Downtown landlords upbeat about WTC tenant shuffle.

Third quarter office market reports show that downtown's vacancy rate and its stock of available large block spaces has continued to decline, measures that indicate Lower Manhattan has crawled out of a years-long leasing lull.

The data, which shows that vacancy downtown has receded from last year's double-digit rates to 9.1%, finally seems to validate the assertion among government officials and real estate experts that Lower Manhattan will be able to absorb the millions of square feet of office space that is planned for the World Trade Center site.

There have been lingering questions whether there is enough tenant demand in the market to fill the large tracts of commercial development planned for the WTC site. Compounding those concerns is the fact that virtually all the site's office towers, according to a revised redevelopment plan that Ground Zero's stakeholders formalized last month, will be delivered within roughly a year of one another.

Such a massive introduction of space in such a short time period presents the possibility of creating oversupply in the market, a risk that even political figures involved at the site and who support the current rebuilding plan have had to concede.

Mayor Bloomberg suggested months ago that the site plan be altered to include a significant residential and hotel component given that downtown office fundamentals at the time were lagging and the residential and hotel markets were soaring.

Just months later, Port Authority chairman Anthony Coscia stirred controversy when he stated that the Port Authority would either scale down or even cancel the Freedom Tower if 1 million s/f of pre-leasing couldn't be secured for the 2.6 million s/f building.

The previous construction schedule, which was nixed due to political pressure and uncertainty whether Silverstein Properties had the financial wherewithal to build out the site single-handedly, had called for the successive completion of the site's planned office buildings. That kind of timetable presents the advantage of affording each building a longer period to find tenants before the introduction of competing space, added supply that could have a damaging impact on rents or simply sit vacant for lack of demand.

But brokers are adamant given the current market conditions and the direction in which it seems to be heading that the World Trade Center's Towers 2, 3, and 4 and the Freedom Tower can't come online soon enough. Their leading concern is that tenants may not be able to wait until the WTC site's planned completion roughly five years from now and be forced to relocate outside of Manhattan in the meantime, to markets like downtown Brooklyn, Jersey City, or even the new district in Pennsylvania being touted by government officials there as "Wall Street West."

"We may see tenants start to migrate to Jersey City," Joe Harbert Cushman & Wakefield's chief operating officer in New York said.

Real estate experts who believe that the downtown office market is already beginning to suffer from such an undersupply cite a dramatic trend known anecdotally to those who track large leasing deals in the city; Lower Manhattan's stock of quality office space has virtually vanished in the past year to a succession of major leases.

The activity spurred Silverstein Properties during the summer to increase its rents at 7 World Trade Center, a thorough rebuke of the criticism Mayor Bloomberg had levied in recent months towards the firm's principal, Larry Silverstein, for not lowering the building's rents to attract more tenants. Brookfield Properties, one of downtown's largest owners of class A office space, did likewise during a flurry of deals that filled all of the significant vacancies remaining in its vast portfolio.

The third quarter data concisely summarizes the situation downtown.

Four of 2006's ten biggest deals have been done in Lower Manhattan, the year's largest being the 600,000 s/f lease signed by Moody's at 7 World Trade Center--a catalyzing moment downtown that seemed to instantly reverse that building's leasing problems and crystallize Silverstein's contention that the space lost in the attacks of 9/11 was sorely needed back.

"7 World Trade Center is the pioneer and that had something to do with the delays in its leasing, there was uncertainty," Brad Gerla, part of the CB Richard Ellis team that is handling the building's leasing said.

"Once people saw tenants like Moody's sign and they understand how great the building is, I think it helps change the entire momentum for downtown. We expect to have the building leased fully in the next few months and I believe that, by the time the rest of the commercial [space] at the World Trade Center site is built, it will be virtually entirely pre-leased."

Just how well the new space will fare as compared to the space before it has been a subject of much debate and, according to brokers, highlights fundamental market changes that have taken place downtown.

When the Twin Towers came online in the early 1970s, they were met largely with indifference from tenants and suffered from high vacancy rates for almost a decade. A confluence of factors contributed to their poor debut, but brokers say the most prominent reasons include the city's fiscal crisis at the time, which made some tenants wary to take space in Manhattan, the buildings' high rents, and the fact that no fewer than six significant office buildings had been built downtown in the years just before the Twin Towers' entry.

Now, conditions downtown seem exactly the opposite. Manhattan more than ever has become a critical location for tenants, even expensive office stock downtown has become widely recognized for its value compared to the skyrocketing rents in midtown, and there has been little new construction in Lower Manhattan in recent years.

But one thing does remain the same. Like the Twin Towers before it, the space at the WTC site will depend upon a significant portion of government leases, specifically 1 million s/f of deals with state and federal tenants at the Freedom Tower and 1.2 million s/f with state and city tenants at Tower 4. Yet this similarity, which has drawn fire from critics who say it amounts to little more than government subsidization, also underscores another key difference in the market.

The Twin Towers were reviled by downtown landlords throughout the 70s and part of the 1980s for poaching tenants to cure its own vacancy woes, a practice that simply shifted that vacancy elsewhere in the market.

Perhaps the strongest evidence for the continued strength of the downtown market is the lack of concern among landlords for the replay of that scenario. Those landlords, unlike their 1970s counterparts, instead seem confident in their ability to find new tenants to fill the space.

"Downtown is a much more diverse market now, it's not just an office market, there's a residential population and there's a lot more options for owners now who lose tenants to reposition their buildings," said Arthur Stern, a principal at Cogswell Realty Group, which owns 60 Broad Street, a 1 million s/f building that will likely be losing 450,000 s/f of government tenants to the WTC site.

"When they took millions of square feet of tenants out of neighboring buildings to backfill the Twin Towers, really the only game in town was to try to find additional replacement financial firms. The office market is more diverse than it was back then, there's all sorts of tenants looking downtown for space, so I think that will mitigate some of the problems."