"The markets that have placed large amounts of space on the market have been the markets most affected by the housing downturn, and the markets that have the highest exposure to mortgage and home building companies, and niche private equity financial firms," says John F. Sikaitis, VP and director of research with Jones Lang LaSalle. "Where we haven't seen a big increase so far are the margin markets in New York. New York is obviously a market we're watching and I think in the coming quarters we'll see a larger amount of space come onto the market."
The report analyzed sublease space in the top 25 markets the company covers in the US from what they defined as the beginning of the credit crunch in June 2007 to the end of Q3 2008. In that span of time, the company reports seeing a 13% increase in sublease space in those markets. "Rents still aren't discounted for sublease space as much as they were last time around in the crash in 2001, when we saw about a 25% discount," Sikaitis says. "Now we're down about 15% comparing direct rent in the market, but we expect that number to increase higher on future subleases. We think this time around though we won't hit the peaks we established last time around."
The company's report shows that the amount of sublease space available is still about 55% less than it was at the peak of the 2001 crash. "We're still substantially lower," he says. "We don't think this time we'll get to that peak we got to in the last downturn, but it's something to be looking toward in the coming quarters." Sikaitis says companies are proving they may have learned from mistakes that came back to haunt them in the last downturn. "Corporations this time around were more conservative and efficient in planning space, so there's not as much space they have to give up," he says. "This time we're seeing smaller chunks of space coming onto the markets, like 20,000 sf to 30,000 sf, not the hundreds of thousands of sf we saw last time."
Sikaitis says the results of the report were about on par with what the company expected."Considering where most of the sublease space is coming from - South Florida, Las Vegas, Southern California - that's where we've seen the most banks close," he says. "The one thing that's somewhat surprising is that we haven't seen more financial space come onto the market in bigger markets like New York."
Howard Wiese, VP of investments with Marcus & Millichap, says brokers have started to see the increase in sublease space, and that while it will continue to increase, it likely won't hit levels as severe as in the past downturn. "Going back to the prior business cycle, with the downturn in 2001 and 2002 when the tech bubble burst, sublease space in certain Chicago region markets got to be as much as 4%." Sublease space in the Chicago market in recent years has been around 1.2%, Wiese says, an amount he foresees tripling. "It's going to triple to around 15 million sf, and it's certainly going to be a factor in the market and affect some markets more than others," he says. "The numbers say total vacancy probably won't get to be as much as last time, but in some markets it might, and there's certainly that potential."
Wiese says the increase of sublease space will make it more competitive for vacant units to be leased. "Sublease space is particularly competitive, and companies will sacrifice space at a discount to get it off their books," Wiese says. "As numbers grow, it can be a significant factor and you can see the pressure in a competitive leasing situation that it puts on landlords as the amount of space available for sublease increases."
Wiese says he has seen sublease space increase about 10 percent so far in the Chicago market to nearly five million sf, and that number could go up. "It remains under control today and we don't have the overbuilding we did in the last one, so there's the potential that this could be better," he says. "We're economically in a different set of circumstances today than we were five years ago. It would appear that where we are in the cycle, conditions are going to get worse in the next six months to a year, and we're not going to know the bottom until the housing market improves."
"On an overall basis nationally, we're seeing rents decrease in markets where space options increase for tenants," Sikaitis says. "We're projecting rents to fall further in the next six to 12 months. Vacancy rates are bound to go up, which is going to bring rents down, but we're not going to see anything compared to the last downturn, because the construction pipeline is more controlled." Sikaitis says he expects rents will fall most in markets with the most new construction and new space coming onto the markets and in areas where financial service firms have the largest footprint.
Sikaitis says the markets that are the most insulated from the increase in sublease space will be those with less presence of financial firms and larger compositions of segments of the economy that are growing, including energy, health care services and education. Regardless of market, however, Sikaitis says it's a tenant's market now, and that he is advising clients to strike when the market hits bottom, which the company expects will happen in the next six to eight months. "In all but a handful of markets, tenants have extreme leverage in terms of negotiating deals and terms, and this is going to continue for the next 12 months," he says.
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