Industry playing game of watch this space

Real Estate Weekly, Sept 24, 2008 by Daniel Geiger

The extent to which the cataclysmic events on Wall Street over the past week and a half will begin to infiltrate Manhattan's leasing market still appears hazy as policymakers and legislators brainstorm a bailout to end the crisis that stemmed from bad mortgage loans.

Lehman Brothers was acquired by Barclays after filing for Chapter 11 on Monday last week, Merrill Lynch arranged its sale to Bank of America for $50 billion when it too appeared to be facing an imminent cash crisis, and a majority interest in America International Group was bought by the U.S. government after the insurance giant's collapse neared.

Already the episode is being called by economic analysts and government officials the most serious succession of tumult since the Great Depression, whose impact will alter the entire financial sector.

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This Monday, the last two major independent investment banks, Goldman Sachs and Morgan Stanley, announced that they would become bank holding companies, a restructuring that will bring them under government regulation and likely profoundly change the way they do business.

The move is expected to lessen the level of investment risk the pair can take going forward, a limitation that will better insulate them from potential market catastrophes like the current problems but may also dampen their growth during times of economic prosperity and lead the two to be more conservative in their need for office space.

With the dismantlement and sale of Lehman Brothers, a similar scenario likely for AIG and the merger of Bank of America and Merrill Lynch's operations, there are, of course, a myriad of other perhaps more pressing questions about how much and how fast the recent upheaval will infiltrate the market for office space in the city.

Some brokers and real estate experts fear that the makeover of the financial landscape could hold potentially serious consequences because investment and banking firms are the largest space using industry in the city and their growth had driven Manhattan's rents and occupancy rates to historic highs in the years leading up to the current crisis.

Worse yet, as Mayor Michael Bloomberg pointed out in a press conference last week held to address the economic problems, the financial sector's influence on the real estate market looms even larger than the direct footprint of square feet it inhabits for its own operations.

"Every job on Wall Street creates two or three other jobs in ancillary industries," Bloomberg said. Among the recipients of Wall Street's cascading economic benefits are law firms and accounting firms, who are both sizeable space takers as well in the city.

But real estate executives have been wary to quantify exactly just how deep the impact will be because they say too much uncertainty remains.

"The merger will add space to the market, the question is how much and where," said Bruce Mosler, president and CEO of the real estate services firm Cushman & Wakefield. "More profoundly, it will draw into question the need for new development."

Mosler put the World Trade Center site among the extra square footage that the city may not be able to digest in the near future given the amount of space that could come on the market as a result of the tumult.

"The notion of building all of that is something we have to rethink," Mosler said, indicating that the development timeline may need to be stretched out for the site. "The current envelope can be absorbed, the issue is how much more do you need."

Lehman's demise for instance, is likely to cast off space at a number of midtown buildings where the firm had offices, including 605 Third Avenue and 399 Park Avenue, which Lehman had already begun to shed as sublease space in the months before its collapse. JPMorgan Chase is also offering significant blocks of space on Park Avenue as a result of the excess space it gained from its fire sale acquisition of Bear Steams in March. Citibank is also quietly marketing space it has in Citigroup Center.

The abundance of cheap sublease space in midtown will put added strain on Lower Manhattan, which works for many firms as a lower cost alternative to midtown. Even without the competing subleases, downtown looks as if it could be hit harder by the recent string of events.

AIG occupies virtually the entire 800,000 s/f downtown tower 70 Pine Street, commensurate amounts of space at nearby 80 Pine Street and, more recently, 180 Maiden Lane, a space it subleased from Goldman Sachs over the summer. If the company is dismantled, as written reports have suggested it could be in the upcoming months, it could dump blocks of space on the market that would be a lower cost option to the space at the WTC site, although not commensurate in quality because the WTC space will be brand new and feature state-of-the-art building systems and amenities.

Merrill's acquisition could compound the problems. The firm is in leasing negotiations with Brookfield Properties to renew its lease at the World Financial Center. But brokers have speculated that Bank of America may opt to bring portions of Merrill's operations to midtown and have the firm vacate some of its downtown space.