11/20/08

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Commercial brokers turn to subleasing

Go to chart: Class A sublease availability

With job losses announced and more predicted in the financial services industry and at businesses hit by its fallout, New York is seeing a citywide slowdown in office leasing activity that could last as long as 18 to 24 months, according to some experts.

But as direct leasing deals have become sparse, many commercial brokerages are turning to the type of deals that may become much more prevalent in coming months: subleases.

"Part of being successful in this business is being able to see ahead, and adjusting your business model to the changing market conditions," said Bob Stella, Cresa Partners executive vice president. "You will probably see a little more disposition work for firms that are putting space on the market. Tenants are contracting rather than expanding."

Sublease space accounted for 4.8 million square feet, or 32 percent of the available Class A office space in Manhattan in April. This figure is up from 28 percent at the end of the first quarter and 25 percent at the end of the fourth quarter of 2007.

A tally of unused space held by several big financial service tenants, calculated by Stella, estimates there is anywhere from 4 to 5 million square feet held by Citibank, Morgan Stanley and Lehman Bros. that could eventually come on the market as sublease space.

Large tenants will often keep this "shadow space," as Stella calls it, in their portfolios, holding onto the space so it is available to them in a more expensive market once the economy rebounds.

But this may soon change.

"Major financial institutions are finally starting to reassess what their space needs are going to be over the next two to three years," said Peter Kozel, head of research at Newmark Knight Frank.

Sublease rent can be anywhere from 15 to 50 percent lower than a direct lease at the same property, according to Andrew Wilkes, an associate broker at GVA Williams.

"Tenants who sublet are not in the market to make money; they're not investors, they're just looking to cut their losses," Stella said. "They don't have a benchmark [rent] to meet to have a certain cash flow, the way a landlord does."

In an extreme example, a 10,000-square-foot space at 450 Park Avenue that Wilkes is brokering for the direct tenant, PNC Bank, has an asking rent of half the building's asking rent for direct space.

PNC Bank is also subletting 21,000 square feet on four floors at Heron Tower, located at 70 East 55th Street.

In May, Crain's reported that communications service provider British Telecom subleased 63,000 square feet at the New York Times Building from asset management company ClearBridge Advisors for around $95 per square foot. Direct rents at Forest City Ratner's recently completed office tower are well above $100 per square foot.

Wilkes noted that PNC Bank is not downsizing, but reshuffling its space in three buildings, with a net result of an increase from 32,000 to 40,000 square feet of offices.

Factors that affect the amount of discount for a sublease include how recently the space was built out and the amount of time left on the direct tenant's lease. If the tenant in place only has two years left, for example, it's a less attractive deal, because once that contract terminates, the subleaser will have to renew for the full, direct lease rent. They also carry the risk the landlord will not renew.

The building owner must approve any sublease deal, and will often veto the sublease if they believe the direct tenant's asking rent is too high, or if they have a creditworthy tenant in place that they would rather not lose, Wilkes said.

"It's probably the most complicated type of lease agreement," Wilkes said. "Because there are so many entities you have to satisfy." In most cases, each party is represented by its own broker.

While large financial institutions are seen as the most likely to put sublease space on the market, brokers predict that small tenants — those looking for less than 10,000 square feet — will be the hungriest for the space.

Kozel said that small high-end private equity firms and hedge funds have the potential to expand in this market.

Brokers say they will also target firms that deal with employment issues to fill space.

"As people get laid off, we've seen a lot of recruiting, human resources and consulting firms looking for space," Wilkes said.