LOS ANGELES—The supply of sublease space is up 10.7% from the same time last year, but asking rents haven't fallen, according to a report from NAI Capital that GlobeSt.com has obtained exclusively. The report shows that sublease available space has increased slowly over the past year, while rents have also continued to rise, and as a result, there is a shrinking delta between direct lease rates and sublease rates. This trend could be signaling a potential downturn in the future, according to Forrest Blake and J.C. Casillas of NAI Capital, who produced the report.

“The activity levels that we are seeing—and I am just talking about phone calls and showings—are slowing down,” Blake, a VP at NAI Capital, tells GlobeSt.com. “In my eyes, one of the first indications of a downturn is that business owners are saying that they don't want to warehouse extra space because they are slowing down or revenue is down, and they want to get rid of excess space. That is a theory that we validated here, and is at least in the very early stages. Rental rates are going up, still, which is interesting, but the vacancy is increasing by 10.7% over the same quarter last year. There is a change that is going to happen. We can't validate it with all of the numbers yet, but it is coming.”

While the report shows that asking rents for sublease space are north of $2.45 a square foot, compared to direct lease asking rates of just under $2.80 a square foot, Casillas, VP of research at NAI Capital, says that those numbers are going to fall very soon. “We are already starting to see announcements of sublease space being discounted, sometimes as much as 25%. A quarter or two from now, the gap between direct lease space and sublease space rents is going to widen. The sub lessors are going to be looking to recapture some of the rent,” he tells GlobeSt.com, while Blake adds, “Rental rates will start coming down, just by virtue of supply and demand. We are also going to see vacancy rates grow even more over the next couple of months.”

Direct lease space is also down, according to Blake and Casillas. Their sources show that all office transaction volume is down 18% or nearly 1 million square feet over the same quarter last year. However, Blake says that the two markets really only begin to parallel when there is a narrow pricing delta. “There is only a connection between the two if the prices are really close,” he adds. “If an executive wants 20,000 square feet of sublease space and the price is really close to the direct lease space, they aren't going to risk it. Right now, the delta is only 6.2% between direct space rents and sublease rents. That isn't going to last for long. That is going to widen substantially.”

If sublease prices do fall significantly, it may mean more competition for direct leased space. “If sublease rates drop substantially in the next few months, anyone looking for direct lease space in the market will choose sublease space as an option, because of the enticement of lower rates,” says Casillas. “That means that the direct vacancy rate is going to go up. So, overall, this an indication of a slower trend in the marketplace.”

When asked if the increase in sublease space indicates a danger that these companies will default on their leases, Blake said no. It is rather an indicator that they are trying to decrease their cash flow or recoup losses from un-used space. The trend, however, does show a clear sign of a slow down ahead. “My doomsday message is that we are at the top of the market, and people in boardroom are starting prepare for a slowdown,” says Blake. “If companies are starting to get rid of space, that says to me that they need to manage their cash flow better. Some people are saying that we are going to have a rough 2017 and a rough 2018, and I am not an economist, but we may have seen the first quarter of that eventuality.”

Instant Insights /

Is More Sublease Supply the First Sign of a Downturn?

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