Bank Cautions on Commercial Real Estate

Adopting a far bleaker view of New York City's commercial real estate market than those of major brokerages, Deutsche Bank is predicting a drop in occupancy rates of as much as 6% this year and next, as well as 0% rent growth.

Based on this outlook, the bank's analysts downgraded the stocks of two of the city's largest commercial landlords, Vornado Realty Trust and SL Green Realty, to hold from buy.

"We believe the sale of Bear Stearns, as well as potential layoffs and shrinkage from other financial services firms, may weaken New York office demand and increase the risk of higher office vacancy rates," a Deutsche Bank analyst, Louis Taylor, wrote in a note to investors. "Until the magnitude of the impact becomes clear, we think the shares will go sideways."

In previous market downturns, the financial services companies that help drive the city's real estate market cut about 20% of their work force, according to the New York State Department of Labor. Financial industry firms presently employ 200,000 people in the city; using the standard industry measure that every employee takes up 300 square feet, demand for office space could be reduced by 12 million square feet.

Executives from SL Green and Vornado declined to comment on their stocks' downgrading, citing internal company policy.

"What drives the office market is the financial and professional industries," an economist at the state Department of Labor, James Brown, said. "In previous scenarios like this, like 1990 to 1991, 2000 to 2001, the employment losses tended to run into the 20% range. ... It is within the realm of possibility to have 30,000 or 40,000 layoffs."

With about 4,500 layoffs at financial firms since the beginning of the credit crunch and another 7,000 expected at Bear Stearns, the numbers are already starting to tick higher, Mr. Brown said.

The Deutsche Bank downgrades came during a week of sudden shifts. After worrying signs emerged at Bear Stearns, the Federal Reserve swooped in with emergency funds to stave off bankruptcy. Two days later, JPMorgan Chase & Co. agreed to purchase the investment bank for $236 million, or just $2 a share, including its headquarters at 383 Madison Ave., valued at $1.4 billion. After the deal was announced, JPMorgan said it would consolidate its employees at the Bear Stearns building instead of moving its investment bank operations to a new building on the site of the site.

Lower Manhattan could be the hardest hit by the changing fortunes of investment banks. The World Trade Center buildings will add 7.5 million square feet of rentable space, on top of about 1.5 million square feet of space that Goldman Sachs will vacate when it moves to its new headquarters. Merrill Lynch could also vacate the 3 million square feet it occupies at the World Financial Center. Melissa Coley, a spokesman for the owner and landlord of the center, Brookfield Properties, said the company is in negotiations over the renewal of its lease.

"There's a scenario where by the time the World Trade Center buildings go up in 2012 or so, there's some 10 million square feet added to the market. Who knows where the market will be at by then? The impact on rental rates could be significant," an executive at a real estate firm, who requested anonymity, said.

The developer of the World Trade Center site, Silverstein Properties, said the loss of JPMorgan's headquarters downtown will have little effect on the market.

"I don't think it really impacts where downtown is headed," the director of World Trade Center development at Silverstein Properties, Janno Lieber, said. "We believe the fundamentals for downtown are strong. The market for office space is so tight that people are having trouble finding space."

Real estate companies like Silverstein Properties have remained bullish on New York City, with indicators for the commercial market showing minimal change thus far. The vacancy rate for Manhattan's class A buildings, for example, increased .2%, to 5.4%, between January and February, according to Cushman & Wakefield.

"So far, we've seen the write-downs, but not the layoffs," the chief economist at Cushman & Wakefield, Kenneth McCarthy, said earlier this year. "It could be that we get through this without a major problem."

While a slowdown may not yet be apparent, the Deutsche Bank analysts wrote of SL Green and Vornado, "We don't think the stocks move higher until there is visibility regarding the magnitude of financial services layoffs and the resulting impact on NY office demand."