Silverstein deal sparks a downtown migration.

The bumper 600,000 s/f lease signed by Moody's investors service at Larry Silverstein's pristine 7 World Trade Center kicked off a third quarter that has seen the supply of office space in the city continue to dwindle and rents spiralling to record levels.

The downtown market has enjoyed an unprecedented level of activity with Class A vacancy dipping to 9.6% from 10.2%, according to the latest numbers from Colliers ABR.

Rental rates there now stand at $44.64 psf, up from $33.76 at the beginning of the year, a remarkable jump which many market watchers attribute to Silverstein's $50 psf deal with Moodys kick-starting a virtual migration downtown.

"People finally understand what the transformation of downtown is, and how large it is actually going to be," said Michael Hofmann, senior managing director at Colliers.

Speaking at Colliers recent 3Q market forum, James Frederick, the firm's principal and executive managing director, added, "Once complete, downtown will have the greatest and best transportation infrastructure in Manhattan, better than midtown. Not to mention, in Midtown the lowest of B, B-property is going for $40-43 psf. You can get a brand new property downtown at face rates of $50 psf before incentives, whereas in midtown you have to look at buildings that were built in 1920 to compete on price."

Craig Evans, Colliers senior managing director, couldn't agree more, "From an investment standpoint, the cost per square foot is much lower downtown and the projected returns are higher. The upside potential there is extraordinary. You're going to have tenants fleeing the high rates in midtown and going down town. The upside potential for downtown is reflected in the extraordinary infrastructure improvements," he said.

With the third quarter numbers reflecting a continued slide in vacancies, some brokers believe a slow down in the market wouldn't necessarily be a bad thing.

"It'll help in a way. Calming the market out of the hysteria point will give landlords time to build finally, so they can catch up to the market," said Robert Sammons, director of research at Colliers ABR.

According to Colliers, the vacancy rate for the entire Manhattan market has fallen to its lowest level of 8.1%, since March 2001's 6.4%, and the average asking rent is $47.66 psf. "It's good that the market has tightened across the board, not just midtown, even though it might drop even further to 6% by early next year," said Sammons.

Midtown has the most inventory, with the highest asking rate of $57.80 psf. Yet according to the Trammell Crow Company (TCC), it had a net absorption of 950,153 s/f in the third quarter.

According to Hoffman, "There are a handful of concentrations of hedge funds in the world: New York City; Greenwich, Connecticut; London and, to a lesser extent, Chicago. These are companies that have such enormous revenues and profit margins that whether they spend $50 psf for office space or $150 psf, it's really inconsequential to them. It has really caused landlords to feel bold enough to ask for rents as high as they feel like."

Most of the recent major leasing activity has taken place in buildings that are not yet to be complete or under major renovations, including the 200,000 s/f Legg Mason lease at the New York Times building at 620 Eighth Avenue, which won't open until next year.

According to TCC, midtown South has the lowest total vacancy rate in Manhattan at 5.6%, and Collier's said that the asking rental rate rose 14.6%. The Collier's report stated, "Few substantial blocks of space remain in this market, limiting how much leasing activity can actually take place." The largest lease reported was the Absolut Spirits Company, which is taking 40,000 s/f at 401 Park Avenue South.

Nonetheless, the most improved section of Manhattan has been downtown. Lower Manhattan's class A vacancy dropped to 9.6% from 10.2%. Its asking rental rates are at $44.64 psf, up from $33.76/sf at the beginning of the year, which was driven in part by 7 World Trade Center, with asking rates of $50 psf, reported Colliers. Most notable leasing downtown was Moody's Financial Services, signing a 600,000 s/f lease, the largest since 9/11. With developers unveiling WTC plans, the three new towers will bring 6.2 million square feet to the downtown market.

Rental rates, especially for class A space have everyone talking. Class A vacancy rate has fallen to 6.8%, the lowest since the 6.7% recorded in August 2001, and the average asking rent climbed to $60.35 psf.

Rental rates in the retail sector have skyrocketed Fifth Avenue in particular. "Rents on Fifth avenue are over $1,000 psf, and I tell you this, if we come back next year, it'll be at $1,200 maybe $1,300. $1,100 will look like a bargain in five years," said Hoffmann.

"We believe clearly, that there's really going to be no ceiling to that level. Fifth Avenue will continue to be the epicenter of the world's leading retail."

Although the market is expected to cool somewhat, investment analysts believe rental rates will continue to soar. "Very astute investors believe that this is going to continue. They're making a bet that inflation or higher rental rates will be sustained and continued," said Evans.

Frederick shared the same sentiment, saying that foreign investment, for example, is likely to continue to increase. "Statistics will show that we're relatively cheap [compared to other nations.]. A lot of people doing business with international firms in Paris, London, some of the cities in China and Japan, find rents there are much higher than they are here. I think that is a significant factor, and that's why your going to see a continued rise in rents in the city."

Added Evans, "Foreign money is looking for a risk adjustment return on capital; in their country, the risk is very high, and this is money that they think is secure in the long term in NYC."

For now, such high rental rates will try to be avoided by tenants that can't afford to stay in NYC, who are already looking elsewhere. "Tenants start looking out of Manhattan, into New Jersey, Long Island City and Brooklyn, where they've tried to build secondary markets, but they haven't really caught on to stand the tide of firms leaving NYC," said Sammon.

TCC reported that employment in NYC has risen 2%, pushing unemployment rates down to 5.1%, at the close of the quarter. "The job growth should slow down, as in the rest of the country, not in a negative aspect, but just enough to allow the market to settle," said Sammon.

"Real Estate moves in cycles, it just depends on how long a low or high cycle lasts. Previous to 9/11, the real estate market fell, because so many dot-com firms were leasing space, and they ended up going under, now more stable firms are leasing space."