Trophy Office To Benefit from Fundamentals

NEW YORK CITY-Manhattan's trophy office buildings are poised to benefit from improving fundamentals, new options and higher rents during the next 12 months. After a year in which the city's office market seemed paralyzed by outside political distractions and economic uncertainty, the trophy market will remain somewhat uneven over the next year, with some submarkets and certain high-end buildings—and even select spaces within those properties—seeing strong demand while others languish.

Although Wall Street employment continues to lag other industry sectors, stock indices have reached record levels and profits have risen consistently in recent quarters. Confidence appears to be on the rise. The spike in vacancy rates for Downtown trophy properties the market recorded in late 2012 was the result of several large financial institutions reducing their space requirements. These moves were anticipated by the market several years before the spaces became available and, while none was positive for the market, they did not represent a material change in current supply/demand fundamentals.

While some banks continue to have excess space, most are making cautious, portfolio-wide decisions based on future space needs. At the very top of the trophy market—where hedge funds and private equity firms account for most of the activity—demand has been stable. The city saw 51 closed transactions with starting rents of more than $100 per square foot in 2012, compared with 56 in 2011. While significantly lower than the 81 deals of more than $100 per square foot recorded in 2007 or the 91 seen in 2008, recent year-over-year demand for top-end space appears sustainable.

Rents for Manhattan's trophy office buildings have remained flat since the recovery of 2010 and 2011, when the market experienced double-digit gains. Midtown saw trophy rents grow more than 22 percent from 2009 to 2011, and even more within some submarkets. While these gains in asking rents were not lost in 2012, on a building-by-building basis, the average did fall as a number of large blocks came to market. Average rents for Midtown trophy buildings fell to $85.14 per square foot in January 2013 from $89.30 per square foot one year ago, representing a 4.7 percent decrease in rates. Asking rents among the submarket's most exclusive buildings have not receded, although owner concessions have risen throughout the market.

Over the next few years, Downtown will offer some of the newest trophy product available in the region at a significant discount to Midtown. Although the spread between Midtown and Downtown trophy rents has decreased to 32%—after reaching a high of 44% in 2008—much of this was the result of new product entering the market at the World Trade Center and high-quality space returning at Brookfield Place, previously known as the World Financial Center. The Downtown Trophy rent index registered $57.88 per square foot in January 2013, the highest rate the submarket has recorded since 2008.

Over the next year, large blocks of space will continue to weigh down New York's trophy office market, keeping vacancy above equilibrium and diluting asking rents. The traditional tenants for these blocks—large financial services and legal services—are currently growing at rates below the national economy. Over the long term, the limited supply of top-tier buildings in Manhattan, especially in Midtown's Plaza District, will result in diminishing options and higher rents. When the market tightens—and it often does very quickly—spikes in Trophy rents, particularly for large blocks, are common.

Peter Riguardi is president of the New York region for Jones Lang LaSalle and leads all operations for the company in the New York, New Jersey and Connecticut area. The views expressed in this column are the author's own.