Unable to line up tenants, developer to cap his second Trade Center tower at seventh floor.

Developer Larry Silverstein is planning to halt construction by the end of the year on the second of the two towers he is currently building at the World Trade Center site if he can’t find a major office tenant, sources close to the company said.

Minor modifications have already been made to the ongoing construction of the tower that will allow it to be capped at the seventh floor—73 short of its planned height. Retail tenants would be sought for the seven-story podium.

If Mr. Silverstein finds a tenant before the tower is capped, he can go ahead and complete what will be known as 3 World Trade Center, although there might be some delays, depending on when the deal is struck. The building was slated to be completed in 2015.

Mr. Silverstein is not currently close to signing a tenant, sources said. The building’s cap can be removed and construction can resume after he finds one. Mr. Silverstein’s spokesman declined to comment.

The move to cap the tower stems from a 2010 agreement between the developer and the Port Authority of New York & New Jersey, the site’s owner, to end a long-running feud. Under the deal, Mr. Silverstein has to pre-lease 400,000 square feet in his second tower, line up $300 million of private equity and secure private construction financing in order to qualify for debt guarantees from the Port, the city and the state.

But amid financial tumult in Europe, a weak U.S. economy and a cooling in the city’s office-leasing environment, Mr. Silverstein has been unable to attract a tenant. Experts say his near-term prospects are dim.

“The willingness of large-scale tenants to commit in this environment is limited because companies don’t want to go out and spend a lot of money,” said Peter Hennessy, president of Cassidy Turley’s New York Tristate Region. “It’s not the building; it’s the market.”

Cheaper to stay put

Despite a host of government incentives to lure firms to lower Manhattan, Mr. Hennessy estimates that a 400,000-square-foot tenant would need to spend about $100 million just to outfit an office. Faced with those kinds of costs in a lackluster economy, Mr. Hennessy said, it’s likely that more companies might opt to renew their current leases.

Morgan Stanley, for example, has been searching for months for between 1 million and 1.4 million square feet. Now, sources said, the bank is very close to renewing its lease at 1 New York Plaza and taking some additional space there, which would be a much more cost-effective option.

While other big companies—including Time Warner, News Corp. and Credit Suisse—continue to prowl the market for huge digs, their ranks are thinning. Last year, the number of tenants seeking more than 100,000 square feet tumbled 23%, from 74 to 57, according to Cushman & Wakefield Inc.

To land tenants, Mr. Silverstein faces competition from both existing buildings and other planned state-of-the-art towers. Related Cos. and Oxford Properties Group are seeking tenants for their massive project at the Hudson Yards west of Penn Station, while Brookfield Office Properties wants to lure firms to the 7.4 million-square-foot complex it plans in the same neighborhood. In addition, by the end of next year, as several large tenants move out, Brookfield will have 2.8 million square feet of space available at its World Financial Center—37% of its total—across West Street from Mr. Silverstein’s towers.

Seeing is believing

Sources say Mr. Silverstein’s tower has an advantage over other planned projects for now: Tenants can actually see the start of the building and visit the World Trade Center site. In contrast, except for one building, Related has to build a huge platform over the rail yards before it can start construction, as does Brookfield. That requires tenants with the imagination to envision the finished product and the confidence to take a chance that the neighborhood can be successfully transformed into a premier office market.

In addition, all three landlords are seeking tenants at a time when they are getting more skittish. While overall activity rose 16% last year, the amount of space leased in the second half of the year fell by 31% from the first half of 2011, and was down nearly 10% from the corresponding period in 2010.

Of course, large deals get done even during choppy times. Two months ago, luxury leather-goods maker Coach agreed to be the anchor tenant for a new tower at Hudson Yards. And just last week, publishing giant Condé Nast exercised its option to lease an additional 133,000 square feet at 1 World Trade Center. That will bring the publisher’s total to 1.19 million square feet in that building, which is being developed by the Port Authority and the Durst Organization.

But sources said the Condé Nast deal was heavily subsidized by the Port because it wanted a strong anchor tenant to establish 1 World Trade Center as a premier corporate location. For example, the Port has agreed to assume the last four or five years of Condé Nast’s lease at its current headquarters at 4 Times Square.

Mr. Silverstein has the right to build three office buildings on the World Trade Center site. The first, 4 WTC, is a 72-story building that is due to be completed next year. About 60% of it is leased. Below-ground infrastructure work is being done on the third tower that is expected to end soon, but the building is on hold indefinitely.

David Goldstein, an executive vice president at Studley, said it’s possible that Mr. Silverstein may find a tenant as firms seek to take advantage of the current environment.

“There are lots of opportunities in this market,” said Mr. Goldstein. “And I wouldn’t count Larry out.”