Office market posts strong quarter.

After several cool quarters, the Manhattan office market posted strong results in the third quarter and is now poised to end the decade with the lowest vacancy rates and highest asking rents since the early 1980's, according to a recent report by Cushman & Wakefield (C&W).

Unlike other markets, where speculative building is the norm, the conservative approach to growing the office inventory is extending the expansion phase of the real estate cycle.

New York's economy added 78,800 private sector jobs over the last 12 months. Not since 1970 has the level of overall private sector employment at this time of the year been this high. This growth is occurring despite lean hiring practices on Wall Street and is being driven by a diversified services sector, which has produced nearly 60,000 jobs in the last year. Within the services sector, business services, which includes many high-tech/computer-related businesses, motion picture and health services employment, have posted the most substantive gains.

These expanding industries possess corporate cultures and aesthetic preferences that are diametrically different from the financial giants which have traditionally dominated the New York economy and real estate market. As a result of these firms' increased presence, notions of locational prestige are being transformed, and both leasing and investment activity in once marginal areas are flourishing, the C&W report concludes.

Manhattan's overall vacancy rate is at the lowest level of the decade, closing the third quarter at 7.4 percent. The direct Class A rate is even tighter at 5 percent.

While the overall and Class A vacancy rates are relatively low, they are higher than those being recorded in some of the country's other major office markets, most notably Boston and San Francisco, where the same type of economic growth is producing Class A vacancy rates below 3 percent.

As a result of the short supply of quality available space, both year-to-date leasing activity and net absorption are below the totals posted a year ago. Leasing volume is down 8.6 percent at 23.9 million square feet, while net absorption is off by more than 30 percent at just under 5 million square feet. Both of these declines are almost entirely attributable to Downtown Manhattan, where an extreme shortage of large Class A blocks has frustrated the efforts of many larger tenants in the market. Only two new leases over 100,000 square feet have been signed thus far this year.

The direct weighted average asking rate, currently $39.44 per square foot, is up 19.9 percent from a year go and should reach the $40 per square foot by the early 2000. Class A asking rents are $46.04 per square foot.

Midtown's overall vacancy rate has continued to drop, reaching a 17-year low of 6.6 percent in the third quarter of 1999.

Direct weighted average asking rents in Midtown rose by only $0.03 to $41.57 per square foot during the third quarter of 1999. Paradoxically, Class A,B and C direct rents increased by substantial amounts, with Class A rents reaching a record $48.40 per square foot and a few top properties signing leases for higher floors in the $80 to $90 per square foot range. The narrowness of the overall increase is not an indication of the market's peak, but reflects the fact that less expensive Class B and C space constitutes a larger share of the overall supply of available space than in the past.

Several mega-deals at development sites are in the pipeline and these should alleviate the pressure on Midtown's already limited supply of large blocks of available space. Ernst & Young's recent 1.1 million square-foot lease at 5 Times Square, for example, will result in the return of two large blocks of space to the market t 787 Seventh Avenue and 750 Seventh Avenue, while Random House's move to a new tower at 1745 Broadway will open up more than 400,000 square feet at 825 Third Avenue.

Midtown South's overall vacancy rate is currently 6.9 percent. With a shortage of supply, multiple tenants are pursuing the same spaces, and some tenants are in serious negotiations at multiple sites at one time.

At $29.96 per square foot, overall weighted average total asking rents continue to rise and should break the $30 per square foot mark by the end of the year. Class A rental rates have appreciated by 20.5 percent since the beginning of the year and are currently $36.72 per square foot. Direct Class B space, which accounts for nearly 40 percent of the overall supply of available space, commands $33.41 per square foot.

Demonstrating the direction of the "new" Midtown South, leasing activity continues to be dominated by new and traditional media firms, telecommunications companies, high-tech/Internet outfits and engineering firms. These industries accounted for 17 of the 20 largest leasing transactions so far in 1999. While these industries now are entrenched in the market, as recently as 1994 they produced only three of the 20 largest leases.

Buildings of formerly questionable condition and location are being transformed into desirable space for better tenants. For example, 450 West 15th Street is now 96 percent leased to new media and arts tenants; 85 Tenth Avenue has been acquired by Level 3 Communications; and Martha Stewart is setting up shop in 75,000 square feet at 601-25 West 25th Street. The buildings at 325 Hudson Street and 260 Eleventh Avenue, both of which are available and are being upmarketed, are looking to become the next success stories.

In a market with minimal vacant land, these redevelopment efforts are creating "new" buildings in Manhattan that are available for rents comparable to those asked at newly constructed buildings in the suburbs.

Downtown's total Class A vacancy rate has edged up slightly from the record-low posted at year-end 1998 and stands at 5.8 percent, still lower than the 6.2 percent posted in Midtown. At 9.5 percent, the Class C vacancy rate is now lower than Class B and half the level of two years ago. This is largely due the fact that nearly 25 percent of the Class C inventory has been removed from the market due to residential conversion. The conversion phenomenon continues to transform Downtown, and 19 Rector and 17 Battery Place have been confirmed as the latest major office buildings to be slated for the luxury residential market. These may be the last large office buildings in either the Financial East or. West submarkets to be removed from inventory, however, as the conversion phenomenon has taken a new turn, focusing on smaller, older Class C properties located in the City Hall and Insurance districts.

Year-to-date leasing activity is down dramatically over 1998, when over 10 million square feet was leased and six deals over 200,000 square feet were recorded. In contrast, 1999 has witnessed only one deal of this size, and just under 5 million square feet has been leased. With several large financial services firms in the market, leasing activity should rise next year, C&W predicted.