Five-year low vacancy spurs office space race.

Cushman & Wakefield released third quarter statistics for the Manhattan office market showing Manhattan posting its lowest vacancy rate in five years.

At the end of the third quarter, Midtown, Midtown South and Downtown all had single-digit vacancy rates, with Midtown and Midtown South at less than 6.5%. The overall Manhattan vacancy rate declined to 7.0% from 9.6% at this time last year.

Boosted by several high-profile transactions, including Moody's 589,945 s/f lease at 7 World Trade Center, Downtown's overall vacancy rate fell to 9.1% at the end of September, down 2.1% from midyear 2006. Midtown's vacancy dropped to 6.5%, while Midtown South's vacancy dropped to 6.1%.

The continued decline in vacancy has contributed to a rise in Manhattan asking rents to an average of $45.84, up from $43.46 in the second quarter of 2006. Leading the rise is Midtown, where rents for class-A space available directly from landlords now average $60.71, up from $53.92 at this time last year.

Although on average, prices have not yet surpassed historic highs, records are being set in the high-price arena. In 2003, eight deals above $70 psf were recorded, compared to 110 at the end of the third quarter of 2006. Of those 110, 31 were completed with rents above $100 psf.

"In addition to an increase in the amount of deals over $100, we're also beginning to see variety in the submarkets where these deals are getting done," said Joseph R. Harbert, Cushman & Wakefield's chief operating officer for the New York Metro Region. "In the past, only the Madison and Fifth Avenue submarket commanded this level of rent. However, this year, and specifically during the third quarter, we're seeing buildings on the East Side, on Park Avenue and in the Grand Central submarket with triple-digit taking rents."

Harbert also reinforced that these were not unsubstantial deals. In fact, 19 of the 31 deals completed at more than $100 psf were in excess of 10,000 s/f, and seven were more than 20,000 s/f. The five-year vacancy low was a result of Manhattan's most-active leasing quarter in nearly two years. At the end of the third quarter, the total absorption rate for Manhattan was positive, at 2.1 million square feet, despite the addition of 1.7 million square feet added to the market at the start of the year.

Leasing activity also surged Downtown, marking the busiest quarter recorded in recent years. Year to date more than 4 million square feet of office space has been leased Downtown, compared to 3.4 million square feet in all of 2005. Four of the year's top 10 leases were completed during the third quarter in Lower Manhattan.

"These low vacancies reinforce the need for new office space," said Harbert. "Manhattan does not currently have enough space to accommodate all the tenants who are currently seeking locations or looking to expand, particularly those corporate users that require the amenities, systems and infrastructure only found in class-A buildings."

The prospect of limited space encouraged some tenants to jockey for the remaining Midtown class-A space in the third quarter. More than 4.2 million square feet of class-A space in Midtown was taken off the market in the third quarter, bringing Midtown's direct class-A vacancy rate to 4.8%, its lowest point in nearly five years.

Looking forward, only two Midtown class-A properties are expected to be completed over the next 18 months, and each is already more than 85% pre-leased. "With much of the development in Midtown already spoken for, it's going to become increasingly difficult to find office space, especially for those tenants looking for large, contiguous blocks of space," said Harbert.

All of the 10 largest leases completed this year have been in excess of 200,000 s/f, and though the amount of large blocks of office space has diminished, the number of tenants looking for them has not.

According to Cushman & Wakefield statistics, there are currently at least 16 tenants--ranging in industries from financial services to government agencies--that require space in excess of 250,000 square feet. However, only seven such spaces exist in Manhattan.

"Tenants in these situations have several options," said Harbert. "Some tenants already locked in growth space early by negotiating renewals and expansions. Others may choose to diversify their operations into several locations."

According to Harbert, this has led to a shift in corporate leasing trends.

"We're beginning to see a 'new lease' market," said Harbert. "Tenants are relocating, either because they're being priced out of their current space or their current owners are unable to meet their expansion requirements.

"According to Cushman & Wakefield data, eight of the top 10 leases completed in the third quarter were new leases.

In contrast, seven of the top 10 deals at midyear 2006 were renewals and expansions.

Financial services led all industries leasing space in Manhattan, accounting for 35 percent of all leasing activity year-to-date. Financial services firms also made up four of the 10 largest leases in the third quarter.

At the end of the third quarter, more than $14.3 billion in Manhattan sales have been closed, up from $12 billion at this time last year.

"With more than $16 billion under contract, we are clearly on a path to exceed last year's record of $20.9 billion in sales," said Harbert.

Manhattan office buildings continue to be actively sought by investors, accounting for 62% of all property sales closed and under contract. Residential properties accounted for 12.7% at the end of the third quarter, down noticeably from 22.9% this time last year.

According to Harbert, investors are taking advantage of strong office leasing fundamentals.

With 42% of sales, private capital continues to dominate the marketplace. REITs also made a strong showing at the end of the third quarter, accounting for 30% of activity and driven by transactions like Equity Office Properties' purchase of 1540 Broadway.

Acquisitions made with Dubai-based capital, like Istithmar's purchase of 280 Park Ave., bumped foreign investment to 13.9%, up from 7.4% this time last year.

"There is a larger supply of capital--coming from a variety of investor types--than there is supply of quality product on the market," said Mr. Harbert.

The Manhattan retail market continues to see historically low vacancies and soaring asking rents. Asking rents rose notably on the Upper West Side, with landlords asking $288 psf, up from $242 this time last year.

Madison Avenue also experienced a large rent increase, jumping more than $50 year-over-year, from $862 psf at the end of the third quarter of 2005, to $913 psf at the end of September.

According to Harbert, there continue to be two primary drivers for retailers entering and operating in the Manhattan commercial real estate market: sales and branding.

"We're seeing an increased focus on the brand value of retail real estate," said Harbert, "which has led to a structural change in how this real estate is valued."

This trend has spread beyond the traditional tourist-heavy Times Square and Madison and Fifth Avenues, and has now spread to other areas based on retailers identifying customers and targeting their marketing messages geographically.

Additionally, different types of retailers have undertaken this type of branding effort.

Technology and wireless retailers are now utilizing their real estate as marketing tools, most recently illustrated by Nokia's flagship on Fifth Avenue and 57th Street, which follows Apple's success at Fifth Avenue and 59th Street.

According to Harbert, investors have shown an increased interest in retail properties, which accounted for 4.7% of sales closed year-to-date, compared to 1.4% this time last year.

OFFICE MARKET STATISTICS BREAKDOWN

MANHATTAN          3Q '06   2Q '06   4Q '05   3Q '05

Total Vacancy      7.0%     7.8%     8.4%     9.6%
Sublease Vacancy   1.3%     1.4%     1.6%     2.0%
Overall Rent       $45.84   $43.46   $40.58   $41.35

DOWNTOWN           3Q '06   2Q '06   4Q '05   3Q '05

Total Vacancy      9.1%     11.2%    10.6%    11.5%
Sublease Vacancy   1.5%     1.9%     2.1%     210.0%
Overall Rent       $36.18   $35.18   $30.89   $31.09

MT SOUTH           3Q '06   2Q '06   4Q '05   3Q '05

Total Vacancy      6.1%     6.0%     7.4%     810.0%
Sublease Vacancy   1.0%     0.7%     0.6%     0.6%
Overall Rent       $37.50   $35.78   $33.63   $33.58

MIDTOWN            3Q '06   2Q '06   4Q '05   3Q '05

Total Vacancy      6.5%     6.9%     7.8%     9.3%
Sublease Vacancy   1.3%     1.4%     1.7%     2.3%
Overall Rent       $53.02   $50.35   $47.41   $48.06

Source: Cushman & Wakefield Research