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The Manhattan office vacancy rate during Q1 2008 was the lowest of any major market, although the rate of increase in sublet space was higher than the national average. So says Grubb & Ellis in recently issued reports, while SL Green Realty sees the driver of that uptick in sublease space—turmoil in the financial services sector—as the catalyst for a softening in leasing activity.

While Manhattan’s vacancy rate of 4.9% was well below the quarterly national average of 13.6%, the island’s available space for sublease jumped to over seven million sf, which an increase of about one million sf from the end of 2007. The increase of approximately 16% compared to the 12% national average. “Most of this was from Downtown,” although iStar Financial put 107,000 sf at 1095 Ave. of the Americas back “after leasing it less than a year ago,” Richard Persichetti, client services manager with Grubb & Ellis’ New York office, tells Real Estate New York.

He adds, “There was more than just an addition of available sublease space in the first quarter. We also saw a drop-off in leasing activity,” a 15% decline compared to Q1 ‘07. In addition, Persichetti says, 48% of the square footage leased in Q1 ’08 was in lease renewals.

“So most of the demand is not coming from new requirements; it’s coming from tenants renewing in place because they don’t want to face moving costs or disruption in business,” Persichetti says. “For the most part, they’re not early renewals, but renewals out of necessity. It’s good that these firms aren’t leaving the city, but at the same time, almost half the demand in the first quarter was because firms had to renew, not because they were looking for new space.” By comparison, 19% of the square footage leased in the first quarter of ’07 stemmed from renewals, Persichetti says.

The investment market “completely stalled” for the most part in Q1 ’08, says Persichetti, at least when it came to office properties of 100,000 sf or greater. Grubb & Ellis recorded $1.7 billion traded during the quarter, compared to more than $13 billion in Q1 ’07—a quarter that saw Macklowe Properties’ $7-billion purchase of an eight-building Equity Office Properties portfolio. “That’s a direct result of banks pulling back on loans,” he adds.

Although Persichetti acknowledges that “one quarter doesn’t make a trend,” Q1 results suggest that “the market appears to be turning. That isn’t a bad thing, if you think about it, because we’re at 25-year vacancy lows and all-time highs in asking rents. However, vacancies are starting to tick up as well, and as that happens, tenants will have more options.”

As reported on GlobeSt.com, SL Green CEO Marc Holliday in a recent earnings call said the REIT’s performance “was very good in the first quarter, especially when viewed against the backdrop of the challenging economic environment and the continuing illiquidity in the credit markets.” Despite the strong quarterly leasing performance, Holliday added, “We do, however, stand by our previous statement that we believe the leasing market will soften as a result of the lack of financial services firms’ participation.” He estimated that net effective rents could drop by 10% to 15% from their peak levels. In addition, he said, “there could be some widening of free rent to give some tenants relief from the sticker shock that they might feel when they roll over from the old rents to today’s market rents.”

During the call, SL Green’s president and CIO, Andrew Mathias, said that office building sales in Manhattan “slowed significantly in the quarter as a standoff developed between buyers and sellers and a lack of financing continued to make it difficult to get deals done.” He added that there were some notable exceptions during the quarter, with several properties selling at prices that “demonstrated the continued willingness of buyers to still pay sub-5% going-in cap rates for quality assets that have a strong mark-to-market story.”

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