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In Midtown, have the best deals been had?

Throughout the first quarter of 1993, we saw more evidence of the bottoming-out of the New York commercial market, a process we have been discussing for the better part of the last year.

A year ago, we forecasted that net effective rental rates at Class A buildings would soon be stabilizing. Net effective rents -- or the cash-flow available to property owners after real estate taxes, operating expenses, transaction expenses, free-rent and amortization of workletters -- had been in a three-year free-fall. At the time, we saw that the supply of available Class A space was on the decline and, as a result, net effective rents had little room to drop further.

In hindsight, we see now that the bottom, at least for the premium properties, was reached in the fourth quarter of 1992. Tracking the value of "typical" closed leases -- net effective rents -- along Midtown's Sixth Avenue corporate row illustrates our point: Mid 1990-- $21.15; Mid 1992 -- $4.87; End 1992 -- $3.02; Mid 1993 -- $6.68.

To us, this provides strong evidence that the best values have already been had in Midtown. Net cash-flows of $3 per square foot are insufficient to support debt service, let alone produce a return on equity, and therefore, are clearly not sustainable over the long-term.

It is inevitable that net effective rents will continue to edge up as new leasing cuts further into the available supply-Midtown vacancies have diminished to 13.8 percent from 15.2 percent over the past year.

This edging up has manifested in a number of different ways. At many Class A buildings, landlords are less negotiable on asking rents. Workletters have become less generous: $65 per square foot landlord contributions are history; today $50 to 55 per square foot is more the norm. Free-rent periods have been slightly scaled back as well.

Thus far, the tightening of the market has only been modest; and tenants, for the most part, continue to wield tremendous negotiating leverage. But there is now tangible evidence that the market is slowly rebounding, and we expect this trend to accelerate as market fundamentals improve.

More than a year ago, a proprietary analysis by CB Commercial's Torto Wheaton research unit predicted an upturn in net absorption. This analysis proved prophetic as net absorption turned positive last year for the first time since 1989. Net absorption strengthened further in the first three months of this year, totaling an impressive 800,000 square feet.

The local commercial real estate market may well receive a boost from the growing, though somewhat tentative, perception that the New York City economy may be emerging from the long recession. The latest employment figures showed a gain of 31,000 City jobs in May and a recent survey by the New York City Chamber of Commerce & Industry pointed to growing confidence about the local economy within the business community.

If sustained, this renewed optimism could prompt some companies to act on long-deferred expansion plans or to invest in new ventures. This scenario could further fuel the recovery of effective rental rates at Class A buildings by creating more demand for a shrinking supply of available space.

Increasingly, tenants that are looking for "bargain" deals will be forced to the secondary market. We have seen no evidence yet of a similar recovery in Class B and C properties. Vacancies persist at extremely high levels at these properties, but because many are technologically obsolete, they are not viable location options for many of today's tenants.

This is but one additional factor that will bolster the future moves by landlords at Class A buildings to tighten up on concessions and raise base rents as market fundamentals slowly improve.
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Title Annotation:Mid-Year Review & Forecast, Section V; evaluation of New York, New York real estate market for first quarter of 1993
Author:Swerdlow, Steven A.
Publication:Real Estate Weekly
Article Type:Column
Date:Jun 23, 1993
Previous Article:Corporations want more than just office space.
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