Shadow Inventory of Subleased Space Warps Market Info

NEW YORK CITY—Shadow inventory of subleased office space is the space which is potentially available but not listed on the sublease market. When large corporations lease substantial floorplates on multiple floors but keep areas vacant, that’s the shadow inventory brokers are concerned about, says Kenneth Salzman, executive managing director and principal at Lee & Associates, New York office.

He adds shadow inventory is not unique to New York. Every city with substantial office space experiences it with New York having the largest market.

“Tenants in big buildings cannot compete for that space because it isn’t being tracked,” says the brokerage firm executive. He describes a scenario where a tenant is renting the first five floors in a building but is only occupying three of them. Just say the tenant on the eighth floor needs to rent another floor and a half. The vacant floors with space could have been recaptured had they been listed on the sublease market.

“Brokers are in the information business,” explains Salzman. They know about shadow space because it’s part of their job to canvass property to let clients know what’s out there and what soon could be available. By definition shadow inventory is not tracked, so no one knows exactly how much is out there. But by their own fieldwork and in talking to other brokers, Salzman’s team says—it’s a lot.

But it’s not just a problem for brokers, according to Salzman. “When the metrics that lenders are using to judge the market, that landlords are using to judge the market, when the publicly available information that they are trading off of is inaccurate or fuzzy, it is not a healthy market indicator,” he says. “So increasing the amount of shadow inventory is not healthy.”

This inventory, availabilities and vacancies in the office market tend to be markers for future recessions. Lack of solid information can throw off economic predictions.

Salzman points to the 9/11 tragedy aftermath, where surprisingly the absorption and vacancy rates remained relatively stable. He underscores the shadow inventory’s providing spaces.

Franz Fuerst’s 2006 research paper for Henley Business School, University of Reading, and the Center for Urban Research, City University of New York analyzed how 9/11 affected the New York City office market. He wrote the attack obliterated 13.4 million square feet of office space at the World Trade Center, and seriously damaged 17.8 million square feet in 23 nearby buildings. This added up to 31.2 million square feet, 10% of the total amount of Manhattan office space.

However, Fuerst concluded, “The expected surge in additional space consumption attributable to the leasing activities of displaced tenants did not occur.” He explained the results with the “backfill of displaced tenants into existing leased space [shadow inventory], employee layoffs and reduced space usage per worker.”

Following 9/11, the extra inventory played a positive role. But Salzman notes the lack of information, not knowing what’s out there can pose problems or market distortions.

He predicts shadow inventory will increase in the upcoming year due to GAAP lease accounting rules and an anticipated rise in labor costs. Companies are being forced to become more efficient and work with fewer employees. With real estate leases from five to 15 years, and even longer, this would suggest more shadow inventory.

In addition, Salzman points out businesses that would have typically taken subleases are now renting in co-working centers or managed office suites. These arrangements provide advantages of smaller capital requirements, lower security deposits, and the immediacy and ease of the transactions.

The effect of co-working and office suites on the sublease market and shadow inventory is not tracked. However, Salzman says, “Just because WeWork, Knotel or Convene signs a lease, it doesn’t necessarily mean they have tenants paying full freight from day one.”

He says with shadow inventory the amount of available subleasing space is likely significantly greater than the approximately 2% of office space that’s currently being reported as subleased in New York City.

“There is a big difference when every square foot that’s available is occupied and you need more and more space,” says Salzman. “The problem is when shadow inventory increases and people are making final decisions based on information that’s inaccurate.”