Sublease Space: New Years Wild Card

Real Estate Weekly

Wednesday, December 26, 2007

Sublease space: New Year’s Wild Card

By Jason Turcotte

With a whirlwind of uncertainty circulating the market, everyone’s watching and waiting to see what’s in store for the real estate industry this season. Santa just may bring a whole lot of sublease space to the city.

"You have to look at the subleasing market. This is the first indicator of a weakening of the economic picture and the real estate picture," said Ruth Colp-Haber, partner at Wharton Property Advisors. "The sublets are really a harbinger of weakened markets."

With thousands of layoffs expected at financial firms like Wachovia and Citi, Colp-Haber believes increased activity in the sublease market is imminent. Speaking at the NYU Real Estate Institute’s "Tri-State Real Estate Market Trends" seminar, David Lichtenstein, chair of The Lightstone Group, made similar remarks on the inevitability of added sublease space. And Denis Friedrich, president and COO of Brookfield Properties spoke on the matter at a CoreNet panel earlier this month: "I think, quite simply, the big wild card out there right now is sublease space."

If history repeats itself, when this added sublet space does come online, it will dramatically change the overall commercial landscape.

Traditionally, when additional sublease space comes on the market, it foreshadows increasing vacancy rates and lower rents. Colp-Haber says firms offer sublease space anywhere from 10-50% lower than market rates, forcing landlords to reduce asking prices in order to compete with the sublet space.

According to Wharton Properties data, when vacant sublet space grew in 2000 from 501,088 s/f to 5,797,690 s/f (in 2003), the overall vacancy rate climbed from 3% to nearly 10%; meanwhile, average rents dropped from approximately $54 psf to $42. But signs of a market slowdown, thus far, have been subtle, as the health of New York’s commercial market remains strong.

According to New York’s Economic Development Committee November snapshot, average Class A office rents were $79 psf last month.

The demand continues to drive steep commercial rents to the point where Colp-Haber believes small entrepreneurial firms can no longer afford to grow and expand here.

But if the demand begins to waver, sublease space could pile up and trigger a downward spiral of asking rents – both for sublets and direct office space.

Washington Mutual announced earlier this month that it is letting 3,000 employees go; Wachovia and Citigroup are also rumored to be readying for layoffs. Sublease space – typically well built-out, hardwired and ready for a move-in on short notice – is going quickly from the market now, but could become a big-time bargain if companies look to downsize and relinquish space next year.

According to the EDC’s report, unemployment rose from 5.1 to 5.3% in November, but the current commercial numbers are strong.

The city’s hotel occupancy rate continued to rise, up to 92% last month. November’s downtown Class A office vacancy rates remained at 4% and the overall sublease rate also remained stagnant, at 1.1%, while the average sublease rent in Manhattan increased by a dollar, reaching $68 psf.

All vital signs still point to a strong commercial market, but some caution that New Yorkers would be arrogant to expect business as usual for the real estate industry next year, though Colp-Haber said it could take up to 24 months before the New York market feels the effects of financial companies axing thousands of employees from their payroll.

"It takes a long time," Colp-Haber said. "It’s like turning around an oil tanker to get this market to move."