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NEW YORK CITY-Downtown office rents could hit freefall as Larry Silverstein puts his World Trade Center office space back online, using funds from his insurers to cover construction costs. Industry experts tell GlobeSt.com that the developer stands to undercut the market unless his competitors rents remain buttressed by federal incentives, and that, ironically, the new space could upset the stability of an environment it was intended to unify.

“My concern is that, given the insurance proceeds that they could have a price advantage over two different types of product: either new buildings that are proposed, or, given the degree of the price advantage, perhaps even over existing class A buildings,” Woody Heller, executive managing director, Capital Advisors Group at Insignia/ESG tells GlobeSt.com.

“These buildings could be constructed at a cost structure which would give them an advantage over existing buildings,” says Heller. “The new properties would have a low break-even point, which would suggest that in a down market, or maybe not even in a down market, they could lease for lower rents than traditionally class A buildings demand, which could put downward pressure on the market overall.”

Silverstein has been battling his 22 insurers since Sept. 11 over whether the destruction of the World Trade Center towers constituted one act of terrorism or two. Under the later scenario, the Silverstein group would collect two $3.6 billion payments for a total of $7.2 billion. The bombings occurred just weeks after Silverstein’s investment consortium closed on its 99-year lease for the World Trade Center site.

An unnamed source estimates the cost to construct 5 million sf on the site: roughly half the amount of office space removed from the market on Sept. 11, at $1.5-$2B, and $3-$3.5B for 10 million sf. Therefore, says the source, given an insurance ruling of:

One occurrence and redevelopment of 5 million sf, Silverstein’s break-even rent could be $34 per sf.

Two occurrences and redevelopment of 10 million sf, Silverstein’s break-even rent could be $22 per sf.

One occurrence and redevelopment of 10 million sf, Silverstein’s break-even rent could be $29 per sf, including construction loans at 7%, necessary to pay for a portion of construction in this example.

The above scenarios factor in Silverstein’s existing debts and outstanding finance obligations with regards to previous development on the site, and extrapolate operating, transportation, infrastructure and retail costs from the equation. Similarly, they take in to account ground and operating rents and property taxes. Total construction cost for class A office space was placed by the above source at $300-350 per sf, although additional sources say $400 might be a more “realistic” number.

Bruce Mosler, president of US operations, Cushman & Wakefield, predicts Downtown leasing to pickup by the time World Trade Center space begins to come online, and indicates that a strong demand would cushion the impact Silverstein’s new low-cost rents would have on the market. “There will be an increase in demand in the downtown market by then,” he tells GlobeSt.com. “I think there will be a national shift back to the west side as the combination of Lower Manhattan as a tourist attraction and a source of prime office space will position it as a more sexy area.”

But at what cost to leasing prices Downtown? Given that Silverstein stands to apply his insurers’ dollars to push up to 10 million sf of prime class A office space onto a soft market at rates his competitors can’t hope to match, what sort of a counterbalance can the market expect?

Federal incentives, it appears, will be used to bridge the gap between what Silverstein can charge and the asking prices his competitors must realistically ask. A spokesman for Larry Silverstein commented: “Incentives are always put in place to attract tenants to an area that the powers that be feel needs that kind of stimulus.” An unnamed source placed subsidized class A office rents at around $24 per sf, in harmony with what Silverstein could charge based on the figures above.

Dirk W. Hrobsky, vice president Trammel Crow Co. New York City is optimistic that the federal business incentives Downtown will allow the market to correct itself, but only as long as they remain in place. “Even given the federal subsidies [for Silverstein], he’s still not going to be able to undercut.” However, “that would be the case if the other product in the area didn’t have those incentives.”

Hrobsky estimates subsidized class A office deals “in the low 30′s right now, even high 20′s.” Additional GlobeSt.com sources place unincentivized rents in the $40-to-$50 range, offering a snapshot of the vast impact this federal package has on the market’s stability.

Hrobsky tells GlobeSt.com that class A rents on Sept. 10 hovered near $45, a far cry above current net prices. Similar to Mosler, he says the drop-off in demand (the office vacancy rate currently sits at 14.8%, according to Insignia/ESG), coupled with the prominence of World Trade Center space will drive tenants back to the area.

“People will move back to the WTC site because it’s going to be the best product in the area,” Hrobsky tells GlobeSt.com. “That absorption is also going to increase downtown as superior product comes online at significantly discounted prices, compared to class A Midtown space.”

“Silverstein has to source dollars, so he’s not really buying futures on America,” says Hrobsky. “People who are buying futures will be the frontiersmen who move from Midtown class A product to downtown class A product. Those frontiersmen will be the most rewarded.”

It appears, then, that President Bush’s 10-year, $5B federal “Job Creation and Worker Assistance Act of 2002,” designed to attract and retain businesses downtown through federal employee and leasing subsidies, should allow the market to remain stable as the new World Trade Center space comes online. However, as vacancy hits comfortable levels Downtown, Hrobsky expects those incentives to disappear. “Once you reach critical mass in that area, you will begin seeing a falloff in incentives pretty quickly,” he says.

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