Downtown sublease space drops to lowest since end of 2008

(Crain's) — By at least one measure, things are looking up for the downtown office market.

The amount of space available for sublease has dropped 20% since the end of last year, to 3.38 million square feet at the end of the second quarter. That's the lowest amount since the end of 2008, according to data from Chicago-based MB Real Estate.

Sublease space is a good indicator of market conditions because it shows how much excess space companies are looking to unload. So sublease space tends to rise, as it did from mid-2007 through last year, when demand for office space is weak. Sublease space generally declines when demand is strong.

Less sublease space also is a positive for landlords because it reduces competition, and sublease space is generally cheaper than so-called direct deals with landlords.

Over the past decade, sublease space peaked in 2002 at 6.28 million square feet — a result of the dot-com bubble bursting — and then bottomed out in 2007 at 1.98 million square feet.

Sublease availability stayed relatively low this recession the 130.5-million-square-foot downtown office market, peaking at 4.2 million square feet in the fourth quarter last year.

Andrew Davidson, an executive vice-president who heads MB's tenant-representation group, says he's not convinced the fall in sublease space means the market is turning in landlords' favor.

Sublease space appeals to tenants in today's market because many want move-in conditions and cheaper rents, Mr. Davidson says. Also, sublease space has become increasingly attractive as many cash-strapped landlords are no longer willing to pay much for move-in renovations, which is generally an advantage of so-called direct leases with landlords.

“I think there's been a lot of people searching for good, as-is conditions,” Mr. Davidson says. “It's certainly a good sign that the sublease market went down, but until there is real job growth I'm not convinced that the market has made its permanent turn for the better.”

In MB's second-quarter report on the downtown office market, the firm says layoffs and employment declines in this recession have far outpaced office space reductions, suggesting the direct vacancy rate, which excludes sublease space, is poised to climb higher after edging up 0.1 percentage point in the second quarter to 16.1%.

“MB Real Estate's baseline office forecast expects substantial declines in occupancy over several upcoming quarters to correlate with job losses,” the report says.

The firm predicts the direct vacancy rate will exceed 17% by the end of 2012 and that demand for office space won't turn positive until 2013.

Also, because there's so much uncertainty about the economy, many companies are just sitting on excess space rather than seeking to sublease it, and are likely to restructure and downsize when their leases come up, Mr. Davidson says.

“I think there's a lot of excess space,” he says. “Some tenants aren't even willing to talk about any type of extension right now. They would rather sit with excess space for a year or two rather than extend five years.”

Local landlords had some reason to feel encouraged by economic reports last week. The U.S. Labor Department said Friday that the unemployment rate edged up to 9.6% in August from 9.5% in July. But private payrolls climbed by 67,000, more than economists had forecast.

“The double-dip talk was probably misplaced,” Maury Harris, chief economist at UBS Securities LLC in New York, told Bloomberg News. “From a historical perspective, things are still soft. The economy ought to be doing better.”

The Chicago Business Barometer, an index of U.S. business activity, last week showed an 11th straight month of growth, but six of the seven indicators that make up the report showed “slowed expansion.”

The index, compiled by the Institute for Supply Management-Chicago and formerly known as the Chicago Purchasing Managers Index, registered 56.7 in August, down from 62.3 in July and lower than economists' forecast of 57.6 from a Dow Jones Newswires survey.

According to the MB report, just one large block of sublease space was added to the downtown market in the second quarter: Citigroup Inc.'s 58,094 square feet at 227 W. Monroe St.

Just four other large blocks of Class A space are available for sublease downtown, while there are four such spaces in older, so-called Class B buildings.

The largest sublease spaces on the market are:

• Aon Center, 200 E. Randolph St., 296,247 square feet, expiring December 2011, and 95,103 square feet, expiring December 2013.

• 231 S. LaSalle St., 167,179 square feet, expiring June 2023.

• 600 W. Chicago Ave., 117,001 square feet, expiring November 2015.