Industrial Subleasing Is on the Rise But Shouldn't Affect Absorption

Industrial sublease space is increasing as more tenants see it as a viable way to earn revenue, and landlords are attracted to its potentially shorter lease terms.

However, even though subleasing has more than doubled compared to a year ago, it still represents only less than 1 percent of the nation’s total industrial inventory.

Therefore, it’s not a threat to industrial’s streak of 13 consecutive years of positive absorption, according to a new report from CBRE.

The rise in sublease availability, up by 30% alone between April 1 and June 9, is attributable to several factors, CBRE said: Overestimates of product inventory needs, economic uncertainty, retailer store closings, and record-high rents.

Meanwhile, taking rents have grown by nearly 67% over the past three years.

“This makes subleasing an enticing option for many occupiers, which can often generate enough revenue from subleasing a portion of their facility to pay rent for the entire building,” according to the report.

New and under-development industrial space represents a sizeable chunk of available subleasing space.

Sublease blocks of 300,000 sq. ft. or more that account for 38% of total sublease space are in Class A buildings, 37% of which were completed within the past two years or are still under construction.

General retailers account for more than 26% of available sublease blocks of 300,000 sq. ft. or more, followed by general wholesalers at nearly 24% and e-commerce-only occupiers at nearly 18%, CBRE found.

The Inland Empire has the most blocks at 300,000 sq. ft. or more.

CBRE said it “expects that available sublease space will continue to increase due to economic uncertainty and lower product inventory levels. Demand for such space also is expected to increase due to the opportunity for shorter lease terms with lower-than-market rental rates.”

Firms Leased Large Volumes When Scarcity was Acute

Lisa DeNight, National Industrial Research Managing Director at Newmark, tells GlobeSt.com that, based on its Q1 report, subleases have been added to the industrial market at an “accelerated rate” over the past three quarters.

Sublease volume in Q1 2023 was on par with the volume charted during the height of the pandemic and significantly above the long-term pre-pandemic average.

E-commerce, 3PL and consumer goods firms are among the largest contributors to the sublease volume, but a wide mix of industries are represented across sublease availability.

“Many firms either leased large volumes of space when scarcity was most acute and international supply chain disruption was at its peak or leased an excess of space because it was the only available option, DeNight explained.

“Now, rising interest rates, an inflationary environment, and declining consumer demand are driving some firms to control costs via supply chain optimization and consolidation, which includes putting excess or underutilized space up for sublease.”

Newmark said that over the next few quarters, pre-leased construction deliveries “will continue to apply upward pressure to net absorption as some right-sizing occupiers apply downward pressure through subletting or giving space to landlords. Sublease volumes stand to impact local market dynamics — but on a national scale, still represent a very slim portion of total availability.”

Adam Roth, executive vice president, industrial services, NAI Hiffman, tells GlobeSt.com that the unreliable supply chain caused corporations to miss sales due to displaced inventory.

“The result of this was in 2022, corporations mandated their product be on the continent, therefore, increasing their inventory and real estate footprint to not miss a sale,” Roth said.

In 2023, as the supply chain unwinds and dependability returns, “corporations are right-sizing their footprint as traditional trade flow patterns resume,” Roth added. “Therefore, there will be an increase in sublease vacancies; however, due to the record-low industrial vacancies, I don’t see this as a concern.”

Port Activity a ‘Direct Driver’ for Sublets

Rick John, SIOR, Executive Vice President and Branch Manager at Daum Commercial’s Ontario Office, tells GlobeSt.com, “The direct driver for the increase in industrial sublease availability seen throughout California’s Inland Empire can be accurately correlated to the decrease in Southern California’s port activity this year.

For the ports of Long Beach and Los Angeles, activity is down 22% from last year and this slowdown directly affects the Inland Empire’s absorption rate, John said.

At the close of Q2 2022, the amount of sublease space available in the Inland Empire for buildings over 100,000 square feet included 8 buildings totaling 1,469,110 square feet. Nearing the close of Q2 2023, sublease space currently available has more than doubled last year’s metrics with 19 buildings available totaling 6,464,301 square feet.

“Current lessees are increasingly lacking the inventory to fill their leased space resulting in challenges to pay their monthly rents. With vacancy rates on the rise, the sublease market is becoming an attractive alternative for lessees to meet these economic challenges head-on.”

The sublease market in the Inland Empire is particularly desirable to third-party logistics (or 3PL) companies that provide outsourcing of e-commerce logistics processes.

Fewer Occupants ‘Circling’ 300k+ Assets

Joe Santaularia, Senior Vice President, Managing Partner of Bradford Commercial Real Estate Services/CORFAC International, tells GlobeSt.com that the market has bi-fricated since Amazon switched gears and stopped eating up space.

“This has led to a ‘trickle down’ effect leaving vacancies of 300k+ square-foot facilities sitting for much longer and have fewer occupants circling,” he said.

For spaces below 200K SF, Santaularia is seeing the opposite effect: 80%+ bumps on renewals and very few options to show clients that are expanding as the market is tight and rents continue to escalate at a heightened space.

“This is leading to landlords of bulk vacancies being more flexible in breaking up larger vacancies and come out with more TI incentives, sign tenants with lesser credit and term,” he said, adding that this trend will not diminish as the development of bulk assets continues its record pace.

O’Hare Sublet Market Healthy

Mike Plumb, Principal, Lee & Associates of Illinois, tells GlobeSt.com that industrial vacancy rates, including subleases, remain at historic lows in the Chicago area.

He said the highest concentration of sublease availabilities are in the 50,000- to 200,000-square-foot range, and that the O’Hare market—where rents tend to be the highest of all Chicago submarkets—is seeing the most subleasing opportunity.

“While the space is coming on the market for a variety of reasons, it seems like the cost of the space (higher than in other locations) may be a factor as companies look to their real estate portfolios to save money as the economy slows,” Plumb said.

Newly available sublease space is creating opportunities for both tenants and landlords.

“For tenants, strong subtenant demand has made it easier to reduce lease liability in economically uncertain times, or in the event of an operational change within the company.

“Landlords will likely be amenable to release tenants from their lease obligations to capitalize on higher rents. These subleases that could ultimately lead to lease terminations allow for immediate backfill with new tenants giving landlords the opportunity to “mark to market” the rent that was typically leased at a much lower rate a few years ago.

“The result is the realization of impressive rent growth that the Chicago market has achieved over the last few years.

He said that from the landlord’s perspective, a sublease also creates an opportunity to profit share in a portion of the rent growth above the prime lease prior to that lease maturity.

For example, if a tenant subleases their space for more than their negotiated base rent, the landlord and original tenant can share in the profits that come from the rent the sublease tenant pays over and above the original rent.