Feb. 4 (Bloomberg) -- New York developer Peter Malkin, faced with declining commercial real estate markets, has dropped plans to use a second mortgage on the Empire State Building to finance a $625 million renovation.

Malkin began seeking approval for the loan in June from more than 2,700 investors who collectively own the master lease on the iconic 102-story skyscraper, according to regulatory filings. After winning their consent, his company concluded that the worsening economy made it more prudent to pay for the project using the building’s rental income.

“In today’s environment, we are going to decide whether we want to put on debt,” said Anthony Malkin, Peter’s son and president of Wien & Malkin LLC, which oversees the building. “And at present, we have chosen not to.”

Landlords in New York, the most expensive U.S. market for office space, are finding it harder to obtain loans and meet debt payments as the recession cuts demand, leading to higher vacancies and falling rental rates. In turn, commercial real estate values have plunged.

Class A office towers in midtown, where the Empire State Building is located, sold for an average of $500 a square foot during the fourth quarter of 2008, down from $1,000 a year earlier, said Robert Sammons, director of research at Colliers ABR Inc., a Manhattan-based real estate brokerage.

“It’s a very tough environment all the way around for anyone holding onto commercial real estate right now,” said Sammons. “Financing is much more difficult to come by for big players and small players alike.”

Ownership Structure

Peter Malkin, 75, and his father-in law, the late Lawrence Wien, created Empire State Building Associates LLC to acquire a 114-year master lease on the office tower in 1961. The firm bought the underlying land in 2002 through a $61 million mortgage provided by North Fork Bank. Wien died in 1988.

Associates sublets the operation of the tower to a Malkin- controlled company, Empire State Building Co. LLC, in return for an annual fixed rental payment of about $6 million and 50 percent of net operating profits exceeding $1 million, according to a Jan. 16 filing with the U.S. Securities and Exchange Commission. Both entities are overseen by Wien & Malkin.

Empire State Building Co., whose owners include Peter Malkin and members of his family, is the entity that decided against taking out a second mortgage.

Instead, the Malkins will use rental income to pay for the upgrades, a move that will slash annual payments to Associates investors, according to regulatory filings.

“We can either decide to distribute profits or reinvest them in the building,” Anthony Malkin, 46, said. “We have decided the prudent thing to do is reinvest them in the building.”

Malkin’s firm didn’t publicly disclose the size of the loan it was considering, though prior regulatory filings show that the plan would have left the building with debt of about $300 per square foot. That would equate to a total ranging between $660 million and $825 million, with some of that amount set aside for acquiring other properties.

To contact the reporter on this story: Miles Weiss in Washington at mweiss@bloomberg.net

Last Updated: February 4, 2009 11:07 EST