The near-meltdown of the banking system has forced several major lenders, hedge funds and other companies to reconsider newly signed office leases in prime Manhattan locations — a phenomenon that could eventually force massive amounts of sublet space on an already weakened commercial real estate market.
A growing number of office tenants are asking to renegotiate or back out of leases that were signed in 2007, when office rents were averaging more than $85 a square foot in Midtown and approaching $200 a square foot in the priciest buildings.
The realities are grim for landlords. In some cases, brokers can find a creditworthy subtenant to take over if a company breaks its lease, but if that doesn’t happen, the space will more than likely languish on the market as the original tenant runs out of funds to pay the rent.
Legal options might not be much better. “I can’t imagine what the landlords are going to gain,” said attorney Hugh Finnegan, a co-director of the real estate department at Sullivan and Worcester. “They’re going to spend some money on legal fees and get a judgment [to deal with tenants who break leases], but it’s a judgment that’s not going to get them much value.”
Doug Linde, Boston Properties president, noted during the company’s third-quarter conference call that it will feel some impact from the bankruptcy of Lehman Brothers, which was paying the company $43 million a year in rent. He also pointed to the now-defunct law firm Heller Ehrman, which had been paying the company $7.7 million a year in rent and is now vacating its space. (The law firm has been leasing 144,000 square feet at Times Square Tower.) Boston Properties said it is negotiating a termination of the Heller Ehrman lease.
Meanwhile, Boston Properties has said it will write down $13.2 million for the remaining rent balance from Lehman Brothers, which occupied 436,000 square feet of office space at 399 Park Avenue. It believes the Lehman space will be empty until 2010.
Boston Properties officials say the loss of the two tenants would cost the company “about $50 million in revenue in 2009.”
Brokers say most commercial office landlords will try to pre-lease space over the next year or two to limit exposure during the economic downturn. However, the stock market dive and the accompanying economic tumult have prompted a number of companies to review decisions made just months ago about their future real estate needs.
“There are companies that have signed leases very recently and their business plans have totally changed,” said Benjamin Kursman, a lawyer at Herrick, Feinstein. “For those tenants who put up a security deposit and don’t have any assets, they will leave. If they have a full guarantee [to honor the terms of their lease], then that’s an issue.” London-based HSBC withdrew plans to lease space at 7 World Trade Center after a deal to sell its 452 Fifth Avenue North American headquarters flopped. Lower Manhattan officials said that German lender West LB has, however, agreed to lease that space, where asking rents have been going for $75 a square foot.
Meanwhile, Fran Pollaro, managing director at Brentler Realty, said a recent negotiation involving a private equity firm planning to double its 3,000-square-foot office space at Park and 57th Street just failed. The tenant, who had been in negotiations for a year and a half, had agreed to sign a deal for $110 per square foot, but pulled out just days after the federal bailout was announced. Pollaro said tenants are doing a lot of
window-shopping these days and are very reluctant to sign new deals. “I’m better off sticking to marketing at this point,” he said.
Alliance Bernstein, an investment firm based in Manhattan, has also slashed office space as the credit crunch has begun to impact earnings.
The firm put 46,000 square feet of sublet space on the market at the old Sports Illustrated building at 135 West 50th, after signing an extension for 86,000 square feet in 2007.
Alliance Bernstein had previously leased 220,000 square feet at the tower. CB Richard Ellis officials confirmed they are subletting the space, but declined further comment.
At the same time, landlords like the Blackstone Group are facing similar problems at 1095 Avenue of the Americas — the 1.3 million-square-foot tower that has long been home to Verizon Communications .
Financially troubled real estate investment trust iStar Financial Inc. is desperately trying to sublet 107,000 square feet of space at the building. IStar had previously agreed to lease for 15 years at a whopping starting price of $132 a square foot.
However, the firm, which is based in New York, ran into trouble after it acquired the $1.9 billion commercial real estate portfolio of Fremont General Corp. At the end of September, the most recent time period on record, iStar had $2.5 billion in loans on its nonperforming loan list. The firm lost $305 million in the third quarter, compared to $93 million in profit a year ago.
According to published reports, Blackstone is also in talks with another newly signed tenant, Centerline Holding Co., regarding its 100,000-square-foot lease in the Verizon building.
In late October, Moody’s Investors Service downgraded Centerline’s credit rating to junk status, noting that the company may not have enough cash to meet its near-term needs, which include a $109 million loan that is due this month.
The firm, which is led by Stephen Ross, the chairman of the Related Companies, said it would slash its nationwide workforce by 20 percent. A Centerline official, who asked not to be identified, said no decisions have been made yet, but emphasized that a wide range of options was possible, including negotiating lower rent, subleasing or even maintaining the current lease agreement.
“Everyone is taking a hard look at their revenues and expenses,” the source said. “We’re in the same position as many financial services firms.”
CB Richard Ellis, which is the leasing agent for 1095 Avenue of the Americas, declined to comment. In addition, the Blackstone Group was not immediately available for comment.
‘Good boy’ lease breaking
Under most commercial leases, tenants must forfeit a security deposit ranging anywhere from two to six months in cash or get a letter of credit when they break a commercial lease, according to Sullivan and Worcester’s Finnegan. Subleasing the space to a credit-worthy tenant can prevent default. However, tenants can also negotiate a “good boy” clause into their lease agreement, which means if a tenant exits a lease early with the premises in good shape, the tenant can avoid additional penalties.
Robert Bielsky, president of Manhattan Commercial Realty Co., said one of the reasons why tenants are backing out of current contracts is the flood of subleases coming on the market.
Instead of paying $150 a square foot in the Plaza District and other prime submarkets, hedge funds and other midsized firms can sublease space at a fraction of the cost.
“The fact that there’s a lot of space out there gives customers a reason to think that when they narrow out a choice, just before they go to the finish line, there is something better out there,” said Bielsky. “They hear that the market is crashing. They don’t want to be tied down with a lease, because they think something is better out there.”
Indeed, a series of third-quarter market reports show that Manhattan office rents have peaked and that large blocks of space will begin to flood the market by next year.
A Cushman & Wakefield report noted that asking rents in Manhattan were up 16 percent from a year ago, at $72.66 a square foot, but noted that rents have been flat for the past three months. The report also noted that the vacancy rate rose 0.3 percent from the previous quarter to 7.4 percent, its highest level in two years.
The report stated that available sublease space rose 72 percent from a year ago to 6.5 million square feet, the most since 2005, and that the Midtown, Midtown South and Downtown submarkets all recorded negative absorption, which means more space opening up than is being taken.
A report from rival Colliers ABR forecast more than 10 million square feet of office space will hit the open market by the end of 2009, as banks and other financial services firms trim back space commitments.