Office Market Fall-out

Lehman Brothers' bankruptcy filing and Bank of America's buy-out of Merrill Lynch will affect the New York office market, according to a report released by Grubb & Ellis in Santa Ana, Calif.

The biggest impact will come in the form of available sublease space, since the two firms occupy approximately 6 million square feet in Manhattan. In addition, the struggles at AIG need to be closely monitored, since the firm owns and leases close to 3.5 million square feet of office space in Manhattan. Although the Federal Reserve bailed out the world's largest insurer, AIG, the company's Manhattan portfolio could be restructured since the U.S. government is now in charge.

"Although capital remains available for residential loans, the credit crunch is pronounced in commercial lending," said Lawrence Yun, chief economist at the National Association of Realtors (NAR). "Combined with a slowing economy, the lack of credit is curtailing activity in the commercial real estate sectors. As a result, there's been a slowdown in the net absorption of space, which is leading to higher vacancies and more modest rent growth."

At 5.7 percent, the Manhattan vacancy rate is already up 120 basis points since 2007. Since the start of 2008, 2.1 million square feet of sublease space has been placed on the market, and that number is expected to grow as the fall-out from the credit market turmoil continues. The growing sublease inventory will likely cause asking rents to decrease in the last quarter of this year and into 2009.

As landlords begin to price direct space more competitively with discounted subleases, expect overall average asking rents to decline by nearly 7 percent over the next 12 months, according to Grubb & Ellis.

In August, the increase in marketed subleases altered the ratio of direct versus sublet available space. Sublease space now accounts for 25 percent of the market's availability rate, compared to the 22 percent market share averaged over the last 19 months.

The financial services sector has already shed between an estimated 22,000 and 25,000 jobs this year. However, after the Lehman and Merrill announcements, New York Governor David Paterson, stated that an additional 40,000 Wall Street job cuts could occur.

These projected job losses translate into approximately nine to ten million square feet of occupied office space, which if placed on the market would increase the vacancy level to 8.5 to 9 percent.

In New York, this vacancy range is accepted as market equilibrium, or a healthy market balance. Although an increase in vacancy would give tenants more space options, the additional inventory will keep negotiations between landlords and tenants on an even playing field.

However, the New York Office market is not going to be the only market to be affected. For more information, listen to the latest "What’s Next in Real Estate: Industry Snapshot Series."