The New York City office market is experiencing higher vacancy and reduced effective rents resulting from the terrorist attack on Sept. 11 and the weakened U.S. economy. While prices of New York City commercial real estate have so far generally held steady, it is expected that prices will soften as additional sublease space comes to market, capital flows expand to other sectors, and expectations for rental rate improvements diminish. Standard & Poor's expects the U.S. economic recovery will be sluggish, employment to grow at a slower pace than usual, and the stock market to remain relatively weak. All these factors suggest that New York City, like other U.S. cities, will face many challenges in its recovery over the next few years.

Before Sept. 11

By late 2000, the U.S. economy began showing signs of weakness with technology firms (mainly Internet start-ups and telecom companies) downsizing and/or filing for bankruptcy en masse. The resulting reduction in demand for office space led to a surge in vacant and sublet space in both the midtown and downtown property markets of New York City. As more space became available, rents - which had spiked from a few years prior - dropped, and in some submarkets quite dramatically.

Throughout 2001, the U.S. economy continued to weaken and stock prices began their descent. Consequently, companies began seeking ways to reduce operating costs, including the relocation of all or part of their operations out of New York City. Companies moved to areas such as New Jersey's Gold Coast (in Jersey City, Hoboken and Weehawken, across the Hudson River from Manhattan) where rental rates were generally 35% to 50% lower than in Manhattan. This retreat from New York City increased vacancy and the level of sublet space, which negatively impacted rental rates. By early 2001, New York City began to experience negative absorption, with more space available than was being leased.

The Sept. 11 attack damaged or destroyed 22 office buildings including the World Trade Center (WTC). These buildings encompassed 29.1 million square feet of office space with an economic occupancy of 97% (physical occupancy was modestly lower). The six office buildings that made up the WTC were destroyed and comprised 13.4 million square feet of "Class A" space, which represented roughly 4% of the city's total office space. Seven other nearby "Class A" buildings, including the World Financial Center, were damaged and comprised 12.3 million square feet of space. In addition, nine other "Class B" and "C" buildings were also damaged. It was expected that this reduction in office space would decrease vacancy rates as displaced tenants moved into the available space. However, these gains were quickly erased as those tenants with underutilized space who were not directly affected by the attacks quickly made the space available for sublease to the displaced tenants. Because a number of those displaced tenants either scaled back their space requirements or relocated some or all of their operations out of New York City, this rapid addition of sublease pushed overall availability rates higher.

Access to the downtown area became challenging due to the destruction of key transportation systems. Psychological barriers also developed as people no longer felt comfortable working near the WTC site where there were constant reminders of the attack, nor did they want to work near the site during the massive cleanup effort. As the site is rebuilt, there will likely be concerns over disruptive construction activity and poor air quality.

After Sept. 11

A year after the Sept. 11 attack, the U.S. economy remains weak, and companies continue to reduce their workforce. This is especially true in New York (where the financial services industry has been hard hit), where the unemployment rate is currently hovering around 8%, or two points higher than the national rate. The general downsizing and/or other cost-saving initiatives pursued by major employers in conjunction with the decision by some to diversify operations have resulted in a continuation of negative absorption of office space. By the end of April 2002, available space for sublet accounted for 54% of all available space downtown, which was up from 31% a year ago, and in the midtown market available space for sublet accounted for 43% of all available space, up 30% from a year ago.

Much work has been done to restore downtown's infrastructure since the Sept. 11 attack. Seven of the 11 subway stations that were closed have reopened and three of the four remaining subway stations are expected to re-open by the end of September. Ferry service has emerged as a substitute for the destroyed Path Stations carrying passengers from New Jersey to the downtown area. To lure employees to downtown and retain them and to break the psychological barriers that may impede tenants from moving there, the city, state, and federal governments began to offer cash incentives, tax breaks, reductions in utility costs, and low interest rate loans to eligible downtown employers. Furthermore, six preliminary proposals have been presented to redevelop the WTC site. While there appears to be a consensus on developing this site as a cultural, business, and transportation hub, a number of different parties, such as developers, businessmen, and families of the WTC victims are contending over a suitable size of a memorial and the specific square footage of office, retail and housing space that will be built on this site. Therefore, it is too early to determine how much additional office space will eventually reenter the downtown market.

Despite these efforts, the combined impact of a weak economy and corporate relocations continues to pressure occupancy and rental rates. According to, as of the end of the second quarter of 2002, the downtown market office vacancy rate was 13.0% and the midtown office market vacancy rate was 6.94%. As of the end of second quarter 2002, said that New York City's overall vacancy rate of 9.5% remains below the 14% average of all major metropolitan centers, but in large part because of the office space that is no longer there. If all of the space destroyed or still unoccupied because of Sept. 11 were on the market, the vacancy rate would be near the national average.

The rental rate decline has obviously been more dramatic in the downtown office market, where effects of the terrorist attacks have had a more tangible and pronounced impact. While anecdotal information suggests that landlords prefer to lower face value rental rates rather than offer rent concessions (such as free rent or increased tenant improvements), there is empirical data indicating that both are occurring. It appears that rental rates peaked in mid-2000 at roughly the same time that occupancy rates peaked. Today's asking rents have declined 10% to 25% from their peak, depending on location and quality of space. While today's asking rents of roughly $50.00 dollars per square foot in midtown and $40.00 dollars per square foot in downtown are still well above the inflation-adjusted asking rates of the mid-1990s, there remains the potential for further erosion.

Despite the deteriorating real estate fundamentals, new supply continues to be added to the market, albeit at a modest pace. While there is little construction scheduled to be completed in the downtown market this year, an additional 2 million square feet of office space will be delivered over the next two to three years. In the midtown market, there is less than 1 million square feet of construction that will be delivered this year but an additional 5.5 million square feet will come on-line during the next two to three years. An additional 1.5 million square feet of office space is currently in the planning phase in the midtown office market and anticipated to be completed within the next three years.

There are a handful of rated real estate companies that own office buildings in both the midtown and downtown markets, including Equity Office Property Trust (BBB+'/Stable), Brookfield Properties (BBB'/Stable), Reckson Associates (BBB-'/Stable), and Vornado Realty Trust (BBB+'/Stable). Equity Office's and Reckson's building are located mostly in the midtown market, while Vornado has a large concentration in the Penn Station submarket; Brookfield's buildings are located in the downtown market. Combined, these four companies own roughly 36 million square feet of office space in New York City (about 10% of the total), which Standard & Poor's estimates to have above-market occupancy statistics due in part to the long-term nature of the in-place leases and comparatively better credit quality tenant base.

Long-term Prospects

Standard & Poor's expects the U.S. economic recovery to be sluggish, perhaps the slowest of any postwar economic recovery. Employment will grow more slowly than usual. The stock market is likely to remain weak by standards of normal economic upturns. All of these factors suggest that the New York office market will remain soft over the next few years.

Although vacancies have increased and rents have decreased in the New York office market, investors have looked at commercial real estate as an alternative investment as the stock market continues to be weak. This has driven up demand for better-positioned office properties, while at the same time there is a relative scarcity of supply. As a result, the price per square foot on investment sales has generally held steady. Generally, however, property values have historically tended to lag behind economic reality and, as a consequence, values may be artificially supported by the current low interest rate environment and renewed investor interest in hard assets, given the recently weaker U.S. stock market performance. With additional office supply coming onto the market over the next few years, which will further pressure rental rates, prices are expected to soften.

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