn't occur, "it will have a negative impact on the growth of New York City," Harbert said. "The business of New York is business. If we want to see it grow, this needs to be built."