Blame the Lawyers For Next Office-Market Slump

If you followed the Manhattan office market in 2006, you’ve had a long bath in a tub of overheated acclamations. Roaring! Red-hot! Historic! Meteoric!

But don’t go thinking the 2006 office market’s anything special.

For all the understandable exuberance over the current boom market, it’s just following the path that history dictates through employment levels, construction activity and events no one can really see coming.

“All indications are that the market will stay steady,” said Robert Alexander, chairman of CB Richard Ellis’ tri-state region and a 27-year veteran of the Manhattan office market. “Beyond that, who the hell knows?”

Commercial brokerages generally project that the Manhattan office-vacancy rate will plunge from around 7 percent now to below 4 percent in the next couple of years. At the same time, asking rents should keep rising—CB Richard Ellis projects the average could top $90 a square foot by 2010.

All this is buoyed by high-school economics: supply and demand. Companies are hiring—the city’s October unemployment rate dipped to an 18-year low—and need space. Landlords know this, so they charge more for the space. And companies take it, with financial and law firms often leading in leasing activity.

But this 2006 reality is 2000’s reality, which was 1979’s reality, too. Vacancy rates were lower in those times than they had been in a long while, and asking rents were higher; but then something(s) happened, and the office market cycle started all over again, from down to back up.

In 2000, it was a national recession and the dot-com bust that ripped through Manhattan’s mid-tier office space, particularly because that was the space hastily vacated by failing tech startups (remember Silicon Alley?). The terrorist attacks of late 2001 walloped a market already reeling, setting the stage for the five-year climb back that the market’s in now.

What could demolish the boom market now?

Job losses, for one. Brokerage Cushman & Wakefield, along with Moody’s Economy.com, charted the number of Manhattan office-based employees and the office market’s occupancy rate going back to 1987 and through September 2006. It’s stark: As employee numbers rise, the occupancy rate rises. The biggest peaks—and lowest vacancy rates—came in 2000.

Second, a lot of leases are ending in the next 10 years. Leases totaling as much as 91 million square feet of midtown office space alone will expire, according to CB Richard Ellis—a clip of about 500 tenants a year through 2016. These tenants face renewing leases at higher rents, something that may send them scrambling beyond Manhattan, leaving a lot of vacant space on the market.

“If rents keep going up, as history shows us, companies tend to take the back-office and administration operations and take them out of Manhattan—and keep a purely front-office operation,” said Mr. Alexander, citing advertising and publishing as two industries where companies might be the first to exit Manhattan.

Third, there’s just not that much new office space coming to Manhattan, especially that top-tier space that major companies crave. The Hearst building and 7 World Trade Center were the only top-tier towers to open in 2006, and the Hearst building was fully leased before it opened. Next year, only the New York Times headquarters is scheduled to open—and it’s largely leased up.

Finally, law firms are leasing a lot.

Law firms expand into new space when business is good—not in anticipation of business being good. When business turns bad, then, law firms spill a lot of space onto the market.

This phenomenon played out 15 years ago. Manhattan law firms swelled during the busy, bullish final years of the 1980’s, only to flame out after the turn of the decade, helping to send vacancy rates toward 20 percent in Manhattan.

One firm alone, Shea & Gould, spilled 250,000 square feet onto the market after its dissolution in 1994. Mudge, Rose, Guthrie, Alexander & Ferdon (Richard Nixon’s old firm) went out of business the following year, leaving 145,000 square feet available at 180 Maiden Lane. Other firms simply contracted, and others ceded space to firms based outside Manhattan.

Law firms have leased madly in 2006. In the new 1.5 million-square-foot Times building alone, three firms signed up for 320,000 square feet, all the more notable because law firms normally eschew the area west of Seventh Avenue. (The building’s going up on Eighth Avenue.)

So, it’s anyone’s guess—law firms expanding, leases expiring, rents skyrocketing—as to what’s going to trigger the next Manhattan office-market meltdown. But you can almost feel it; things have gotten so meteoric/scorching/roaring in 2006 that history’s surely sharpening its knives for a cyclical repeat.