Although New York office market rents are going strong, industry watchers are looking at scenarios that could take the market down. As mixed economic data comes in, people are speculating about the possibility of a slowdown in the U.S. economy turning into a fullfledged recession. At a recent Cushman & Wakefield media briefing in New York, Kenneth McCarthy, Cushman &Wakefield’s managing director, New York metro region research, said that everyone is “waiting for the other shoe to drop.”

Everytime there has been a major downturn in New York, it has happened during a national recession of some magnitude. In the worst-case recession scenario as many as 100,000 jobs could be lost, and as much as 24 million sq. ft. of New York office space will be back on the market. In this case, the vacancy rate could go up to 9%, from 5.7% at the end of 2007. While the odds of a recession have increased in the last few months, McCarthy believes that “we will slide through without one.”

The New York market is starting out this year with good fundamentals, considering that there is very little new construction and no major negative market factors. In 2006, 27,000 office using jobs were added to this market and McCarthy hasn’t seen any major layoffs in financial companies though as much as $100 billion in mortgage-related writedowns could occur. For every three jobs lost in the financial sector, one job is lost in a supporting sector. According to research firm, Challenger, Gray & Christmas, however, there were over 153,000 layoffs in the financial sector nationwide in 2007, 31% more than in 2001.

Joseph Harbert, Cushman & Wakefield’s chief operating officer for the New York metro region, noted that while demand for space declined in the Manhattan office market last year, rents continued to go up. Is this a situation of economic laws not holding good? Not so, according to Harbert. The Cushman & Wakefield executive explained that the underlying theme here is that this is a supply constrained market in which office property landlords are looking at very low vacancy rates.

For the overall Manhattan office market, rents at yearend were up 28.7%, compared with the fourth quarter of 2006, even as leasing activity was down 12.8%, on a comparative period basis. The Midtown market saw leasing activity decline 16.4% in the fourth quarter, while rents were up 29.4%. Along similar lines, the Downtown office market saw rents go up 22.9%, even as demand for space declined 17%. Midtown South is the only major office submarket in the city that saw both demand, up 21.5%, and leasing activity, up 15.6%, rise in tandem. Rents in the Manhattan office market were at $65.08 per sq. ft. on average considering the three submarkets, a 28.7% increase from yearend 2006.

Harbert noted in his briefing that there was record activity in the first half of 2007. And while the second half of 2007 was slow in terms of deals, with the financial uncertainty, the activity didn’t “fall off the face of the earth.” However, the subprime mortgage-induced credit crunch has left an imprint on the market. Thanks to a tightening of lending standards, investors are now required to put in more equity.

Capitalization rates are up about 50 basis points and insurance company lenders are back in favor. Foreign buyers account for 33% of the sales under contract at the end of 2007, and institutional investors and pension funds account for 24%. Private equity investment activity is down sharply, considering that this source accounted for 65% of the sales closed in 2007 and only 23% of the sales under contract at the end of 2007.