For more than two decades, the U.S. publishing arm of EMI Group happily called midtown Manhattan home. Early last year, when the company opened negotiations about renewing its lease, the good times ended.

“The landlord wanted a rent that was substantially more than we’re used to paying, and then the price kept going up every time we talked,” says Roger Faxon, co-chief executive of EMI Music Publishing.

Instead of biting the bullet and remaining in their two Rockefeller Center locations, EMI executives chose to decamp to Chelsea. There, the scene is far trendier, and the rents are significantly lower. Mr. Faxon reports that the move has brought significant cost savings.

“We love midtown, but we realized we don’t need to be there,” he says. “The more we thought about it, the more appealing the notion of moving became.”

All across midtown, longtime tenants are beginning to harbor similar ideas. Following last year’s rent spike of as much as 30% in many tonier locations, such as Park Avenue and the Plaza district, many firms whose leases are coming up for renewal have major cases of sticker shock. Brokers report that they are being inundated with requests from tenants to investigate alternatives to midtown.A growing number of companies, like EMI, are already packing up.

“Companies by and large want to stay in midtown, but they’re asking whether it’s worth it,” says Peter Riguardi, president of Jones Lang LaSalle’s New York office.

It’s hard to find a broker these days who isn’t working with one or two major companies that are considering relocating all or part of their businesses from midtown to less pricey parts of Manhattan—or in some cases, heading out of the city entirely.

“It’s happening right now,” says Dean Shapiro, executive managing director of CB Richard Ellis’ New York operations. “But it will happen more as leases roll over.”

He notes that many midtown companies that signed leases in the mid-1990s are looking at rent increases of at least 100%. For a tenant paying $30 per square foot for 100,000 square feet of space, a doubling would translate into $3 million a year in additional costs.
 
Rents for Class A office space in midtown averaged $68.32 per square foot at the end of last year,according to Cushman & Wakefield Inc.—up 28% from levels at the beginning of 2006. That dollar figure breaks the neighborhood record of $67.40 set in 2000, on the eve of the dot-com bust.

In some buildings and submarkets, the run-ups have been truly phenomenal. Asking rents now exceed $100 per square foot at 25 midtown properties. And it’s not only a handful of buildings with Central Park views that command these rents. Several towers on once-lowly West 42nd Street joined the triple-digit club last year, as did the newly constructed New York Times Building, across the street from the Port Authority Bus Terminal way over on Eighth Avenue.

“Probably this rise in rents in midtown has occurred at a faster rate than ever before in the history of the Manhattan real estate market,” says Stuart Lilien, managing partner at tenant brokerage The Lansco Corp.

The hedge-fund effect

He and others attribute the change to the recent phenomenal growth of law firms and private equity and hedge funds, and their immense appetites for Class A space— especially in trophy buildings.
 
“I see no reason for that to slow down so long as the economy remains stable,” Mr. Lilien says.
 
Until recently,most of those fleeing midtown rents, or considering doing so,were nonprofits and smaller service firms on tight budgets. Now the range of businesses is broadening to include media and marketing firms and, lately, even financial services and law firms.
 
Later this year, for example, Aon Corp.—which relocated some operations to midtown following the loss of its WorldTrade Center home on Sept. 11, 2001—will consolidate its operations downtown on Water Street.There, the insurance company will pay $30 per square foot,compared with $80 at East 52nd Street. Brokers say that they expect the market to be increasingly characterized by such rental “arbitrage” moves.

The prospect of reaping big savings certainly appealed to Jim Spitz, managing partner at law firm Harris Beach, which is heading to 100 Wall St. from 805 Third Ave.

“When you analyze the added commute for our staff and attorneys, you’re talking about an extra five minutes,” Mr. Spitz comments. “When you put that up against a 40% difference in rent, moving was an easy decision.”

23 skidoo
 
Such arguments are not lost on Viacom and The Walt Disney Co.,which are both widely believed to be weighing similar steps. So, too, is the U.S. arm of British advertising and marketing conglomerate WPP, whose units include Grey Advertising and Young & Rubicam.

Despite all of the talk, most midtown landlords are still betting that when the time comes for tenants to make decisions,the vast majority of them will stay right where they are. History is clearly on the landlords’ side.

“The last few years have shown us the premium that companies are willing to pay to stay in midtown,” says Marcus Rayner, managing director of tenant broker Cresa Partners.

Certainly, the ultralow vacancy rate for Class A offices in midtown—5.8% and sinking—demonstrates that demand for space there remains robust.Last year,there were many early renewals of leases ending as far out as 2009, says M. Myers Mermel, chief executive of real estate advisory firm TenantWise.

New tenants are moving into the area as well.

“Despite the prices,we’re getting more business than ever from out-of-town companies coming in,”says Marc Miller, president of tenant broker Miller & Partners Ltd.

Inevitably, however, the higher the rents, the smaller the pool of tenants able to afford them. No wonder the speed of the recent run-up has created so much nail-biting among tenants. Some experts say that any sign of a faltering economy could finally turn the legions of fretful fence-sitters into midtown defectors.

“Historically, when you get to a level where the rent differential between midtown and downtown hits 50%, that’s the tipping point where you see large groups of tenants start to move,” observes Mitchell Konsker, a Cushman & Wakefield executive vice president. “We’re at that point now.”

Copyright 2007 Crain Communications, Inc