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NEW YORK CITY-The peak of more than one year of financial crisis resulting from bad mortgages and real estate investments materialized this weekend as locally based Lehman Brothers filed for bankruptcy, and as Bank of America revealed it would pay around $50 billion to acquire Merrill Lynch. Although there are still some questions as to how layoffs will occur, and how it could affect the broader economy, sources tell GlobeSt.com that the office leasing market here will soften.

According to a Jones Lang LaSalle forecast, looking at the situation with Lehman and depending upon if all or none of the space is added to the market, if there is 100% of disposition, roughly 2.7 million sf will be added to the market resulting in a potential Q1 ’09 midtown class A vacancy rate of 12.1%. The forecast already assumes more than 15,000 in job losses prior to recent announcements. If there is a 75% disposition, a little more than two million sf will be added to the market resulting in a potential vacancy rate of 11.7%. If there is 50% of disposition, about 1.3 million sf will be added to the market leading to a vacancy rate of 11.3%. If there is 25%, roughly 673,345 sf will be added to the market, pushing a potential vacancy rate to 10.8%.

Hugh Finnegan, an attorney in the real estate group at Sullivan & Worcester LLP, tells GlobeSt.com that the result of financial industry failure in Manhattan will most definitely have an effect on the office leasing market here. “The leasing market will soften,” he says. “There will be a lot vacancies created wherever Lehman has large chunks of space.” Merrill Lynch reportedly has approximately 60,000 employees, and Lehman has more than 20,000. Finnegan says that as for the firm’s 32-story Midtown office building–said to be worth north of $1 billion–”is valuable, even if vacant, so I doubt there will be a foreclosure.”

However, Finnegan says that “given how tight the debt markets are, it will not be that easy to finance.” Finnegan further notes that “if Merrill Lynch, Bank of America, AIG, Washington Mutual and others start to lay off, there may be a significant number of vacancies. This will further erode the class A market in New York City.”

Finnegan explains that “the assets financed by Lehman should not face any immediate effect because of the bankruptcy. In fact, as long as the loans are performing, they will be valuable assets in the bankruptcy.” The assets mentioned include the debt of SL Green’s 1166 Sixth Ave., 1515 Broadway and Broadway Partners’ acquisitions of 340 Madison Ave., 450 W. 33rd St. and 280 Park Ave. “The issue will be that efforts to refinance will not be easy because there are not many players right now and even fewer at the magnitude of loans on assets like these. Some large property owners may need to call upon affiliated entities to assist with the efforts to refinance.”

Robert Knakal, chairman and founding partner of Massey Knakal Realty Services, tells GlobeSt.com that Lehman’s bankruptcy filing is an unfortunate–but necessary–step in the overall stabilization of financial institutions. He explains that one of the things that need to happen before the markets can turn around is that financial institutions need to be stabilized. As for Lehman’s real estate portfolio, Knakal says that “Lehman has a tremendous amount of great real estate in their portfolio, which should be in high demand from institutional buyers. There is a massive amount of capital which has been sitting on the sidelines waiting for such an opportunity.”

Knakal says that unemployment hit 7.8% in the early 1990s and is only 6.1% today with many economists expecting it to rise to about 7%. “These job losses have likely already been anticipated in these extrapolations,” he says. “Unemployment has the most profound effect on the fundamentals of commercial real estate market as it not only affects office vacancy but also residential vacancy.” Knakal further notes that Lehman’s midtown building is a tremendous asset, and believes it would be in high demand from buyers in the market.

Whatever the final layoff number, numerous workers will be impacted, and statistics show a dip in asking rents and a drop-off in leasing velocity in the Manhattan market. A Studley Q2 report noted that rental rates declined by 2.2% to $69.29–the first decline since 2005, while availability jumped to 8.2%. “Layoffs in the financial sector have fueled speculation about the amount of sublet space that would come onto the market and to what extent rents would decline,” Steve Coutts, Studley’s SVP of national research services, says in a prepared release. “But during the first half of 2008, the proverbial axe fell, resulting in sublet space that spikedto 7.8 million sf from 6.2 million sf in January, and closed at 8.3 million sf in June.”

While the numbers are clearly heading in the wrong direction, there is still hope that the damage may be contained. “If the markets get worse and the S&P continues to drop and credit markets continue to deteriorate, we will certainly see more layoffs,” James Feldman, an analyst with UBS, recently told GlobeSt.com.

Marc Francis, president and CEO of the Delphine Real Estate Advisory Group Ltd., tells GlobeSt.com that “leasing prices will soften up following layoffs at Lehman, Merrill, and later possibly Morgan Stanley.” Lehman’s building will attract buyers internationally, he explains. “The proceeds can be used to pay down part of its huge debt.”

Dan Fasulo, managing director of research at Real Capital Analytics, tells GlobeSt.com that as far as the real estate side of things, “Lehman has not been a major player since last year, so the impact will be more indirect through further risk repricing and negative investor sentiment,” he says, noting that “a majority of the Lehman real estate assets are good.”

An anonymous industry source tells GlobeSt.com that as far as trading goes, “with the recent financial news, we should expect financials to trade down pretty significantly today [Monday], especially the broker-dealers.” The source notes that “there will be others up next, as confidence in the system—and business model—is not great.” The source further explains that as far as New York City’s office leasing market goes, he agrees with others that “I think it will put downward pressure on rents in New York City,” noting that “the publicly traded office companies with exposure to New York City may trade down today [Monday].”

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