The Landlord’s Market: Midtown South’s Uphill Climb

Midtown South is starting to look a little like Downtown North.

In the latest sign of the evolution of Manhattan’s former no-man’s land between Midtown and Downtown into the hottest office submarket in the U.S., Cushman & Wakefield last week noted a migration of financial firms into Midtown South and a corresponding overflow of technology and media firms into the Financial District over the past 10 years.

“We’ve never seen such an intertwining of the Midtown South market and Downtown,” Andrew Peretz, executive vice president at C&W, said in an interview.

Gas Odor Investigated In New York CityThe “invisible dividing line” at Chambers Street or Canal Street that used to separate financial companies from more creative industries to the north has virtually disappeared, he said.

Financial companies now occupy 6.4 percent of the office space in Midtown South, up from zero a decade ago, C&W said in its quarterly update on the Manhattan office market. Information, media and technology companies—the kind normally associated with the converted warehouses and low-lying buildings between Canal Street and 32nd Street—have increased their share of Downtown by a factor of 10 to 20 percent. Financial users’ share of Downtown space has plunged to 7.4 percent from one-third in 2003.

The changes mark a more cost-conscious attitude and a smaller role played by the financial industry in New York’s economy—as well as the increasing importance new media and technology firms, which have raised their share of the Midtown South market to more than 38 percent from 27 percent a decade ago. The evolving tenant makeup also shows a shift in development strategy, as landlords and developers seek to emulate the kind of “live, work and play” environment that drew entrepreneurial tenants to Midtown South and created a more vibrant atmosphere Downtown as older office buildings were converted to residential use.

“Midtown South right now is the healthiest submarket in the country,” Mr. Peretz said. “Demand is very strong. In the last 14 quarters, [leasing] activity in Midtown South has exceeded the 10-year quarterly rolling average—a direct reflection of space being taken off the market.”

Technology entrepreneurs have been drawn into the area, he said, by the “gravitational pull” of Google Inc., which bought the 2.9-million-square-foot Art Deco building at 111 Eighth Avenue in 2010 and has since expanded in the Chelsea Market.

Brokers said the district has also proved alluring to private equity and hedge fund owners, who have set up shop near the hot residential areas of Tribeca and Chelsea where they live. Financial tenants in the area range from Paul Tudor Jones’s Tudor Investment Corp., which has offices at 401 West 14th Street, and Two Sigma Investments LLC, at 100 Avenue of the Americas, to investment banking companies such as Credit Suisse Group in and around 11 Madison Avenue.

The submarket’s vacancy rate of 6.9 percent at the end of the first quarter makes Midtown South “a market that’s beyond equilibrium,” and well into being “a landlord’s market,” said Mr. Peretz, who estimated that the balance of power between owner and tenant in New York tips at a vacancy rate of 8 or 9 percent. Net effective rents in the area are up 70 percent since the recession ended, he said.

Total weighted average rent in Midtown South at the end of March stood at $51.97 a square foot, compared with $40.28 Downtown and $66.34 in the Midtown market, Cushman & Wakefield data show.

CBRE reports the top leasing transactions in the first two months of the year included J.Crew Group Inc.’s expansion by almost 80,000 square feet of space at 770 Broadway, a 22,000-square-foot renewal and expansion at 609 Greenwich Street by ITV Studios, and Syracuse University’s lease on 22,000 square feet at 136 Madison Avenue.

Major new availabilities included 117,000 square feet of Credit Suisse sublease space at 315 Park Avenue South, 84,000 square feet of Kaplan Educational Centers sublease space at 395 Hudson Street and 60,000 square feet at 85 10th Avenue, CBRE found.

Rents and the type of space found in Midtown South vary widely, and some recent leasing activity has reflected moves within the district. In a deal brokered by Adams & Co., marketing and branding company And Partners is moving from space on West 27th Street to a 5,000-square-foot office at 121 East 24th Street, at an asking rent of $45 a square foot.

Midtown South’s smaller floorplates and “older vintage” buildings may accelerate the migration to other areas as entrepreneurial firms mature and grow, said Justin Halpern, vice president of tenant representation at Cresa New York.

Avison Young counts only six blocks of space bigger than 100,000 square feet available in the Midtown South, compared with 22 Downtown.

“This used to be the low-cost alternative,” Mr. Halpern said. “Downtown is the No. 1 beneficiary” as would-be Midtown South tenants seek lower rents, and “Grand Central may be the next best bet.”

Ira Z. Fishman, the president of Winoker Realty Co., who chairs the Midtown South committee at the Real Estate Board of New York, said the panel had a visit recently from a representative of the group’s Grand Central committee who was looking for overflow business.

“Maybe you can bring some people to Grand Central, where you can save some money,” Mr. Fishman quoted the visitor as saying.

New construction in Midtown South is limited to a handful of projects, the biggest of which is a 430,000-square-foot building at 51 Astor Place, due to open next month. Developer Edward J. Minskoff and broker Paul Glickman, vice chairman at Jones Lang LaSalle, said the property offers the 14- to 18-foot ceiling heights and open work spaces that Midtown South tenants like—along with state-of-the-art technology that isn’t available in 90 percent of the buildings in the area. It’s within walking distance of four hotels and “dozens of great restaurants,” Mr. Minskoff said.

The property has attracted strong interest from prospective tenants, Messrs. Minskoff and Glickman said, including companies vying to anchor the building and put their brand on the neighborhood, just as Google  put its mark on the western part of the district.

“It’s a change in the neighborhood for the good,” said Mr. Minskoff, who is seeking rents ranging from the mid-$80s to as much as $115 a square foot.

On the western side of the district, developer Christopher Albanese, principal in the Albanese Organization, said he hopes to begin construction of a 169,000-square-foot building with frontage on the High Line park by the end of the year and to have it ready for occupancy 14 to 18 months later. Rents will range from the mid-$70s to the mid-$90s per square foot, he said.

In the Meatpacking District, Taconic Investment Partners and Thor Equities have broken ground on a 55,000-square-foot office and retail building at 837 Washington Street, which the developers expect to complete in the first quarter.

In all, the new construction won’t be enough to increase the vacancy rate or curb rents in the district, where inventory totals more than 65 million square feet of office space, according to C&W data. The migration to Downtown and Midtown is likely to continue, as tenants who signed leases in the high $30s per square foot experience “sticker shock” when time comes to renew, said Gregory Kraut, principal and managing director of Avison Young.

Some of the new developments, meanwhile, may be out of character with the gritty, non-corporate ambiance that attracted companies to the area, said Andrew Berman, executive director of Greenwich Village Society for Historic Preservation. The group opposed the zoning for 51 Astor Place on the basis of its size, even though the Cooper Union building it replaced was “no treasure,” he said.

With the construction of 51 Astor Place and the nearby Sculpture for Living apartment building, “that intersection’s almost unrecognizable,” Mr. Berman said. “There was room for improvement, but I fear it looks like an office park in the suburbs of Dallas rather than the gateway to the East Village.”

Midtown South’s success has created a model for the redevelopment of industrial areas and older office districts throughout the city and country. Matthew E. Galligan, group president of CIT Real Estate Finance, said olderMidtown office buildings may be converted to residential use, to create a similar “24/7” live-and-work environment and spur demand for new office construction, while more warehouse areas along the Brooklyn waterfront are likely to converted to residential and office use.

A similar dynamic is at work in San Francisco, as technology companies, which typically employ the kind of workers who want to come to work “on a skateboard,” move in from the suburbs, Mr. Galligan said.

For now, Midtown South brokers and property owners are still waiting for rents to hit a plateau.

“I still think people would prefer to be in Midtown South and pay a little more,” said Bradley Gerla, executive vice president of CBRE’s Downtown office.

“Nobody really balks at $60 a foot,” said Andrew Roos, vice chairman at Colliers International. “I don’t know what happens if it gets to $70. I don’t see it dropping back to $30.”

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