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This study focuses on the possible impact of the events of September 11, 2001 on tall and trophy office buildings for market behavior that could influence value. The findings indicated that there is little evidence of any significant departure from general market trends for tall buildings or most "trophy" property, yet for a small subset of truly famous buildings in both New York City and Chicago, such as the Empire State Building and the Sears Tower, there are significant rental and value losses. Sublease activity appears to work well as an indicator of future occupancy trends. Using an additional survey aimed at property managers, there is little evidence of tenant flight away from tall buildings, or dense urban areas, yet property managers do expect significant design changes in the future as a result of September 11 and most have tightened security procedures. [PUBLICATION ABSTRACT]

Introduction

On September 11, 2001 (9/11), 13.4 million square feet (MSF) of Class A office property in New York City was destroyed and another 14.4 MSF damaged.1 This was more than the total vacant space in an already tight New York City office market.2 Immediately, a number of property analysts suggested that this reduction in supply would create an even tighter office market. It is easy to speculate that a reduction in supply with only a small reduction in demand should result in lower vacancies. But that optimistic view did not happen. Instead, the New York City office market witnessed a downward spiral and increasing vacancies. For example, on 9/11, the overall vacancy rate for Manhattan office space was 8% and even lower for Class A trophy property. At the end of November, 2001, it had climbed to 9.1%.3 After 9/11, some tenants spread to multiple locations, including suburbs, and, in many cases, moved to low-rise buildings raising the specter of a similar tenant exodus across major markets in the United States (Kelly, 2002).

In some sense the 9/11 attack provided a wake-up call to the complacency of American business with respect to security. According to an Ernst and Young survey conducted in February and released in March 2002, 30% of corporate boards were very concerned with the security of facilities after 9/11 compared to almost zero prior to 9/11.4 Forty-seven percent of surveyed firms planned some changes in access policies. Thirty-one percent of surveyed firms indicated that they would be less likely to lease space in a high profile building as a result of 9/11.5 It seemed in the winter of 2002 that the office market was destined for a number of significant changes.

In a survey by Jones Lang LaSalle released in fall of 2002, the 9/11 attacks had a profound impact on the attitudes among corporate real estate executives. Most firms, as tenants, were adopting a number of new security and safety measures, including data backup, power backup, decentralization and redundancy of records, revisiting all communication and client visitation procedures, space access policies and engaging in general disaster and business recovery planning. Total occupancy costs, as a result of security and insurance costs, were said to increase by 1% to 3% on average with greater increases on CBD high-rise properties. Bernasek (2002:104-12) suggested significant security cost increases for all commercial real estate.6 At the same time, it appeared that lenders would not finance property if terrorist insurance was not part of the coverage. While insurance companies were disavowing terrorist coverage in the winter of 2002, every real estate trade group lobbied in Washington DC pleading for federal insurance backup, something that came into being on November 26, 2002.

Now that reality has had time to set in, $1.00 per square foot is probably about double the actual increase in costs for most buildings as a result of 9/11. Yet security costs have increased, insurance costs have increased and tenants everywhere have had time to react to the events of 9/11 with greater objectivity.

In a Torto Wheaton research effort focusing on only New York City and reported in the late fall of 2002, they suggest "some sort of flight to quality as tenants seek out these trophy buildings despite initial, post 9/11 concerns that tenants want to avoid them."7 They further point out a disconnect with the capital markets as rating agencies seemed more concerned about terrorist insurance than potential market trends. High-rise office buildings continue to exhibit the same fundamentals that made them successful before 9/11. Specifically, high-rise buildings allow proximity to clients, banks, governmental institutions, services, restaurants and more. While some analysts initially thought all central business district (CBD) tenants would want to flee to the suburbs, this has rarely been the case.

This study is preliminary in that the lasting effects of 9/11 will not be known until much more time has elapsed. At the same time, another attack on a major office property or any significant property will likely increase anxieties to the winter of 2001-2002 levels forcing new evaluations on the question of work location. This study examines the effects of security concerns on a set of tall and trophy buildings across major U.S. cities and compares these trends with those of the general Class A urban office market. A survey is used to try and determine longer run behavior patterns towards tall and trophy buildings.

Preliminary findings indicate that tall office buildings have not suffered as a result of 9/11 in comparison to the general office market and only truly famous buildings have and will continue to suffer significant economic consequences. These results are consistent with recent general comments by Torto Wheaton except that more cause for concern is seen among the truly famous structures.8 The results are also consistent with anecdotal evidence that came to light in late 2002. For example, in a November 2002 Forbes magazine article, the Sears Tower in Chicago was described as a property straining under both too much leverage and the effects of 9/11. "The 3.5 million square foot tower is struggling with rents down to $25 a square foot," (Fitch and Patsuris, 2002:54).

Empirical Data

The data for this study is a proprietary data set provided by the CoStar Group. In the data set, information was collected for the thirty-seven buildings in ten cities listed in Exhibit 1.

The data collected for the tall and trophy buildings consists of rent per square foot on available direct lease and sublease space by quarter, total vacant space available per quarter, total sublease space available per quarter, total square feet per building and number of floors. To enable comparisons between the sample and the more general population, the same variables were collected for CBD Class A office buildings across the United States covering thirty-six major markets.

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The number of time periods in which data were available for each building varied, but at minimum for each building there are data from the first quarter of 2000 until the third quarter of 2002. Since the period of interest occurred in the third quarter of 2001, most of the graphs presented here show the period from the first quarter of 2000 until the third quarter of 2002.

General Hypothesis

The hypothesis in this study is fairly straightforward. The study explores the possibility of a disproportionate impact of the 9/11 terrorist attacks and the specter of future attacks on tall and trophy office buildings. Such effects that can be tested include a disproportionate impact on vacancy rates, sublease rates, or rental rates compared to the overall Class A office market. Any of these impacts would thereby influence value so the general test is one of examining the impact of 9/11 on office property values. Unlike the earlier Torto Wheaton review of New York City where the focus was primarily on vacancy rates, sublease activity is included here as a key variable with the thought that unexpired leases will dampen the effects on vacancy and rental rates. Sublease activity is seen as a leading indicator of where vacancy rates and/or rents might head over the longer term. Given the short time period since 9/11 such leading signals are more important.

Empirical Graphical Results Using CoStar Data

Several graphs were produced in order to gain insights into the overall market trends prior to attempting more technical statistical analysis. These are divided into six sections included in the Appendix 1 as follows:

Section 1: All Trophy Buildings vs. All CBD Class A Office Buildings

Section 2: New York City Trophy Buildings vs. All CBD Class A Office Buildings

Section 3: Chicago Trophy Buildings vs. All CBD Class A Office Buildings

Section 4: New York City Trophy Buildings vs. Only New York City CBD Class A Office Buildings

Section 5: Chicago Trophy Buildings vs. Only Chicago CBD Class A Office Buildings

Section 6: Ultra Famous Trophy Buildings vs. Tall Trophy vs. CBS Class A Office

Each of these will be briefly discussed in turn.

Section 1: All Trophy Buildings vs. All CBD Class A Office Buildings

Trophy buildings have generally experienced lower vacancy rates than the overall market both before and after 9/11. In the fourth quarter of 2001 and first quarter of 2002, vacancy rates did climb for the trophy buildings much more rapidly than for the overall market, yet overall vacancy rates remained lower. Sublease patterns and rent trends for both trophy and non-trophy property followed similar patterns before and after 9/11, but before 9/11 trophy buildings were doing quite well compared to the overall market.

Section 2: New York City Trophy Buildings vs. CBD Class A Office Buildings

Trophy buildings in New York City were also fairing very well compared to the overall market with lower vacancy rates before and after 9/11. There was a temporary increase in the vacancy rates of trophy property in the third quarter of 2001 and a relative increase in both the vacancy rate and the sublease activity. Sublease activity for trophy property increased rapidly after 9/11 in trophy property going from almost nothing to 3% by the third quarter of 2002. Rents in trophy buildings were starting to soften in the third quarter of 2001 and may have softened even without 9/11 simply as a result of the overall dampening of demand from the weaker economy. By the third quarter of 2002, trophy properties started to improve with respect to rental rates relative to the overall market.

Section 3: Chicago Trophy Buildings vs. CBD Class A Office Buildings

As in New York City, Chicago trophy buildings were faring quite well prior to 9/11. After 9/11 the trophy property vacancy rates climb to slightly more than the general market but still in line with general market trends. Sublet activity increased significantly in trophy property and rents softened since 9/11 more than in the general market.

Section 4: New York City Trophy Buildings vs. Only New York City CBD Class A Office Buildings

While New York City trophy property saw vacancy rates climb since 9/11 relative to the overall New York City market, they have remained below those of the overall market. The biggest change in vacancy occurred in the fourth quarter of 2001 and they have continued to climb through at least the third quarter of 2002. Rents remain higher for trophy property in New York City but all property has seen rents soften. Sublease activity has increased since 9/11, more so for trophy property.

Section 5: Chicago Trophy Buildings vs. Only Chicago CBD Class A Office Buildings

Trophy property in Chicago has seen vacancy rates climb since 9/11 relative to the Chicago Class A market while sublease activity has increased and moved somewhat in tandem for all office property in Chicago. Rents have softened more in trophy property and it appears that by the third quarter of 2002 there was no premium rent for trophy property leases, dropping by over $5 dollars from the peak in early 2001-about 13% of new leases. Should this persist, it represents a significant decrease in the value of trophy property in Chicago.

Section 6: Ultra Famous Trophy Buildings vs. Tall Trophy vs. CBD Class A Office

The most famous property in New York City and Chicago was separated from the tall and trophy group and a significant relative increase was observed in the vacancy rates and sublease activity within these famous buildings relative to the overall market and other tall and trophy property. This suggests a greater effect on the really famous properties perhaps seen as more likely targets of terrorism. Rental rates have suffered the most on new leases or renewals signed within these famous properties and by the third quarter of 2002 a tenant could expect to pay less in a really famous building, such as the Empire State Building, than in the average unknown Class A building while other tall buildings continued to command some rental premium. The conclusion is that all tall buildings, defined here as sixty stories or higher, cannot be grouped but rather the degree of fame of the property must be considered.9

Regression Analysis Using CoStar Data

Two different sets of regressions are run to analyze the effects of 9/11 on the tall and trophy buildings. In the first set, the dependent variable is the percentage change in vacancy rates between the second quarter of 2001 and the fourth quarter of 2001. The second set uses the percentage change in subleasing from the second quarter of 2001 and the fourth quarter of 2001. Within each set, two different regressions are presented with the first regression being the full model, and the second regression being a reduced model. No attempt was made to perform regression tests on rental rates as the data were not always available in sufficient detail on every lease and every property.

The independent variables used in the regressions are dummy variables based on the height of the building, the location of the building, and whether or not the building is "famous." Buildings were divided by height into three categories. H1 includes buildings up to 69 stories, H2 contains buildings from 70-99 stories, and H3 contains buildings with 100 or more stories. New York (NYC) and Chicago were selected as dummy variables due to the high number of tall buildings in those cities. The buildings in the Fame category were chosen based on their famous stature relative to the other buildings in the sample. The famous buildings here are defined as the Chrysler Building, the Empire State Building, the John Hancock Center and the Sears Tower.

The reduced model was used in addition to the full model because the dummy variable for the tallest of the tall buildings is highly correlated with the dummy for the fame buildings. There are only three buildings in H3 (the highest height category) and all three of these are in the famous building category of which there are only four buildings. The results from these regressions are presented in Exhibits 2 and 3.

In the regressions, significant and positive signs associated with H2 (70-99 stories), H3 (above 100 stories), Fame, NYC and Chicago were expected. The theory is simply that more famous buildings, tall buildings, or more dense famous cities would increase the likelihood or perception of the building being the target of an attack and therefore affect vacancy and subleasing rates. The null hypothesis for the regressions would be that the associated coefficients would be zero.

In the full regression with vacancy as the dependant variable, H2 is almost significant at the 10% level and none of the other variables are close to significant. In addition, the coefficient for Chicago is negative, which is the opposite of the expected sign. As mentioned earlier, there is a high degree of correlation between Fame and H3, so the regression was run again without the height variables. In this case, the results for the Fame variable are much stronger, but still not significant. Also, the overall F-Statistic is worse in the reduced model even though it is not significant in either model.

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The second set of regressions focusing on subleasing as the dependent variable shows results more in line with expectations. In the full regression, NYC's p-value drops to .153 while the Fame variable is positive and significant at greater than the 1% level, while the p-value for the overall model on the F-Statistic is .015. Once again H2 and H3 were removed because of the multi-colinearity problem, and Fame is still significant at the 5% level and the overall model is significant at the 1% level. The statistical evidence suggests that subleasing activity is a better indicator of possible flight from tall and trophy buildings, yet even here little impact is seen on tall buildings and only extremely famous buildings have suffered any significant market reaction from or since 9/11 compared to the overall market trends.

In results not shown here, when just NYC and Chicago were used as independent variables, both cities coefficients were positive and NYC was significant at the 10% level. This seems to indicate some problems with correlation between NYC, Chicago and Fame. This makes sense as each city contained two of the four Fame buildings while there were only eleven buildings in the Chicago sample and twelve in the NYC sample.

Prior Evidence on the Effects of Terrorism and Property Manager Survey Results

Perhaps the elapsed time since 9/11 is too short to be able to gauge market effects as most properties have leases in place and the data may not reflect a pending exodus of tenants from tall buildings and large cities in favor of less dense areas or buildings. In a fairly recent review of the impact of warfare and terrorism on urban form, Glaeser and Shapiro (2001) provide a historical context for such questions. Jerusalem and London are both examined with respect to growth patterns while under the threat of terrorism. The authors find little impact on the growth of Jerusalem or London from terrorism, indicating that most people feel safe enough as if terrorism will only happen to someone else. In this same vain, a quick and short survey of property managers was conducted to see if the fear of tall buildings or dense urban settings will likely impact the behavior of tenants in the future.

During the period of March 6-15 of 2003, the following statements were made to nearly 500 members of the Building Owners Managers Association (BOMA), and asked for their agreement or disagreement. The response rate was about 13% (see Exhibits 4-9).

1. Since 9/11, you will avoid very tall and trophy buildings for your future space needs.

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2. If you work with tenants, your tenants prefer to avoid very tall and trophy buildings since 9/11.

3. You or your tenants are more likely to move away from downtown on the next move and to avoid more concentrated urban areas.

4. You or your tenants are more likely to move to smaller cities in the future in face of terrorist threats.

Exhibit 5 shows that few property managers as of March 2003 have decided to flee tall and trophy property for their own space needs in light of terrorist concerns. At the same time, when asked about the behavior of their tenants, as shown on Exhibit 6, the view was a bit more negative with over 20% agreeing that in the future tenants will prefer to avoid very tall and trophy property. Exhibit 7 shows that only 12.5% feel that terrorism concerns will move tenants away from dense urban areas in the future, while 73% disagree or strongly disagree with that assessment. Exhibit 8 shows continued support for large cities and no rush to "Smallville" in the near future as a result of terrorist fears. In this regard, there seems to be enough continued support for remaining in tall buildings and dense urban areas that property owners should not be overly concerned with the exception of those really famous buildings that a greater proportion of tenants now seem to want to avoid. Tall buildings have never been an advantage to every tenant in the past nor should are they expected to be in the future.

"If the skyscraper error is not over, it's at least on hold," said Steven Sandberg, President of Staubach Advisory Services, a tenant representation firm, in May of 2002.10 The value of having people and businesses nearby has generally superseded safety concerns. At the same time, most high-rise buildings are not built for mass evacuation. Recognizing the difficulty of quickly leaving a high-rise several firms are now marketing emergency escape parachutes designed for low altitude exits, some as low as fifteen floors.11 It is difficult to imagine that such devices will offset the fear and disadvantages of being stuck in a high-rise should an attack occur, but the novelty may be profitable for as long as high terrorist alerts persist. Perhaps in the future, several take-off points can be provided and designed into tall buildings along with emergency parachutes not unlike the cruise ship providing life jackets to passengers and lifeboats. With the more general notion of design changes in mind, the following statement was made in the survey: "Concerns of terrorism influenced or will influence design changes in your buildings." See Exhibit 9.

Unlike the responses to the prior questions, which for the most part negated any significant and lasting impacts from 9/11, the majority of respondents affirmed that future design changes are likely as a result of 9/11. Speculators about the future, such as Jim Young, President of the Jameson Group, have suggested that trophy property may be redefined in the future to include a variety of features now present only in a few cutting edge properties.12 See Appendix 2 for a list of such features and attributes.

However, implementing design changes and providing new security measures will inevitably add additional costs, which ultimately will be passed onto tenants. Moreover, additional security measures create inconveniences, such as delays of companies' personnel and clients. At the same time, the longer the period of time without any terrorist acts of a similar nature, the less concerned people may become about security. Right after 9/11 many tenants were ready to pay for security improvements. Now they are less tolerant of spending more money on occupancy costs just for the sake of more security (Levy and Powers, 2002).

Security Costs, Insurance Coverage and Value Impact

On November 26, 2002 the President of the United States signed the "Terrorism Insurance Act" intended to provide some protection for property owners who recently witnessed dramatic increases in insurance rates as well as cancellation of coverage required by lenders. With this new legislation, the federal government agrees to cover 90% of the losses related to terrorist attacks for claims greater than $5 million. The three-year program is capped at $90 billion declining to $85 billion in the third year but does not cover recent losses from the World Trade Center attacks estimated at $40 billion dollars.13 While it is too soon to estimate longterm figures for the increases in security costs and insurance costs as a result of terrorist concerns, the range of anecdotal evidence runs from fifty cents per square foot to several dollars per square foot per year. Using fifty cents of new costs and ignoring any rental rate effects, and using a capitalization rate of 9.0% results in the average trophy property losing $5.55 in value per square foot. With an average of 1 million square feet, this is not trivial, but, again, the long run may prove this estimate to be high.

Hypothetical "Fame" Property Value Impacts with Softer Rents and/or Increased Vacancy Rates

It is probably unwise to speculate too much on the extent of permanent net operating income (NOI) effects on famous office property, but it is certainly fascinating to examine the possible impact. Under the excuse of mere curiosity, decreases in rent, as well as increases in insurance and security costs will likely reduce NOI by approximately $10 per square foot in the Sears Tower. This suggests a decline in the value of the Sears Tower by $350 million dollars, using a conservatively high cap rate. Using similar numbers for other fame property, there is a possible decline in value of $225 million dollars for the Empire State Building, $240 million dollars for the John Hancock Tower and Center and $120 million dollars for the Chrysler Building.

Conclusion

While the empirical results provided here did not indicate any significant findings for relatively increased vacancy rates in tall and trophy property, the results for subleasing activity indicate that really famous buildings have suffered from the events of 9/11. Increases in subleasing activity lead to increases in vacancy rates. Also, it seems that being located in New York City has had modest but direct and negative effects on vacancy rates in the sample of tall buildings. At the same time, survey results suggest little lasting impact on most tall and trophy property and only the truly famous landmarks have suffered really significant property value damage from 9/11. All trophy property has suffered some negative value effects from increased security and insurance costs despite the new federal insurance act intended as a temporary back up program. In the tall and trophy office market, the conclusion seems to be that since 9/11 a little fame is okay but too much fame can be painful.

Tenants are now more concerned with co-tenants and wish to avoid high profile commercial firms or government agencies likely to be higher priority targets for terrorists. Some are also more concerned with evacuation procedures and escape routes. In this regard, some office buildings in the future may have take-off ramps for braver tenants willing to use the parachute exits and all tall buildings will likely see improved safety features designed into the building.

[Footnote]

Endnotes

1. On September 11, 2002 at http://www.thenow.com/wtc_damage.asp.

2. Vacant space in Manhattan was 22 MSF prior to 9/11 and 26 MSF in the suburbs.

3. See Christina Gear, "Downtown Manhattan Office Market Faces More Tough Times, National Real Estate Investor, Dec. 5, 2001 at http://rebuildnewyork.nreimag.com/ar/real estate_downtown_manhattan_office/.

4. See Trends in Global Real Estate Survey: The Latest in Technology, Security and Corporate Real Estate Strategy, a Ernst & Young survey at http://www.ey.com/global/Content.nsf/US/AABS_-_Specialty_Advisory_-_REAS_-_ Issues.

5. Jim McMahan of Centrprise suggests that many firms wished to be no higher than the seventh floor of any building, the maximum height typically reachable by an extended fire truck ladder.

6. Anecdotal evidence from talking to property managers indicates that a $0.50 to $1.00 psf increase would not be surprising for the next few years. Some high profile buildings have incurred much higher rate increases according to research by Dwight Jaffee, Berkeley Professor of Economics.

7. See Trophy Buildings in New York Fare Well One Year Later, November 22, 2002 at www.tortowheatonresearch.com.

8. Ibid

9. We claim no ability to properly scale the fame variable without some form of large survey that is beyond the scope of this study.

10. See The Site Selector Online Insider, May 13, 2002, at www.conway.com/ssinsider/snapshot/sf020514.htm.

11. For example, see the Evacuchute at http://www.evacuchute.com/ a product that makes the following claim: "The Evacuchute is a first-of-its-kind personal building parachute. Using breakthrough technology and a patent-pending design, Emergency Evacuation Systems created the Evacuchute to provide tenants and rescue workers in high-rise buildings with the individual means to escape safely in the event of a life-threatening emergency-when all other evacuation options have been exhausted." The Evacuchute is currently priced at $1,495 dollars.

12. See http://www.realcomm.com/ and also http://www.realcomm.com/index2.asp.

13. From Commercial Investment Real Estate (2003).

[Reference]  »   View reference page with links

References

Bernasek, A., The Friction Economy, Fortune, 2002, 145:4, 104-12.

Bram, J., J. Orr and C. Rappaport, Measuring the Effects of the September 11 Attack on New York City, Economic Policy Review, 2002, 8:2.

Commercial Investment Real Estate, 2003, Jan./Feb., a CCIM publication.

Costello, J., Trophy Buildings in New York Fare Well One Year Later, Torto Wheaton Research, 2002, 3:41.

The Economist, Terrorism Insurance: A Limitless Risk, November 23, 2002, 26.

Fitch, S. and P. Patsuris, How to Spell Relief, Forbes, November 25, 2002, 54.

Glaeser, E. and J. Shapiro, Cities and Warfare: The Impact of Terrorism on Urban Forms, Harvard discussion paper #1942, 2001.

Jaffe, D. and T Russell, Extreme Events and the Market for Terrorist Insurance, Working Paper Fisher Center for Real Estate #02-282, HAAS School, University of California-Berkeley, April, 2002.

Jones Lang LaSalle Report, The Impact of September 11 on Corporate Real Estate: Survey Results, Fall, 2002.

Kelly, H., Raising Lower New York, Urban Land, 2002, Nov./Dec., 62-9.

Kotkin, J., Beyond the Global City, The New York Sun, Oct. 18, 2002, from The New Geography website at www.newgeography.com, 10/21/2002.

LaRose-Senne, C., Terrorism Insurance, Legislative Update, CCIM, 2003, Jan./Feb., 26

McMahan, J., Corporate Real Estate-Post 9/11, Centerprise presentation to the Urban Land Institute, April 25, 2002.

Newman, O., Design Guidelines for Creating Defensible Space, Washington, DC: National Institute of Law Enforcement and Criminal Justice, 1975.

This study was made possible through the generous assistance of Jay Spivey, Research Director at CoStar.

[Author Affiliation]

* University of Cincinnati, Cincinnati, OH 45221-0195 or norm.miller@uc.edu and visiting at DePaul University or nmiller4@depaul.edu.

** University of Cincinnati, Cincinnati, OH 45221-0195.

*** CoStar Group, Bethesda, MD 20814 or aflorance@ costar.com.

**** University of Cincinnati, Cincinnati, OH 45221-0195 or stevenbe@uc.edu.

***** Dexia Securities, Netherlands or hans.op.t.veld@dexiasecurities.nl.

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