In Manhattan and London, office sales have been few and far between since the onset of the financial crisis. But that is starting to change. Since April, 37 office properties greater than US $20 million have traded or gone into contract in London—versus only 15 in Q1’09. Manhattan’s office market, with three trades in Q1 and six since April, is months behind London’s. In both cities, any turnaround is dependent on clearing a path to price discovery, and that seems to be taking place in London. As displayed in the charts below, the first real clustering of transactions in London since early 2008 has occurred in the past few months. Yet Manhattan has not followed suit.

Consider the similarities in the office marketplace of these two global business capitals. The tenant base is comparable—often duplicative—with similar credit profiles; the investment communities are very much intertwined; and the space markets are locked into similar patterns. With dependency on and commingled with the fortunes of the financial services industry, millions of square feet of leases are at risk. Vacant space is filling slowly and competing with lower-priced sublease space. This dynamic adds to downward pressure on values. Rental rates have already sharply corrected by 50% after incentives such as free rent or build-out monies are included. Combine the bleak income scenario with the shortage of debt capital and the difficulty of pricing, and the reasons for the prevailing commitment phobia among investors are evident.

London-focused investors have begun to brush these concerns aside with a simple strategy based on a cathartic realization: buy leased assets, since not every tenant will go bust and leave a vacant building. Fully leased, well-located commercial property is viable and desirable—at the right price. Such assets, if not the asset class, have thus reappeared on investor radar screens. Anecdotes abound about competitive bidding over stabilized assets, a situation that had vanished. Thus, almost all of the recent London office transactions were for fully or mostly occupied properties under long term lease agreements. Even an asset that was sold vacant, Cheapside 107, only traded after the seller guaranteed the rental income well into the future.

The switch in investor preference from value-added (i.e., partly or wholly empty) to stabilized (well-leased) assets has certainly helped muddy the pricing picture and may explain why Manhattan’s sales activity lags London’s. The major 2009 Manhattan transactions have not only involved assets with significant vacancy risk, including 1540 Broadway and Worldwide Plaza, but that were also the result of distress situations. The pricing achieved for these assets has created confusion (and fear) among investors bidding for long-term leased Manhattan property, which are relatively rare.

Two equivalent pricing tiers are emerging in these two financial capitals: one for prime assets under long term lease, and another for assets with significant leasing risk. When analyzing recent London office trades, average cap rates have moved to around 7.5%, up 300 basis points from the height of the market (see chart above). Stabilized building sales in Manhattan will need to occur before the acquisition yield picture clears and pricing benchmarks can be established that will reassure investors. The recently announced potential sale of an interest in 485 Lexington and sale leasebacks by HSBC and JP Morgan may provide a foundation, but the leasebacks are short.

With every additional data point, commercial property market participants get a bit closer to discovering where true value resides. There are early indications that cap rates in London may have fallen slightly in recent weeks as investors compete for the few assets on the market. However, the hard-to-fill vacancy embedded in recently completed Manhattan transactions skews pricing and thus comparables. How does one value such vacancy? Guesswork. However, the thought process that encouraged investors to overpay for vacancy is not working in reverse. Whether the sales of 1540 Broadway and Worldwide represent clear new pricing benchmarks or the aberrant outliers of a market gone wrong remains to be seen. But investors in London have already indicated that stability is the new opportunity in today’s market, and there is every reason to believe that New York buyers investor will buy into that.

Data subject to future revision; based on properties & portfolios $5 mil and greater.
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