Manhattan office market forecast to cool in the short term

Real Estate Weekly, July 11, 2001

Marcus & Millichap Real Estate Investment Brokerage Company recently released its Office Research Report for the Manhattan market, which states that the market is expected to cool slightly, but remain healthy in the short term.

"While the explosive growth of the past few years will moderate this year, Manhattan's office sector will continue to enjoy steady gains," said Mitchell R. LaBar, regional manager. "The first half of 2001 will see new job formation falloff considerably, but a rebound is expected by the end of the year. Investors will continue to acquire office properties here. With rental growth slowing in the near term, there may even be some bargain buys in the market, at least by New York standards."

Following are some of the most significant aspects of the report: Job growth is forecast to slow this year as companies exercise caution with respect to hiring and expansion.

F.I.R.E. (finance, insurance, real estate) continues to play a major role in the local economy, with financial services jobs accounting for more than 13% of total employment, nearly double the national average for the sector.

The struggles of the dot-com and technology sectors are continuing. While these companies accounted for much of the huge gains in rents and values in recent years, the local economy, with its diverse employment base, should be able to withstand the temporary lull in growth that is now being experienced. Despite the ongoing volatility in the stock market, the financial services sector will continue to drive the local economy.

Construction starts will drop slightly this year, as the slowing economy will cause many of the projects currently in the pipeline to be postponed.

Although the development pipeline is full with numerous new office projects, the current economic climate may delay many of them. Developers with lofty rent projections may decide to let the dust settle before undertaking new projects. Even with uncertainty in the air, 3.8 million SF of new office construction is forecast to start this year, a large number, considering the area's lack of available land.

Office vacancy is forecast to rise in 2001, but even with an increase of 1 to 1.5 percentage points the Manhattan office market will remain one of the tightest in the country. Office vacancy in Manhattan is forecast to rise to 5.5% this year as the dot-com and technology sectors continue to struggle and vacate space. Manhattan's resilient economy will result in the space left by these companies being re-leased, although at a slower pace than over the last several years.

Rent gains will be constrained due to the increasing availability of sublease space and corporate emphasis on reducing costs. Rents will rise only nominally over the next 12 months after the double-digit gains of recent years, as owners experience more difficulty

in attracting tenants. Corporate profitability has been a major focus of companies across the region recently, and this will continue over the coming months. Reducing real estate expenditures will remain a priority, and the gap between asking and actual rents will grow accordingly. The inordinate amount of sublease space on the market, resulting from layoffs and bankruptcies, will also limit rent growth. The Manhattan office market will become a lessee's market, at least in the short term, for the first time in many years.

"With rent growth forecast to be a fraction of what was seen over the past few years, values will rise only moderately, although investors will continue to crave Manhattan real estate."

The days of double-digit value increases for Manhattan office property may have come to an end, at least in the short term. With vacancy up and rent increases a fraction of what they were in the recent past, values are forecast to rise by just 3.5% on average this year. The local office market is still expected to show moderate growth, however, and investors will continue to covet Manhattan office product as flagship properties in their portfolios.