THE EMPLOYMENT CONTRACTION that began with a bang on Wall Street has spread throughout other sectors of Manhattan.

With the recession expected to push an average of 7,200 borough employees out of work each month, apartment demand will undoubtedly subside. But by how much remains to be seen. So far in 2009, operating fundamentals have varied by submarket. In historically strong neighborhoods such as the Upper East and Upper West sides, vacancy remains relatively healthy, but owners have felt increased pressure to trim rents.

In areas that have seen temporary upswings in demand and redevelopment, such as Midtown West and Upper Manhattan, rent cuts have been more modest, but vacancy has spiked.

Owners are particularly concerned with inventory expansion around the Lincoln Tunnel and along the southern boundary of Upper Manhattan. Nearly 3,200 market-rate apartment units will come online throughout Manhattan in 2009, compared with 1,225 rentals last year.

Additional competition may come from the 3,700 condominiums expected to be completed in the borough this year, as some developers could convert units into rentals to generate revenue. The potential for shadow stock will be pronounced throughout Upper Manhattan, the Financial District, and Midtown South.

Across all five boroughs, employers are forecast to cut 136,900 positions this year for a decline in total employment of 3.7 percent. Payrolls in Manhattan are expected to contract by 86,700 jobs, a 3.6 percent reduction.

This one-two punch of more units and less demand should increase the average vacancy rate by 160 basis points to 4.2 percent by year-end, compared with a 50 basis point rise throughout 2008. Asking and effective rents are projected to recede 3.5 percent and 4.7 percent, respectively, to $3,595 per month and $3,449 per month in 2009. Last year, asking rents ticked up 0.1 percent, while effective rents slipped 0.1 percent.

Transaction Velocity

The number of apartment transactions fell 49 percent in Manhattan from the first quarter of 2008 to the first quarter of 2009, compared with a 3 percent reduction in the preceding year. Despite fewer deals, property values continue to climb. Over the past year, the median price has increased 14 percent to $285,700 per unit.

Going forward, investment activity will be shaped by forces beyond the typical downside trends of a cooling market. Industry watchers are monitoring developments in the litigation involving J-51 tax abatements and rent de-control. If appeals are unsuccessful, owners could be forced to put rental units back under rent stabilization and retroactively reimburse residents. As a result, operators with lower capital reserves may be forced into distress.

Not all properties are affected by the J-51 issue, however, and sales activity in the borough will persist, albeit conservatively. Cap rates for top Manhattan apartment assets are still averaging in the low- to mid-5 percent range, while initial yields for properties in tertiary locations are approximately 6.5 percent or higher.

Liquidity Available, but Tighter

Despite ongoing uncertainty in the financial markets and among some of the country's largest banks, debt financing remains available. Standards have tightened considerably, however, with lenders requiring loan-to-value ratios of 55 percent to 75 percent market-wide.

The apartment sector has benefited from the presence of Fannie and Freddie, as both agencies continue to fund deals. The yield on the 10-year Treasury has been volatile, dropping to nearly 2 percent late last year but rising to 3.95 percent in mid-June. This has prompted many lenders to favor all-in rates, which are averaging in the lowto mid-6 percent range for agency loans.

With apartment fundamentals weakening and delinquencies creeping higher, lenders are devoting greater attention to sponsorship. A borrower's asset base and potential economic stresses that may affect the underlying assets are playing a signifi- cant role in determining loan terms.

The Future of Distressed Sales

Distressed property sales and auctions will increase over the next 24 months across New York City. However, the handling of these assets is likely to be quite different than in the early 1990s. During that period, loans were held on balance sheets of commercial banks as well as savings and loans. The government stepped in by taking over failed institutions and creating a clearinghouse in the form of the Resolution Trust Corp. (RTC) to dispose of assets.

In this cycle, securitization of commercial mortgages has complicated the issues. At the end of 2008, 21 percent, or $789 billion, of outstanding commercial mortgages had been pooled and sold to investors as CMBS. Unwinding these loans is far more complex than it was during the RTC days. Nevertheless, attractive investment opportunities are rising as prices adjust based on quality and location, and more assets are brought to the market.

Overall, Manhattan should weather the storm reasonably well, though there is some short-term pain on the horizon.