Conventional Ideas About Subleasing are Changing

New York Times Real Estate

Conventional Ideas About Subleasing are Changing

By Claudia H. Deutsch

Ruth Colp-Haber, a partner in Wharton Property Advisors, says "there's a lot more property out there than meets the eye".

Shorter terms are O.K., and tenants don’t only seek bargains.

When it comes to subleasing, three things have seemed almost axiomatic: Short-term sublets are unmarketable; landlords always see sublessors as competitors, not collaborators and sublet tenants only go for bargains.

Well, try to convince the Bank of Boston of the first. It found two tenants to split 20,000 square feet that the bank had under lease for three more years at 2 Penn Plaza, at 33d Street. One sublessee was opening its first New York office; the other was expanding.

"Neither wanted to commit for the long term or spend a lot on building their space," said John L. Peters, a Cushman & Wakefield assistant director who handled the deals.

Now try to persuade Arthur Bocchi, who handles leasing at 666 Fifth Avenue, at 53d Street, of the second. He cut the annual rent that his primary tenant, Bertelsmann A.G., was paying on 66,000 square feet by $15 or so a foot – the amount, after subtracting the cost of customizing the space, that Bertelsmann could have received from a sublessee – and took the space back himself.

He combined it with other space in the building, and rented the resulting four-floor package, at market rents, for 15 years to the law firm Orrick, Herrington & Sutcliffe.

And as for bargain-hunters, ask Alan L. Stein about the 97,220 square feet of lushly appointed space that NBC has out for sublet at 30 Rockefeller Plaza, at 49th Street. NBC, which has decades left on its lease, is asking $45 a square foot. Rockefeller Center is asking for $38 for 80,500 square feet of empty space at 50 Rockefeller Center, a less glitzy building nearby.

"I know of at least one tenant that is talking to both of us," said Mr. Stein, the Center’s senior vice president of sales.

Yet another effect of the last recession has been to turn conventional thinking about sublets on its ear. The shortage of both very large and very small blocks of space in prime buildings, coupled with a general reluctance on the part of many business people to lock themselves into long-term leases, has turned even short-term sublets into marketable commodities.

"No one used to take sublets of three or five years seriously, but they certainly do now," said Andrew H. Roos, an executive vice president of William Real Estate.

Would-be sublessors are not facing universal good news, of course. The demand for sublease space is nowhere close to exceeding supply. There are about 8 million square feet of sublet space in Manhattan, nearly 5 million square feet of it in midtown. Although that’s less than one-seventh of the near 59 million square feet of total space available, it is enough to put damper on the entire real estate market.

"Sublets are a depressant on the market in that if there were no sublet space, rents would be higher," said H. Henry Elghanayan, chairman of Rockrose Development, which owns Carnegie Hall Tower, at 152 West 57th Street.

Since few landlords include sublet space when they report their vacancy rates, an "occupied" building can actually be awash in space. The brokerage firm Wharton Property Advisors recently gathered some fairly eye-opening statistics on that point. The firm notes that 90 Park Avenue, at 40th Street, is generally considered a full building, yet 28 percent of its space is available for sublet. At 750 Lexington Avenue, at 59th Street, a 1 percent vacancy rate becomes 11 percent, when adjusted for sublet space. At 1 Battery Park Plaza, on Bridge Street, a 4 percent vacancy rate becomes 12 percent when adjusted for sublet space.

"There’s a lot more space out there than meets the eye, and that’s a good negotiating tool when you are looking to rent direct space," said Ruth Colp, a Wharton partner.

In some size categories, though there is little space of any kind, so sublessors and landlords can happily coexist without cannibalizing each other. According to Robert L. Billingsley, a partner in the brokerage Colliers ABR, there are only 27 contiguous spaces of 100,000 square feet or more available in prime buildings right now; four of them are sublets.

Small spaces, while certainly more plentiful, have grown scarce as well.

"Decent space of 5,000 to 20,000 square feet has gotten so hard to find that I’ve actually had potential sublessees compete with each other for sublet space," said William Hedman, a senior managing director at the Edward S. Gordon real estate firm.

In fact, space-hungry tenants continue to chase space that no longer exists. Last year a tenant at 535 Madison Avenue, at 54th Street, asked Mr. Hedman to find a sublessee for 7,700 square feet. Soon after, the primary tenant decided to keep the space.

"I’m still getting constant calls on that space, even though I haven’t marketed it in eight months," Mr. Hedman said.

Nor are potential sublessees insisting on basement prices. Lloyd Lynford, president of REIS Reports, which tracks real estate trends, said that sublet rents averaged about 94.4 percent of direct space rents – a bargain maybe, but not a steal.

"This time around, no one is holding a fire sale," said Mr. Roos of Williams, Barry Gosin, Newmark Real Estate’s chief executive, agrees. "Tenants aren’t yet unloading their space," he said. "If they do, it will have a real impact on market rents."

Actually, many primary tenants may never have to deeply discount their space. Mr. Hedman said he had four tenants vying for about 5,600 square feet of park-view sublet space at 9 West 57th Street. Although the space will undoubtedly rent for less than comparable direct space, "it looks like we’ll get $2 or $4 a foot more than we were asking six months ago," he said.

Space shortages are not all that is fueling the sublet market. The proverbial "flight to quality" is helping, too. Brokers report sizable interest from law firms and others looking to trade up neighborhoods. "Firms that are in secondary locations are really looking into Park Avenue sublets now," said James J. De Luca, an assistant director at Cushman & Wakefield.

And the economic downturn has taken the cockiness out of many executives and small-business owners. Many trust the nascent economic recovery enough to start that business they have been talking about, or to open that branch office in New York. But, with so many of their recession-inflicted wounds just barely healed, they no longer take their long-term success as a given.

Thus, they no longer view a five-year sublease on as-is space as too short, or as compromising their concept of the ideal office; rather, they see it as giving them flexibility to grown, contract, leave town, trade up or down in space – in other words, to be controlled by their primary business’s performance and prospects, not by their long-term commitment to expensively appointed office space.

Last year the Du Pont Company’s fibers group took a five-year sublet for 18,000 square feet at 1430 Broadway, at 40th Street. "Du Pont simply does not know what this business will look like five years from now," said Mr. Roos, who represented Du Pont.

At 1185 Avenue of the Americas, at 47th Street, the EDS Corporation, a computer services firm, just sublet 2,500 square feet of as-is space for two years.

"That would have been unthinkable in the past, when tenants always preferred nicely-built-out, long term space," said Anthony E. Malkin, president of W&M Properties, which manages the building.

In contract, some long-term sublets are languishing. Randy Kohana, a senior managing director at the brokerage Julien J. Studley, has been seeking sublessees for seven floors that The Gap has under lease at 3 East 54th Street. "The lease has 11 ½ years to go, and that long term has become a drawback," Mr. Kohana said. He said he finally had one floor leased, and was close to leasing four others, all to subtenants who insisted on assurance that, if they did not want to leave after a few years, they would be able to seek sublessees of their own.

The competition from sublet space has caused many landlords to take the if-you-can’t-lick-them-join-them approach. Many are agreeing to extend leases for those sublessees that do want a longer term, figuring that this way, they will save the cost of marketing the space and building it for a new tenant when the sublease runs out. And sometimes landlords will even help potential sublessors advertise that willingness.

Williams Real Estate, which is trying to find a sublessee for about 100,000 square feet of Digital Equipment’s space at 2 Penn Plaza, recently held a broker’s breakfast to promote the space. Representatives of the Mendik Organization, which owns the building, came to tell brokers that they would entertain proposals to extend the lease beyond the three years remaining.

"A couple of years ago you couldn’t get a landlord to help you repackage the stub end of a lease like that," Mr. Roos said.