Hard Times in Office Space

Who: William E. Hartman, Executive Vice President, Cushman & Wakefield

Where: Nocello, 257 West 55th Street, New York City, July 27, 2009

On the Menu: Gnocchi, salmon and real estate travails

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Nocello, a midtown Italian restaurant I reserved for a lunch interview with Cushman & Wakefield’s William Hartman, happens to face a long blue construction fence stretching the entire length of a city block. Behind the fence, the foundation of another huge Manhattan skyscraper looks nearly complete.

“These people must feel sorry the building across the street wasn’t built,” observes Hartman, surveying the sparse lunch hour crowd at the restaurant. Alas, 250 West 55th Street, a glittering 39-story, 1 million square foot all-glass office tower designed by world-renowned architects Skidmore, Owings & Merrill and developed by Boston Properties, has been a hole in the ground since February.

In fact, observes Hartman, the expected anchor tenant in the building, law firm Proskauer Rose, re-signed its lease in nearby Worldwide Plaza, a 1.8 million square foot complex owned by Deutsche Bank after developer Harry Macklowe defaulted on $7 billion in loans. Deutsche recently sold the building for $600 million, or around $330 per square foot. To gauge how far New York real estate has fallen it would suffice to say that Macklowe bought Worldwide Plaza for $1.7 billion in early 2007 and as recently as December 2008 Deutsche was negotiating a deal to sell it for $2 billion.

This is symptomatic of the real estate situation in New York, says Hartman. There is a glut of vacant office properties and rents have fallen by an average of 44 percent. If special deals, free rent and other perks are taken into account, a decline in rents turns out to be even more dramatic. You can now buy a building for a fraction of what it costs to build a new one — which is why so little goes on behind numerous blue construction fences around New York City.

Top to Bottom

“This crisis has been very different from previous ones,” says Hartman. In the past, a real estate crisis was felt initially in less desirable segments of the market, where rents and prices fell and vacancies rose. Then, in more severe downturns, the market for top-notch properties would begin to soften, as well, although typically not by much.

But now, it has been exactly the opposite.

“The top of the market was hit first, because so many leading financial firms failed or had to cut their staffs,” he says. “On the other hand, all those B-class properties began to feel the pain later, after it was already felt on Park Avenue.”

Similarly, Manhattan — where Hartman specializes in office space rentals and investment deals — was hit first and hardest. Now, the blight is impacting other markets, even though in other cities, where prices didn’t rise quite as much as they did in Manhattan, there has been less room to go down.

A curious aspect of the current recession is the chain reaction dragging down real estate and financial services industries in tandem. The crisis began in residential real estate, but the crux of the matter was severe overleveraging, which triggered mortgage delinquencies and a financial crisis. After the collapse of several top-flight financial institutions, the crisis spread into commercial real estate, where developers and building owners are also severely leveraged. The deleveraging process is still going on. Banks remain reluctant to lend and demand a far larger equity participation in every deal.

One factor supporting office space in Manhattan, says Hartman, may be the fact that during the past several years, even before the advent of the crisis, the construction of office towers slowed, and most construction activity focused on apartment buildings instead. Some older office buildings, especially downtown, were even remodeled and turned into condos. Now, while there isn’t much new office space coming on line, at least not speculative construction, new condos are being finished without many buyers in sight, making lenders extremely nervous.