Manhattan office market posts solid fundamentals.

Due to solid market fundamentals, Manhattan continues as a top investment location. The market has adjusted to restrained lending, and both buyers and sellers are being more conservative with potential deals.

The recent slowdown in transactions earlier this year was more a reflection of a decline in the quality of buildings on the market than of a decrease in investor interest.

Currently, transaction activity has picked up. Two properties in Midtown and one property Downtown traded in the latter part of the first half of the year. The building at 450 West 33rd Street, at the corner of Tenth Street, sold for $223 million ($139 per square foot), and 521 Fifth Avenue, at the corner of 43rd Street, was bought for approximately $93 million ($210 per square foot). The purchase price excludes $4 million that the new owner will use to renovate the property. GE Investments sold 14 Wall Street for $100 million ($100 per square foot).

Overall, Class A properties Downtown are trading at an average of $185 per square foot, according to Cushman & Wakefield. For Midtown, the average is $287 per square foot.

Insurance companies, private partnerships and foreign investors are active buyers. REITs are also participating in the market. Although the total monetary investment in Manhattan by REITs is down from last year, they represent a larger portion of the buying pool.

The market continues to benefit from the continued restraint on speculative new construction. Vacancy rates are still low. In Midtown the vacancy rate was 7.4 percent at the end of the second quarter, according to Cushman & Wakefield, which reports a Downtown second quarter vacancy rate of 8.4 percent. Some submarkets, such as Midtown South, have vacancy rates under 6 percent. Vacancy rates are even lower for Class A space - 4 percent Downtown and 5.2 percent in Midtown. Tight market conditions are minimizing concessions.

This quarter there were minimal shifts in most cash-flow forecast assumptions. The average discount rate (IRR) inched up 1 basis point to 11.36 percent. The average overall cap rate (OAR) slipped down 3 basis points to 9.03 percent. The market rent change rate dropped 6 basis points to 3.5 percent, while the expense change rate held steady at 3.44 percent.

Prices for Manhattan office properties are still generally below replacement cost. Discounts range from 10 percent to 40 percent, with the greatest discount being received by Class B properties. However, prices for Class B buildings are increasing. Overall, investment survey participants estimate that the average price of Class A and Class B properties together is 82 percent of replacement cost. Prices are expected to increase from 3 percent to 10 percent over the next 12 months; the average projected increase is 6.63 percent. This is a decline of 77 basis points from the prior quarter.

The shortage of space and continued job growth are helping to keep rental rates high. In Midtown the overall average asking rent was $41.54 per square foot; for Class A space, the average was $48.11. Downtown, the overall asking rent hit $32.31 per square foot; for Class A space it was $38.84.

There is some uncertainty as to how long rental rates can keep climbing. Although there is no fear that an oversupply of space may put down ward pressure on rent growth, investors are wary that persistent growth in rental rates will slow leasing activity or cause tenant to relocate out of the market. Investors, concerned that there is minimal upside in current rent levels, are scouting the market for investment-grade properties which were eased during the recession of the early 1990's, hoping to benefit from near-term lease se expirations.

Investors estimate that some leases are currently up to 20 percent below market rent.