Square Feet

A Hopeful Sign for Manhattan’s Office Market

By TERRY PRISTIN

Published: December 23, 2009

The coming year is almost certain to be brutal for the commercial real estate market in New York. More landlords will be unable to hang onto their buildings or refinance their mortgages, swelling the inventory of distressed properties.

SL Green Realty purchased the construction mortgage for the empty 30-story office tower at 510 Madison Avenue. But though rents in Manhattan office buildings are expected to continue falling and the vacancy rate is expected to increase, real estate specialists say that the panic has subsided and that some investors are prepared to bet on the long-term future of the market. As one hopeful sign, some analysts cite the recent purchase by the real estate investment trust SL Green Realty, Manhattan’s largest office landlord, of a construction mortgage for 510 Madison Avenue, an empty new Midtown office building at 53rd Street, which is being developed by the father-and-son team of Harry and William Macklowe. Conceived in headier times before the Macklowes lost most of their real estate empire, the slender 30-story glass tower has floors of 10,000 square feet and was intended for hedge fund operators. At an investors’ conference on Dec. 7, before the 510 Madison loan acquisition was announced, Marc Holliday, SL Green’s chief executive, said that although New York had lost 81,000 office jobs and could lose as many as 45,000 more, “I can now confidently say that the worst is behind us.” He predicted that the vacancy rate, now 13 percent, would not exceed 15 percent. SL Green’s decision to buy this loan “speaks volumes about management’s more optimistic view on both leasing and building values,” Michael Knott, a REIT analyst at Green Street Advisors (which is unrelated to SL Green), said in a recent report. It is a significant turnaround for SL Green, which has issued new equity and sold weaker assets during the past year to strengthen its balance sheet. “Six months ago, this company was trying to stay in business,” said Ross T. Nussbaum, a REIT analyst for UBS. “Now they are on the prowl again for opportunities.” If the loan purchase shows that SL Green is hopeful about Manhattan’s recovery, it also suggests that the company is prepared to engage in a bare-knuckles battle with Harry Macklowe, one of the city’s most litigious property owners. SL Green did not disclose the purchase price for the 510 Madison loan or make anyone available for an interview, but other executives familiar with the deal say the company paid the original lender, Union Labor Life Insurance Company, $170 million for the $267.5 million mortgage. The discount was modest, however, because SL Green will have to dole out $70 million or more to complete the building and cover leasing costs and the creation of office interiors. Several brokers and analysts said the company had not bought the loan simply to collect mortgage payments because the low returns would not have justified the risk. Instead, they say, SL Green’s sole goal is to foreclose on the Macklowes and gain possession of the building. “They didn’t invest in this loan to get a coupon return,” said one Wall Street analyst, who said his company prohibits him from speaking publicly about a deal he has not written about. In addition to angling for 510 Madison, SL Green also expects to assume ownership of 100 Church Street, a 1.1 million-square-foot building near the World Trade Center, which is more than half vacant. SL Green bought three mezzanine loans for the building for $41 million in 2007 and has operated it since last month, when the previous landlord, the Sapir Organization, withdrew a lawsuit seeking to block foreclosure. Among the reasons the building has fared so poorly, Steven M. Durels, SL Green’s leasing director, told investors, was “a seriously flawed lobby renovation, which included a spraying water fountain and more than 30 hideous crystal chandeliers.” SL Green, which expects to spend $20 million to reposition the building, “will have to work some leasing magic” to protect its investment in 100 Church, Mr. Knott said. If SL Green succeeds in wresting 510 Madison from the Macklowes, the company will own the building for about $750 to $800 a square foot, including foreclosure and other costs. The Macklowes, who began assembling their site in the late 1990s, paid $440 million, or $1,200 a foot, in land and development costs. If they lose the building to SL Green, which owns interests in 27 office buildings in Manhattan, the Macklowes will not get the lucrative management and leasing contracts that a conventional lender might have given them.

The Macklowes may find themselves backed into a corner by restrictions preventing them from offering space in the building at the market rent. A clause in most loans bars borrowers from leasing space at levels below the rates agreed on when t
he loan was issued. SL Green is expected to play hardball and not approve any leases below the agreed-upon rates negotiated by the Macklowes with the original lender. The Macklowes, who are certain to fight back in court, had no public comment. When the economy faltered, only one tenant, Jay Goldman & Company, a hedge fund, had committed to occupy space, at $135 a foot. The company has sued to back out of the lease, saying that the building was not delivered on time — a delay that the Macklowes attributed to an electrical fire in February. The watchmaker Tourneau is seeking to rescind a lease for ground-floor retail space at $550 a square foot. At the peak of the market, some tenants were paying $150 a foot or more to be in the most prestigious buildings. In 2009, only 16 leases were signed at annual rents above $100 a square foot, compared with 105 such deals in 2008 and 107 in 2007, said Ben Friedland, a senior vice president at CB Richard Ellis. In 2008, the average high-end deal was $126 a square foot, but this year, the average dropped to $109, Mr. Friedland said. “With some exceptions for unique opportunities, the top of the market is now between $100 and $110 a square foot,” he said. One of those exceptions was Banco Itaú of Brazil’s recent lease of $130 a foot at the General Motors Building. Unlike that building, 510 Madison does not overlook Central Park, but brokers say it has many features that boutique financial services firms find attractive, including space that is virtually column-free, providing clear sight lines between the head traders and the teams out on the floor; floor-to-ceiling glass; and the sleek, minimalist look for which the Macklowes are known. Jeffrey W. Baker, an executive managing director of Savills, a real estate investment banking firm, said he tried to buy the building for a foreign client before the economic crisis. “It’s going to compete head-to-head with the Seagram Building,” Mr. Baker said, referring to the modernist tower on Park Avenue and 53rd Street. “It’s going to be viewed as one of the very top buildings in Manhattan.” For now, it may be tough to attract new tenants because of the uncertainty over the building’s ownership. Robert M. White Jr., the president of Real Capital Analytics, a research firm, said the building would be more attractive to tenants without the Macklowes, whose future has seemed uncertain ever since they had to surrender seven buildings they bought in early 2007. “Its biggest obstacle for leasing has been the ownership,” Mr. White said.