Sublease Undercut

Sublease Undercut

commercial real estate by Jean Gruss | Editor/Lee-Collier

The housing slowdown means companies in that industry don't need all the office space they leased during the

boom. The result is an increase in sublease space and that's putting downward pressure on Gulf Coast rents.

The housing downturn is no secret, but its effects are now spilling into commercial office space.

As housing related businesses from title companies to mortgage brokers and real estate agencies reduce their overhead, they're leasing their empty office space to save money. Subleasing, when tenants lease their unused space to another, is growing throughout the Gulf Coast.

Take Bonita Springs-based homebuilder WCI Communities, for example. The company has reduced the number of employees in every department and is subleasing the office space it's not using.

"It's pretty inefficient to have all your buildings operating at 75%," says Don Lozowski, director of corporate purchasing for WCI. At its headquarters in Bonita Springs, for example, WCI is subleasing 21,500 square feet of offices.

The trend has implications for landlords and tenants because sublease space is often less expensive than direct available space. That's because the tenant subleasing the space is often eager to fill the space at a discount rather than letting it sit empty while paying rent.

To be sure, there isn't the glut of sublease space that there was during the last commercial real estate downturn in the early 1990s. But the gradual rise in the amount of sublease space is a worrisome sign that the market is changing. Complicating this situation is evidence of overall slowing demand while new buildings are under construction.

For now, the problem is contained to housing-related industries. "My guess is that 50% of the sublet space out there is related almost directly to the residential-construction business," says Russ Sampson, executive vice president and principal with brokerage firm Colliers Arnold in Tampa.

However, if the economy takes a turn for the worse, the amount of sublease space may grow. "If the national economy starts to crater, then I think you'll see more of it," Sampson says.

Downward rent pressure

Sublease space tends to pressure rents lower. That's because the tenant subleasing the space is eager to recoup rent on otherwise empty space.

In the Cape Coral-Fort Myers area, for example, asking rents net of expenses for office space are $23.95 per square foot, but $14.63 for sublet space, according to CoStar Group, a firm that tracks such data. However, those numbers may be skewed by the fact that much of the vacant space now is in newer, more expensive buildings.

In the Tampa-St. Petersburg area, rents that are quoted as "negotiated" are $21.81 on traditional space and $10.66 for sublet space. The amount of sublet space in that metropolitan area has more than tripled since the fourth quarter of 2005, CoStar data shows.

Obviously, landlords aren't happy when cheaper sublease space becomes available in their buildings because they're less likely to get their asking rents and other tenants in turn demand lower rents, too.

However, Sampson says the amount of sublet space on the market is much less than it was during the last downturn. CoStar counts 1.3 million square feet of available sublease space in the Tampa Bay area and Sampson estimates there was two to three times that amount during the early 1990s.

In the Sarasota-Bradenton area, sublease space appears to be minimal. Some brokers say that's because sublease space that is coming on the market is offered for rents at substantial discounts. In one downtown Sarasota tower, the sublease asking rent is $29.50 per square foot in a building where the landlord is asking $40.

"Any sublease space we've managed to absorb because the rates are competitive," says Ian Black, president of Ian Black Real Estate in Sarasota.

Anecdotally, the type of client subleasing space in Sarasota is changing, too. "It's no longer your mom-and-pop stuff; it's your corporations," says Anthony Homer of Hembree & Associates in Sarasota.

Homer says he's seen a spike in sublease tenant representation. "I have a 3 p.m. appointment for another sublease listing," he said last week. "This will be my fifth sublease listing in the last 45 to 60 days."

Sublease space may depress rents, but what's driving rents lower in some areas is oversupply and lower demand, says Andrew DeSalvo, a broker with Premier Commercial Properties of Southwest Florida in Bonita Springs. He estimates the office vacancy rate ranges from 15% to 19% and rising.

"It's not a function of price right now," he says. "There's no new activity."

Focus on existing tenants

Landlords now must adapt to the situation of sometimes competing against the lower rents quoted by their own subleasing tenants. "It works better when you have a willing landlord," says DeSalvo.

For example, in some cases it makes sense for the landlord to negotiate for the early termination of a lease to avoid friction. In other cases, a landlord should consider working with the tenant to help find a suitable company to sublease the space.

"[Landlords] don't like to see people moving around a lot like that," says Mary Beth Cangiano, an associate with LandQwest Commercial in Fort Myers. She suggests landlords carefully gauge the financial health of their tenants so that they're not caught by surprise if they decide to sublease space. And when they do have to work with a tenant who decides to sublease, it's important to make sure the company subleasing the space is financially secure.

In some cases, landlords can compete with sublease space by offering free rent and money for tenant improvements. "The lease rates are pretty secure," Sampson says.

What's more, sublease terms generally last a short one to three years. By the time a short-term sublease expires, the market may have changed in the landlord's favor. "You set [the tenant] up for sticker shock in one to three years when he has to renew," DeSalvo says.

BY THE NUMBERS

GULF COAST SUBLEASES

The amount of office space for sublease is growing in all markets of the Gulf Coast, but it's especially pronounced in Tampa and Fort Myers. Data is from CoStar Group and is through the middle of the first quarter of 2008. (Space in square feet)

Vacant Total Total

Area Vacant space Vacant Sublet space sublet vacant space vacant

Tampa-St. Petersburg 9.2 million 12.7% 1.3 million 1.8% 11 million 14.6%

Sarasota-Bradenton 1.5 million 7.6% 124,000 0.6% 1.6 million 8.5%

Cape Coral-Fort Myers 1.1 million 8.8% 100,000 0.8% 1.2 million 9.6%

Naples 481,000 7.5% 26,761 0.4% 528,000 8.2%

REVIEW SUMMARY

Trend. Sublet space

Industry. Commercial real estate

Key. Landlords should monitor the financial health of their tenants to help them manage their space.