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New Document Several key downtown markets saw vacancy-rate decreases during the second quarter of this year as real estate markets began showing clear signs of stabilization. The improved performance of the stock market, low interest rates and the anticipated impact of tax cuts on consumer behavior have had a positive influence on office leasing markets. In several of them, including Boston and New York City, companies have begun to remove sublease space in anticipation of employment growth. Examples include Lehman Brothers and Citigroup.

While Washington, DC, at 7.9%, is the only market with a single-digit vacancy rate, several major CBDs experienced downward movement in overall vacancies, including Chicago (15.3%); Downtown Manhattan (12.6%); and Miami (17.0%).

The amount of available sublease space continues to decline on a national basis. It is currently 36 million sf, down from 43 million sf one year ago. While some of this reduction can be attributed to the rollover of sublease space back to direct as leases expire, we have also observed a flight to quality as companies look to take advantage of the ever-shrinking gap between class A and B space and upgrade their occupancies.

Supply is in check compared to historical levels of construction in the CBDs with 6.3 million sf completed year-to-date and 8.9 million sf of additional space to be completed by year end. The split of these deliveries is roughly 40% build-to-suit vs. 60% speculative. Projected construction completions in the CBDs in 2004 is five million sf and a mere 3.5 million feet in 2005.

Leasing activity continues to increase gradually, outpacing both last year and last quarter in both downtown and select suburban markets. The locales with the largest volume of lease transactions are Chicago; Los Angeles; Orange County; Washington, DC; and Manhattan. Manhattan had 12 leases of more than 100,000 feet through mid-year 2003, double the amount of similar-sized leases through mid-year 2002. These include HIP-Health Insurance Plan of New York (467,556 sf); Associated Press (290,773 feet); and Oppenheimer Funds (193,761 sf). Downtown Manhattan, in particular, has seen a significant increase in momentum with year-to-date leasing activity totaling 2.3 million sf and leases out or deals pending on an additional 1.2 million feet. Tenants are taking advantage of the soft market and government incentives.

Rents continue to decline, which is indicative of the continued trend of building owners’ willingness to market space at reduced rates in order to attract or retain credit-worthy tenants. A significant amount of activity, not captured in the statistics, is early renewals. Midtown Manhattan, Boston and Washington, DC boast the highest CBD rents at $51.50, $42.25 and $41.25 respectively for direct, class A space. Several other downtown markets have begun to see upward movement in asking rents, including Los Angeles, Detroit and Philadelphia. A sustained increase in rents will lag the economic recovery by six to 12 months.

As the leasing market appears to improve, the investment market is slowing down. Interest rates are rising and the stock market is gathering positive momentum while the volume of sales has slowed considerably. Investors are weighing their portfolio allocations and evaluating all alternatives as they wait for the real estate market to stabilize.

While the signs of recovery are emerging, it is important to note that these signs are not evident in all regions of the country. Atlanta, Dallas and San Francisco, for example, may not see a full-blown recovery until 2005.

Employment growth is the key to a prolonged recovery, and economists’ projections remain lackluster. Global outsourcing could likely be the next potential spoiler in the US real estate recovery, as the trend of moving back office; computer programming and other white-collar jobs–including traditional CBD tenants like the legal industry to India and China–continues.

Based in New York City, Think Tank member Maria Sicola is senior managing director of research and analysis for Cushman & Wakefield’s advisory services group.

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