Office market post record setting rent growth in 2006.

Businesses from around the country continued to move to New York during the past year, recognizing that the city has the finest labor pool in the nation.

New firms relocated to Manhattan to take advantage of this talent, and existing companies chose to expand operations in place rather than move elsewhere. This was a significant shift from the mid-1990s, when companies sought to relocate to lower-cost cities while still trying to access top talent.

These trends helped Manhattan's office market post record-setting growth in average asking rental rates during in 2006, with rents throughout the city jumping 23%. High-quality buildings saw rates climb 31% at year-end 2006, boosting rents beyond levels seen during the previous market high early 2001.

The robust interest in Midtown New York office space fueled a 34.6% jump in Class A rents in the fourth quarter of 2006. Rates jumped more than $20 psf in the past 12 months, reaching $78.62 psf. The submarket's trophy class office properties saw rents surpass the $100 psf mark, while penthouse and other top-flight spaces achieved rents of $125 psf or more.

This continued influx of tenants kept Midtown vacancy rates hovering around 6% in the final quarter of the year. The limited options that remain, and the ongoing escalation in rents, among the submarket's Class A buildings have pushed tenants into outlying areas and lesser quality office product.

As a result, Class B buildings in Midtown saw vacancy rates plummet 12% at year-end 2006, slipping just under 6%. This drove up Midtown Class B rents by 14.7%, rising to $46.13 psf in the fourth quarter of 2006.

Midtown South and Lower Manhattan buildings also reaped the benefits of an active leasing market at year-end 2006. Average asking rental rates for Midtown South Class A office space surged by 30.3% to $45.55 psf. Midtown and Midtown South Class B buildings, located in the West 30s and West 40s, offered the best deals for tenants and investors. The potential growth in this part of Midtown South makes existing rent levels a value.

Lower Manhattan Class A buildings saw rents driven up by 17.3%, rising to $46.20 psf. The submarket recorded a major rise in office rents despite a substantial increase in vacancy rates. Downtown's inventory was boosted when 7 World Trade Center's 1.7 million square feet of Class A space was added to the market. Silverstein Properties Inc. priced 7 World Trade Center above market, causing average asking rents to rise despite an increase in vacant space.

Lower Manhattan's lesser quality office buildings also continued to improve, aided by the ongoing impact of the conversion of commercial space to residential property. The Class B market posted a 16.5% decrease in vacancy rates at yearend 2006, dropping to 11.2%.

We expect that the number of tenants seeking quality space will outpace availability this year, especially in Midtown.

This is likely to ratchet overall average asking rents up to $70 psf or more.

BY JAMES DELMONTE, VICE PRESIDENT, DIRECTOR OF RESEARCH, JONES LANG LASALLE