The sublease office stock is increasing on the Westside, and the growing supply is driving rental rates down. According to research from NAI Capital, the supply of sublease office space has increased 10% this year, and it is now a 9.2% discount to direct lease rents. That is a 5.7% decrease in sublease rents over the third quarter 2016. If this trend continues, it will begin to impact direct lease rental rates, according to Ian Strano, an EVP at the firm. We sat down with Strano for an interview to talk about the increasing sublease supply, decreasing rents and why office demand has waned.
GlobeSt.com: What is driving sublease rental rates down?
Ian Strano: This has been a slow year for leasing. At the beginning of the year, subleases began to come onto the market. What concerns me is that subleases that came on the market at the beginning of the year are still on the market. If this was a vibrant market, then the sublease space should be absorbed. What is occurring now is that sublease tenants are lowering the rent to try to move the space. I am finding that even when the rental rate is lowered, activity for sublease space is not tremendously high. That is a concern for the market and where the market goes from here.
GlobeSt.com: So, this is a demand issue?
Strano: The demand for direct space in terms of deal velocity has been down for this year. Many people believe that is because tenants are taking a break or that rental rates are too high. I have heard all of the arguments for why the direct leasing market is slow, but I am seeing that the marketplace is continuing to be slow. It is okay if a marketplace is slow, and then activity picks back up; however, I am seeing a marketplace that is continuing to be slow. I don't think that it will pick up anytime soon.
GlobeSt.com: Why is demand decreasing?
Strano: We have been in a real estate cycle for seven years, and I think that tenants are now beginning to reevaluate where things are going in the future. I see a lot of uncertainty. Tenants don't want to make commitments so fast; they want to think about it. In a high velocity leasing market, tenant activity is very strong. In this marketplace, tenant activity has declined. The decline is because some companies grew too quickly and are now focusing on being profitable; some of them are uncertain about being located in California; and I think the current administration has added a sense of uncertainty as well. The commercial real estate market is a peek into what is going on with businesses in the United States. If companies are reducing their square footage, that will show up in the unemployment numbers of the economy. The question is: when does the increase in sublease space in the market begin to show up in unemployment numbers?
GlobeSt.com: What types of companies are subleasing their space?
Strano: I am getting sublease flyers on the Westside for as little as 2,000 square feet and as high as 70,000 square feet. I can see where a bigger company would consolidate or reduce their square footage, but the sublease footprints on the market show that even small companies with six or seven employees are also putting space on the market.
GlobeSt.com: How is the increase in sublease space affecting the direct lease market?
Strano: There is no crack in the market that tenants have picked up that the sublease space may be a better route than a direct deal. We are at the beginning stages where everyone is trying to understand the implications of sublease space sitting on the market. There is no high alert that sublease space is going to affect the direct leasing market, but if this trend continues, it will become a problem.
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Kelsi Maree Borland
