Hedging for office space

Some guys that bet right on subprime live to rent another place; new funds rise from Wall Street ashes

Sep.September 01, 2008 02:43 PM

The downsizing of New York’s largest financial service companies
means almost nothing but bad news to the city’s office market. But as
investment bankers get their walking papers in the thousands, a handful
of hedge funds that bet right on subprime mortgages and the U.S.
economy are prospering.

The success of funds such as Paulson & Co., Soros Fund
Management and Renaissance Technologies, whose founders earned a
combined $9.4 billion last year, has also inspired plenty of laid-off
investment bankers to do the same and form funds, and they need space
to build their empires from the ashes.

“The economy is a zero-sum game,” said Stephen Gordon, senior
managing director at PBS Real Estate. “For all of the businesses that
have done poorly and are contracting, somebody is going to have made a
contrarian bet and is going to be seeking office space measured by
their recent success.”

Smaller hedge funds and private equity funds that were “just a
little more nimble in their ability to change course” have continued to
do well, according to Gordon.

Recent deals include Turn Key Hedge Funds, which signed a lease for
3,030 square feet at 450 Seventh Avenue, and Bay Harbour Management,
which signed a 10-year lease for 17,500 square feet on the 20th floor
of the Seagram Building at 375 Park Avenue. The company is relocating
from 885 Third Avenue.

Other firms expanded their space. Citadel Investment Group recently
signed a nine-year expansion lease for 30,500 square feet on the 48th
floor at 153 East 53rd Street. The company currently occupies 64,500
square feet on the 44th and 45th floors. QVT Financial doubled its
space in 1177 Sixth Avenue, signing an eight-year lease for the entire
10th floor.

It also seems unlikely that the tens of thousands of employees
slated to get their walking papers in the next year — from Bear
Stearns, Citigroup, JPMorgan Chase, Goldman Sachs, Lehman Brothers, et
al — are going to give up finance and start waiting tables. This
workforce will require desk space at smaller investments firms that can
still afford them.

The great rewards that have come to highly leveraged hedge funds in
recent years come only as a result of great risk, and the potential for
a bad bet to financially bruise a fund and make it unable to pay rent
is not overlooked by astute landlords.

Alan Bonett, senior managing director at Adams & Co., is
representing a prospective tenant that consists of a group of former
Bear Stearns employees who decided to form a hedge fund after the
investment bank’s collapse and sale to JPMorgan. Bonett, who would not
name the fund or its managers, said he expects this type of situation
to become more common over the next year, helping to fill the void in
office demand created by the slips of these new funds’ much larger

Investor groups that have worked within large banks for five or 10
years also have a high degree of credibility in the eyes of landlords,
Bonett said. “The landlord is going to be more willing to strike a deal
with these guys who have a track record,” he said.

Many groups that work within large, established investment banks
have always operated independently, Bonett said. It is often a natural
next step for them to get their own office after their bank goes under
or lays them off.

The demand from hedge funds and private equity funds generally
centers on spaces of 5,000 square feet or less, according to John
Johnson, senior managing director at Studley. Alternatively, Bonett
estimated the range of offices that continue to lease to hedge funds is
closer to between 5,000 and 15,000 square feet.

Johnson said much of the space coming on the market isn’t set up
for small hedge funds or private equity funds, requiring more work
before it’s occupied.

For example, Lehman Brothers has put a 166,000-square-foot block of
sublet space on the market at 399 Park Avenue. While parts of this
chunk would be good for a five- to 10-person investment firm, sections
like the back offices and the trading floor would probably need to be
upgraded to lend themselves to that use.

But some say the space demands of hedge funds in a down market have been overstated.

“A lot of these people who are starting smaller investment
companies might not get off the ground,” said Stuart Lilien, executive
vice president at Lansco Corp.

Lilien said that many new hedge funds are having a tough time
raising funds, during this period of low liquidity and timid investors.
He also explained that because hedge funds are so highly leveraged,
they generally have only a very small percentage of their cash at their
disposal for company expenses, like office space.

“People say ‘that hedge fund has $1 billion in it,’ but they don’t
have $1 billion to back up the lease they signed,” Lilien said. “They
often have a small amount of money, especially at the beginning. And
money can go out the door real fast.”

The Global Hedge Fund Index, an index published by Hedge Fund
Research that tracks the performance of over 55 funds internationally,
was down 3.42 percent year to date in mid-July. While this is a
healthy-looking picture when compared to the greater U.S. economy, it
does not necessarily forecast hedge funds taking the hundreds of
thousands of square feet made available by investment bank contraction.

Another point Lilien considered is that while it’s nice for small
funds to be located in prime locations such as the Plaza District, it’s
not as necessary as it is for the large investment banks, which desire
the cachet and drawing power of being in a central location.

The actual day-to-day operations of a hedge fund rely almost
entirely on access to Internet and phone — amenities that are not
unique to Midtown.

“Hedge funds don’t have to be here in New York,” Lilien said.
“There are loads of them up in Greenwich, Connecticut, and they don’t
suffer from not being here. You used to have people saying, ‘Oh, I want
to stay in New York,’ but now these people just want jobs, and they
will work where the job is.”

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