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Kris
September 13th, 2003, 11:06 AM
September 14, 2003

COMMERCIAL PROPERTY

Office Rentals Tepid, but Sales Stay Hot

By JOHN HOLUSHA

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General Motors Building sold for $1.4 billion, a record price.

THE sluggish economic recovery has held down demand for office space in the metropolitan area. But an abundance of capital has meant that trophy office buildings in Manhattan have sold for eye-popping prices, such as the $1.4 billion paid for the General Motors Building. This apparent paradox continues the pattern of recent quarters, according to real estate professionals, suggesting that not much has changed in the commercial real estate market since the beginning of the year.

The executives tie the weak demand by tenants to employment statistics. "We have not seen a lot of new hires; it seems as if we have a jobless recovery," said Peter G. Riguardi, the president of Jones Lang LaSalle, the brokerage and services company. "If that would improve, I'd be a lot more optimistic."

But the outlook for the future is still cloudy. Brokers who represent landlords say they see glimmers of activity that could mean space being removed from the market and a firming of rents. But brokers who specialize in representing tenants say that plenty of space is still hanging over the market and that the bottom may not have been reached.

Nevertheless, with interest rates still relatively low and investors skeptical of other assets, the most desirable buildings in the city are still the subject of bidding wars, like the one for the G.M. Building, which sold for about $800 a square foot, compared with $300 to $400 square foot for more ordinary properties.

"Building prices are strong, but there are not that many for sale," said Anthony E. Malkin, the president of W&M Properties, a management and development company. "Everybody wants a certain type of product, but there is only so much of it."

He said the most desirable buildings are those filled with good-credit tenants tied to long leases. "Properties with rollovers are not popular because of the exposure to vacancy," he said. "That reduces the pool of properties for sale."

The market for retail space has been as uncertain as for offices, with some major deals concluded, but with others falling apart, brokers reported. Home Depot is due to enter Manhattan by opening two Expo Design Centers one in a 120,000-square-foot store on 23rd Street between Fifth Avenue and Avenue of the Americas and the other at the site of the old Alexander's store between 58th and 59th Streets and Lexington and Third Avenues.

But months of negotiations to bring the flagship Abercrombie & Fitch store to a 30,000-square-foot space at the southeast corner of 57th Street and Madison Avenue abruptly came to a halt when the retailer decided not to proceed. "That was a real disappointment," said Alan Victor, an executive vice president of Lansco, a brokerage specializing in retail properties.

Meanwhile, the city's hotel operators are experiencing their third consecutive year of declining revenues, as a result of the falloff in international and business travel and Internet bargain-hunting on the part of leisure travelers, according to PricewaterhouseCoopers, the accounting and consulting firm. Sean Hennessey, the firm's director of hospitality consulting in the metropolitan area, said that a rapid upturn in travel is not expected anytime soon and that increased comparison shopping on the Internet by travelers will make it harder for hotel operators to nudge room rates higher.

"The outlook is weak as far as the eye can see," Mr. Hennessey said. "Any positive impressions are based on expectations, not facts."

The real estate executives who see signs of gathering strength in the office leasing market cite the fact that more space was leased in the first half of this year than in the corresponding period last year, and statistics showing an upward creep in the percentage of the asking rent that tenants are agreeing to pay when signing new leases in some parts of the city.

"Overall activity is up," said Bruce Mosler, the president of United States operations for Cushman & Wakefield, a brokerage and services company that represents both landlords and tenants. "We have leased 11.4 million square feet so far this year, compared to 9.2 million square feet in the same period in 2002."

He said sublet space, which competes with space being offered directly by landlords was down to 30 percent of the space in the market from 35 percent at the same time last year. At the top of the market in 1999 and 2000, sublease space totaled 18.6 and 18 percent of total vacancy, respectively, according to Cushman & Wakefield.

Mr. Mosler said the outlook in Manhattan was for "a slow, steady recovery."

But Gregg Lorberbaum, a managing principal of the New York office of the Staubach Company, a tenants' broker, does not see the fundamentals in place for an increase in demand. "The broad market in this town goes as Wall Street goes, and they are still laying off people and paying smaller bonuses," he said.

He said that layoffs have increased the amount of "shadow space" that is available. This is space that is left vacant or significantly underused after a company's work force is downsized, but is not officially on the market while the company leasing it decides whether to offer it for sublet or keep for future growth.

Those decisions are complicated by accounting rules that require charges against current earnings for the difference between any sublet rent received and the direct rent paid to the landlord. "If a company has to take other writedowns, they probably will throw real estate in as well," Mr. Lorberbaum said. "Nevertheless, shadow space will put downward pressure on rents."

But the accounting rules may complicate property-management decisions, particularly for publicly owned companies subject to the constant scrutiny of financial analysts, Mr. Malkin said. "If a company abandons space, it must recognize the entire lease obligation immediately," he said. "If you are talking about 500,000 square feet for 10 years, that could be a $150 million hit and the company may just decide to sit on the space," he added. "It has a lot to do with managing earnings."

Mr. Lorberbaum said that while effective rents may be firming in some areas of Manhattan, others are still in decline. "We are not close to the bottom in Downtown," he said.

James Meiskin, the president of Plymouth Partners, also a tenants' broker, noted the stubbornly high unemployment and the fact that the remaining employees at many companies are being compressed into less space as reasons that more space is coming to the market than is being leased. "There was 500,000 square feet of negative absorption in the second quarter of this year," he said, using an industry term meaning more space was offered than was removed.

He said the outlook is that employment and economic growth for the rest of the year will be slow at best. That makes it a good time for tenants to lock in current rents. "Smart tenants are focused on renewals," he said. "These rents will not go on forever."

The overhang of office space on the market means that tenants can be pickier about where they locate, avoiding older buildings with outdated equipment, known in the industry as Class C space, said Mark S. Weiss, an executive vice president of Newmark & Company Real Estate. Instead, they can choose the newest and best located buildings, known as Class A, or those that are somewhat older, but often in good locations, known as Class B.

"Class A is trading at about 10 percent off asking rents, Class B is 15 to 20 percent off and Class C is not trading at all," he said. "Nobody is making deals in Class C because there is so much Class B available at Class C prices."

John Powers, the president for tristate operations for CB Richard Ellis, the brokerage and services company that recently acquired the New York-based Insignia/ESG, said he expected availability the industry term for space that is vacant or available for sublease to drop slowly for the rest of the year, and effective rents, which reflect the value of periods of free rent and contributions to alter or finish interior space, to increase. "Availability by the end of the year will be below where it is now, although Downtown will be softer," he said.

CBRE recently published some information rarely made available by brokers: how far actual rents were discounted from the landlord's asking rent, with the data shown by submarkets in Manhattan. The figures disclose a modest recovery in Midtown, from a recent low of 85.12 percent of asking rents early this year to 88.16 percent about midyear.

The situation in Midtown South is more complicated. The discount from asking rent fell as low as 77 percent in the third quarter of last year before rising to 92 percent in the first quarter of this year, at a time when the asking rents were declining from the mid $30's per square foot to the low $30's. Asking rents leveled off in the low $30's at midyear and the taking rate to 85.9 percent.

According to the figures, the Downtown market is softening, even though asking rents have been declining there as well. Taking rents rose from a recent low of 79 percent in the second quarter of last year to as high as 86 percent in the first quarter of this year. But the ratio fell to 73 percent in the most recent quarter, as some big sublease deals at the World Financial Center pulled down the average.

These figures, while interesting, may represent a false precision in a market where landlords are said to be increasingly aggressive in marketing space and tenants are looking for deals. "Nobody really knows where the market is," said Marcus Rayner, a principal in Cresa Partners, a tenants' broker. "If someone is asking $75 a foot for Class A space, I'd try to get it for $50."

In the suburbs, particularly in New Jersey, the office leasing market "is selectively firming up," according to Jeffrey Dunne, a vice chairman of CB Richard Ellis. He said space in the northern part of the state near Parsippany was experiencing more demand than in the central sections near places like Piscataway.

Nevertheless, he said that rents on average are lower now than they were in January, reflecting the trend in the entire metropolitan region.

Sublease space continued to be a large factor in New Jersey. At midyear there were 6.8 million square feet of sublet space available in the northern part of the state, according to FMB Asset Management of Purchase, N.Y., and 17.7 million square feet of direct availability.

In Westchester County, N.Y., the sublet market totaled 839,000 square feet compared with 4.13 million directly available. In Fairfield County, Conn., space available for sublet accounted for 3 million of 7.8 million square feet of total vacancy.

Investment Sales
The Highest Price Ever Paid

The sale of the General Motors Building at Fifth Avenue and 58th Street to the New York developer Harry Macklowe brought the highest price ever paid for a skyscraper in this country, $1.4 billion. Although more than two dozen groups bid for the property, which one real estate executive described as being like the Star of India sapphire and another as "the best building in the city," only Mr. Macklowe was willing to put down a $50 million nonrefundable deposit to win the deal.

The sale demonstrates there is "still a place for trophy properties," said John Cicero, a managing principal in Miller Cicero, a commercial real estate appraisal company. And for Mr. Macklowe, it represents "the crowning achievement of a career in New York real estate," Mr. Cicero said.

Even so, the total value of transactions in the city for the year could end up below the total for 2002 because of the scarcity of properties for sale, said Darcy Stacom, an executive vice president of CB Richard Ellis. "About $1.9 billion has closed, $730 million are under contract and $2.3 billion are in active negotiation, which puts us at about $5 billion," she said. "A typical year is about $6 billion."

Although some real estate executives see a "disconnect" between the soft market for office leasing and the soaring price of buildings, the term does not recognize that some investors consider more than the rent roll as they evaluate properties, said James D. Kuhn, the president of Newmark.

"Trophy properties have replaced blue chip stocks as a safe place to invest in a low-interest-rate environment," he said. "With low rents and great prospects, institutional investors believe rents will catch up with prices." He added that the preferred investment vehicles for many institutions are top rated corporate bonds or prime real estate.

The General Motors purchase makes sense if rents in the building rise above the $100 a square foot level, he said. Current rents in the building range from the $40's to $70's a square foot for long-term tenants, according to Robert Emden, vice chairman of USI Real Estate Advisors and a specialist in the area near the building. More recently signed leases are in the $80's and $90's and he said new leases on the upper floors "will surely be in triple digits."

But a rapid 1.4 percentage point rise in interest rates during the summer may have killed some deals and forced buyers to scramble to lock in fixed-rate financing, said Peter Hauspurg, the chairman of Eastern Consolidated Properties, a sales broker. "It was the fastest rise in interest rates in 40 years and it is going to have an effect on pricing," he said.

He said the increase was particularly tough on purchasers who had put together deals based on floating rate financing. "They can't keep floating at these levels," he said. "They have to get fixed or get killed."

The rise in rates also reduced or eliminated the positive arbitrage present in some deals that were being made early in the year where the rate of return provided by the rents was higher than the cost of capital, said John Lyons, the president of Granite Partners, a real estate investment bank.

In addition, Mr. Lyons said, the uncertain outlook for interest rates is inducing lenders to increase their spreads, the premium they charge over the basic cost of money to cover their risk, thus increasing the cost of financing.

"Before, lenders would charge 150 basis points over the rate on a 10-year Treasury bond," he said, referring to the hundredths of a percent by which most lending transactions are measured. "Now they want 170 or 200 basis points."

Retail Properties
A Bit More Interest

In Prime Spots Bank branches and drugstores have been the biggest players in the retail sector, where "the general climate was a little better than last year," according to Robert K. Futterman, the head of the brokerage bearing his name.

Mr. Futterman said the retail space in buildings has become a more important factor in the overall price of the properties, particularly if they are located on major shopping routes such as Madison and Fifth Avenues. "People call me and ask me what is the value of the retail space," he said. "And I tell them that the ground level on Fifth Avenue can be $1,000 a foot."

Retail specialists say Home Depot's Expo Design Centers, two of which are planned for Manhattan, are different from the giant warehouse stores in the suburbs. The emphasis is on home furnishings and accessories rather than lumber and garden tools, said Mr. Victor of Lansco. "It will be a refined version, at a higher price point," he said.

Competition for space in the most desirable areas has increased this year compared with last, although rents have not moved up appreciably, according to Faith H. Consolo, vice chairman of Garrick Aug, a retail broker. "If you had six or eight offers for a space in the past, you have a dozen now," she said.

But more marginal areas, like the meat market district on West 14th Street, are less active, brokers report. "The B locations sit on the market a lot longer," said Gene P. Spiegelman, a senior director of Cushman & Wakefield.

Manhattan Hotels
Occupancy and Rates Still Falling

The occupancy rate at hotels in Manhattan dropped to 70.7 percent in the first half of this year, compared with 73.5 percent in the comparable period of 2002, according to PrivewaterhouseCoopers. The average cost for a hotel room also fell, to $171.34 a night from $182.54 in the earlier period. This had the effect of reducing the revenue per available room, a key industry indicator, to $131.12 from $143.84 in the first half of 2002.

Of course, the numbers in Manhattan are still far above the national averages. Nationwide, the average nightly rate was $83.16 last year.

Independently operated hotels were harder hit than those affiliated with chains in every category. The independents' occupancy was off 4.2 percentage points compared with 3.5 points for the chains, and average room rate was down 9.1 percentage points compared with a decline of 4.6 points. These two factors resulted in a decline in revenue per available room of 13.4 points for the independents compared with a decline of 6.6 points for the chains.

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Negotiations to install an Abercrombie & Fitch store in a 30,000-square-foot space at the southeast corner of 57th Street and Madison Avenue were halted when the retailer decided not to proceed.

Copyright 2003 The New York Times Company