New Challenges for New York Start-Ups –

NEW YORK – Prior to the terrorist attacks on Sept. 11, demand for commercial real estate in New York City had loosened considerably as a result of various downsizing along with the shuttering of numerous Internet ventures. Now with 13 million square feet of downtown office space destroyed and another 10 million square feet inaccessible, finding affordable space may become a challenge yet again.

In the week following the attack, desperate buyers scooped up any open space in midtown Manhattan-site unseen. The frenzy on big blocks has not eliminated the couple-thousand square foot offices venture-backed companies need, but it has propped up the real estate market in the seller’s favor.

While several large tenants in the financial district were displaced, 70% of the space belonged to small tenants using a few thousand square feet, according to Diego Recalde, chief executive officer of real estate broker Concrete Stories and a participant in the New York Coalition for Commercial Tenants Assistance.

“About 80% to 90% of displaced tenants can be moved successfully inside Manhattan,” Recalde said. However, the shortage effects companies located outside the financial district. Midtown-based companies looking to move in the next six months are rethinking their plans.

Ideally, the equilibrium for leasable office space hovers around 8% to 10% of the total. The tight real estate market over the last few years left only about 5% of Manhattan real estate officially available before September. With the softening economy, Recalde estimated that as much as 8% to 12% might have actually been empty.

Landlords had been holding these downsized companies to their leases, but given the opportunity to trade their struggling-often dotcom-tenants for traditional refugees from the financial district, landlords have busted leases left and right. After the dust settles, the percentage of empty space may be down to 3% to 4%.

“Is there going to be increased demand? Yes. Is it going to get to where it was? I don’t know,” said Jonathan Mensch, executive vice president of Kickstart, a temporary office space lessor.

Recalde said start-ups should be able to find small parcels of space particularly on the fringes like the West Side of the city, the area below 23rd Street and the non-residential areas of the far edge of the East Side.

New York start-ups also face other challenges. Kathryne Wylde, president of the New York City Investment Fund, said she was concerned that many tech companies had lost customers and beta-testers. The institutions located downtown are too concerned with restoring operations to worry about trying new products.

Those companies still operating in the vicinity of the World Trade Center have experienced serious telecommunications problems. Verizon lost one switching center in the WTC that served about 40,000 access lines, and a neighboring building, 140 West St., contained four switches that served 300,000 voice lines and about 3.5 million data lines. Verizon got the 140 West St. switches back online, but not without some improvisation.

“The challenge is getting around all the crushed cables that are underground,” said John Bonomo, spokesperson for Verizon. Steel girders fell from the buildings and cut through the streets to depths up to 50 feet. Other recovery and rehabilitation efforts have priority over Verizon.

A Silver Lining?

The demand for office space has the potential to save some start-ups in the softening economy. A classic story involves a company that got locked into a 10-year lease with the intentions of growing from 50 employees to 600, but ended up with only a handful of employees working on entire floors of prime real estate.

For example, Mensch moved one company into Kickstart that had been operating in about 12,000 square feet of space but had trimmed its staff to eight employees. This company was able to offlay their lease onto the market and find a smaller, flexible solution.

John Iorillo, CEO of Ambrose Employer Group LLC, a professional employer organization, had hundreds of dotcom clients. “Everybody was trying to get out of their lease,” he said. “Now all of a sudden, you can walk out of your space.” Several people have suggested that this may have even made some of these companies profitable by easing the drags on their profit-and-loss statements.

“They [the large displaced downtown companies] immediately called around saying, Boom, we need space. We’ll take it as is. You don’t have to move out-just move over. Leave the phones. Leave the desks. Leave everything,” Iorillo said.

This is a particular boon for all the entrepreneurs who had made personal guarantees on their leases. Even if the company receives bankruptcy protection, the entrepreneur would still have been personally liable for the remaining lease obligation and likely would have been financially ruined.

“Nobody is trying to gouge anybody in the City right now, but they [struggling companies] are really getting off the hook,” Recalde said. “A month ago they might have had to sublet at a 30% discount. Now, they are at the market rates.”

Long-Term Outlook

“Over the next year, if we continue to move into recession, space will not be a problem,” Wylde said. “Long range as we move into the next upturn, we think it is.”

Some people may be discouraged from setting up shop in New York, but entrepreneurs and VCs tend to be risk-takers. Unless the overall business environment changes, some businesses need to be located near New York or other major cities.

Iorillo remembers the real estate situation in the financial district five years ago. About as much square footage that was lost on Sept. 11 was vacant. It was a ghost town. Wired office space rented for $16 to $18 per square foot, which much more than doubled as start-ups moved in and grew the Silicon Alley community.

“Chances are that one or two years from now, there will be a lot of vacancies down here,” Iorillo said. “It will be fertile territory for start-ups.”

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