The Manhattan office market continued on its road to recovery in Q2 with the overall vacancy rate falling to 12.7%, a slight 10 basis-point decline from the previous quarter, and asking rents rising to $48.64, a 1.9% increase from Q1.

Leasing activity was dominated by financial services and media companies, which accounted for 16 of the 20 largest leases completed during Q2. Two blockbuster deals were completed in the quarter, with Conde Nast signing a lease for 1 million SF to anchor the under-construction 1 World Trade Center, and Nomura moving from Downtown to 900,000 SF at 825 Eighth Avenue in Midtown.

With asking rents continuing to increase, tenants across all sectors are proactively evaluating their current space situation and entering the marketplace to assess alternative options before they are priced out of their desired property type and/or location. This is especially true for hedge-funds, private equity firms and other companies seeking space in Midtown Trophy Class A properties, where overall asking rents are now approaching $100 per SF.

Increased leasing demand is also prompting new office development for the first time since the recession began in 2008 (the exception, of course, is the World Trade Center site). Boston Properties has announced that it will resume construction on its 1.1 million SF tower at 250 W 55th Street in Midtown, and Edward J. Minskoff Equities will commence construction on a speculative 400,000 SF tower at 51 Astor Place in the East Village later this year. In addition, The Related Companies, Vornado and others are actively marketing potential new office developments to the largest tenants in the city, hoping to secure anchor tenants in order to commence construction.

However, the uncertainty that is resulting from the European debt crisis and the US federal deficit / debt ceiling debate is contributing to a slowing US economic recovery and negatively impacting hiring decisions. To date, NYC’s labor market has outperformed the national market, with the city’s unemployment rate standing at 8.6%, 80 basis points below the national average of 9.6% (as of May 2011). However, NYC’s major office-using industries, including the financial services sector, are slowing or stopping hiring, a worrisome trend that could impact the office market in the second half of 2011.

Manhattan’s capital markets continued to gain momentum in Q2. Strong market fundamentals are attracting a plethora of domestic and foreign investors and the ensuing strong demand, combined with readily available financing, is prompting aggressive bidding wars for the few properties currently on the market. Class A office buildings are trading at 4%-5% cap rates, well below the national CBD office cap rate average of 6.72%. With investors willing to pay top dollar for Manhattan properties, more owners are likely to consider selling assets in the coming months. Investors are also focusing on distressed assets, either by buying distressed notes, or partnering with owners in distress to recapitalize an asset to avoid foreclosure.

Click here to read NAI Global’s full Q2 2011 market report on the Manhattan office market.