Office sublet space may pose more of a competitive threat than initial estimates indicated.
Initially, it looked to some that, while the amount of sublet space in the U.S. office market reached record highs, it wasn’t a major threat because not all of it competes with direct space offered by the landlord. For example, spaces with lease terms expiring next year probably aren’t attractive to a wide audience.
According to that line of thinking, as most of the country’s office employees are still working remotely, even the least expensive sublet with 12 or even 18 months of term remaining would be likely to sit unoccupied for the majority of the sublease. The short duration makes it unappealing as the subtenant risks being forced back into the market for different space if it’s unable to come to terms with the building owner to remain after its sublease expires.
However, only about 15% of the 200 million-plus square feet of office space available for sublease has terms expiring in 18 months or less. Arguably, subleases that have more than three years remaining on the lease term become far more competitive with direct space. Right now, nearly 45% of the square footage available for sublease has 37-plus months of term remaining.
Even in New York, which at nearly 30 million square feet has the highest nominal amount of available sublet space, only 9% of that space offers terms expiring within the next 18 months. Conversely, 55% of the sublet square footage has more than three years of term remaining.
An example of a more competitive sublet option is a full-floor availability at 192 Lexington Ave. in New York. The asking rent is $48 per square foot with a term of anywhere between three and 10 years. A similar lower-floor direct space is listed with a $64 per-square-foot asking rent, and upper-floor direct space has asking rents of $75 per square foot. This is just one example of a situation where an office tenant could achieve possible cost savings of between 25% and 36% for up to 10 years compared to a direct lease.
The San Francisco office market bucks this trend a bit, although both office tenants and residents had been looking for more cost-favorable alternatives even prior to the pandemic. Only 38% of the available sublet space in that market has more competitive term lengths.
Assuming the build-out of the office sublet is functional for a prospective subtenant, as build-out allowances to customize sublet space are not the norm, the cost savings could be rather appealing. Amid this challenging leasing climate, landlords competing with sublet space carrying longer terms may be willing to offer an early direct extension at favorable rates, with a full build-out allowance following the expiration of the sublease for those tenants seeking greater lease length while realizing significant cost savings on the front end.
With additional sublet availabilities continuing to come on the market, we may see downward pressure on direct rents grow over the next several months.
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