The days of backfilling vacant spaces at rates and terms favorable to landlords are over – at least in the short term, according to a new analysis from Trepp.

This double whammy of decreasing rental rates and increased “going in” cap rates accelerate the decline in property value. Cap rates increase in this scenario due to the increased risks associated with an unstable asset.

“The recent market disruption has caused unprecedented sublease  space availability which immediately reduces market rental rates in those markets,” Trepp’s Lonnie Hendry writes in a new report. “Tenants with existing leases that are set to expire are not going to renew at their current contract rental rates. They are going to demand the sublease rental rate, or in most cases even less.”

A glut of sublease space has hit the office market this year in particular, and total North American sublease space hit 147 million square feet earlier this summer. Across the 90 North American markets tracked by Cushman & Wakefield, office sublease space is up 76 percent year-over-year (YoY) and up 99 percent since the beginning of the pandemic in Q1 2020. 

And that decrease in rental rates is compounded by increasing “going in” cap rates, which in turn accelerate a decline in property value. 

The result? “The operator’s equity (or perception of equity) evaporates, lenders don’t want to refinance the property without increased reserves and the market doesn’t want to pay a price that allows the seller to exit the property,” says Hendry. “It is hard to refinance or sell a property when contract rents are significantly higher than market rents and your property is occupied by multiple tenants with staggered lease expiration dates.”

Hendry says this reasoning accounts for why industrial leases to Amazon are the “coveted prize” in the current market. “They pay higher rents, sign long-term leases, and provide a significant hedge against downward rental rate pressures.”