Second Quarter Chills

Leasing activity in the first half of 2012 was, by all accounts, a shadow of last year.

About 11.1 million square feet was leased, substantially down from the 17.6 million square feet leased during the first six months of 2011, according to data collected by the real estate services firm Cushman & Wakefield.

dacube inside web Second Quarter ChillsTo be fair, last year, which ended with about 30.1 million square feet of deals in Manhattan, was one of the strongest periods of leasing activity in a decade in the city and hence isn’t a signal alone that the 2012 market is depressed.

Yet activity, after surging during the first half of 2011, has fallen consistently quarter after quarter since then, first to 6.4 million square feet in the third quarter of 2011, then to about 6.1 million square feet in both the fourth quarter of 2011 and the first quarter of 2012 and, most recently, to about 5.4 million square feet in the past three months.

Though the market has clearly been slowing, the numbers alone for months hadn’t been enough to signal trouble; Manhattan has seen an average of about six million square feet of deals per quarter over the past decade, according to C&W, an activity level the market has generally been keeping pace with.

The second quarter’s dip below that threshold, however, affirmed a sense of concern that has been building in the real estate industry about a slowdown. Compounding the dismal quarter was the fact that statistics during the period were substantially propped up by two large transactions, renewals by both Viacom and Morgan Stanley that together accounted for almost three million square feet.

“The European debt crisis, the upcoming presidential election, slowing growth in China and elsewhere, the uncertainty surrounding the global macroeconomy translates into executives being extremely thoughtful before making impactful business decisions—and real estate is certainly one of those decisions,” Ben Friedland, a senior leasing executive at the real estate services company CBRE, told The Commercial Observer. “The uncertainty also leads to a focus on capital preservation, which has caused an uptick in renewals.”

If the market continued at its current clip, not counting for the pace of deceleration it has steadily seen, between 22 and 23 million square feet of space would be leased in 2012, the lowest level of dealmaking since 2009, when the dark depths of the recession brought the market to an anemic 16.3 million square feet of activity.

The numbers weren’t supposed to play out this way.

Many real estate leasing experts predicted that 2012 would be the reverse of 2011, with activity picking up in the latter half of the year as the economy and job growth began to rebound from the macroeconomic uncertainties that had set in during 2011. Now that outlook has been pushed out until 2013—a far foggier timeline.

“I think the increases in the market that we were hoping for haven’t happened as quickly as expected,” Joe Harbert, president of Colliers International’s eastern region, told The CO. “We were looking for a pick up in the third and fourth quarters but most people now think it’s not going to happen until next year.”

What is perhaps the most surprising—and alarming—element in Manhattan’s leasing slowdown is that activity has fallen even as the city has gained a substantial number of new jobs. In fact, according to Ken McCarthy, C&W’s chief economist, New York City has more jobs now than during the last employment peak of 2008, at the tail end of the economic boom of that period: 3.86 million jobs now versus 3.81 million then, and 3.673 million during the lowpoint of the downturn in 2009. Office jobs are also at a peak: about 1.257 million jobs compared to 1.245 million jobs in 2008.

And yet, even as the city gained 35,000 jobs since the beginning of the year, tenants in the city have not taken substantially more space, a fact also reflected in a virtually unchanged vacancy rate, which fell a tenth of a percentage point to 9 percent during the first six months of the year. In 2008, with less overall employment, the vacancy rate was starkly lower; around 6 percent.

“It’s one of the puzzles of the market right now,” Mr. McCarthy said.

Peter Kozel, chief economist at the services firm Colliers International, said one explanation is that the major space-using industries in the city haven’t returned yet to previous employment peaks. Mr. Kozel pointed out that financial services companies, the largest space-using sector in the city, are still down nearly 20,000 jobs from their peak employment in 2008. The legal industry is down 7,000 jobs, he said, and publishing, another big taker of space, is down almost 9,000. Concurrently, in the 35,000 jobs gained during the opening half of the year, not all were office-using positions.

Though this alone wouldn’t appear to answer why more space hasn’t been taken up in a city with more office jobs now than ever before, during the last peak market cycles it was some of these industries, particularly the financial companies, that would aggressively lease more space than they needed in order prepare for further growth. Anticipatory leasing, driven by the expectation of need rather than immediate occupancy requirements, was a large factor as to why vacancy was so much lower just a few years ago.

In contrast, many companies today, rather than banking on expansion, are shrinking their office footprint by more densely packing employees to become more efficient.

“Goldman Sachs is the classic example,” Mr. Kozel said. “They got approximately 20 percent efficiency by relocating their operations into their new building [200 West Street]. They freed up about 2.5 million square feet and moved it into 2 million square feet in that new building.”

Both Morgan Stanley’s and Viacom’s deals are expected to have a similar impact on the market. Viacom, in its deal, renewed and expanded at 1515 Broadway to 1.6 million square feet. But growth likely wasn’t behind the move. The company is expected to backfill the additional space by importing offices from other locations. On balance the deal will probably allow the media conglomerate to occupy less space on balance in Manhattan. Morgan Stanley has similar plans, sources say, to cram employees in where it renewed, at 1 New York Plaza.

“Companies across the board just want to be a lot more efficient with the space,” Mr. Friedland said. “They want to know that they’re using the best practices out there in terms of how many square feet each employee is occupying on average, and the result is it’s pushed down occupancy levels.”

During a market breakfast hosted in Midtown by C&W last week, Mr. McCarthy made a case that despite some of the gloomy trends, the city could nonetheless be poised for a fast turnaround.

“How many jobs would it take to get back to 6 percent vacancy?” Mr. McCarthy asked then. “The number is about 40,000 jobs.”

Mr. McCarthy defended that number in a conversation with The CO, even though the opening six month’s 35,000 jobs hardly made a dent in vacancy and appeared to drive very little activity.

“There’s only so much space these companies can backfill,” Mr. McCarthy said. “You can only be so efficient, and if you see office-using jobs added, the vacancy number could very well dip quickly.”

Mr. Kozel agreed with Mr. McCarthy’s projection.

“I think it’s reasonable to think that 40,000 jobs would get us back to 6 percent or thereabouts,” Mr. Kozel said. “The question is when are the sectors that use space going to grow by that amount? It’s unclear right now.”

The abundance of empty space in the city and the uncertain outlook for job growth would appear to be daunting, especially for development, but Bruce Mosler, a top leasing executive at C&W who is the agent for the multimillion-square-foot office project Manhattan West, planned by Brookfield Properties, said the abundance of companies in search of efficiency has made new buildings an attractive option.

“You would think that to get a new office building out of the ground you would have to be at a 6 percent vacancy rate,” Mr. Mosler said. “But with the way companies want to be ultra-efficient with their space, there is a wide field of interested tenants in our project. New space that is column free and that has state of the art amenities and design like this offers a level of efficiency you just can’t get in the city’s aging stock of existing buildings.”

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