Economic Update — Office Market Doldrums Driving Up Supply of Sublease Space

Moody’s Investors Service reported on Thursday that commercial real estate prices in the United States dropped 14.9 percent in 2008–a greater drop for the year than housing prices (down 12 percent), as it happens. Commercial property prices are roughly 16 percent off their peak of October 2007, the report continued, a drop that effectively turns the clock back to 2005 when it comes to commercial real estate valuation. Such valuation must have been a little hard to gauge, however, since separately the National Association of Realtors reported that U.S. commercial real estate activity is the slowest it has been in more than 12 years. The organization’s index of commercial brokerage activity now stands at 109.2, which represents a decline of 6 percent between the third and fourth quarters of 2008. According to the NAR, the two property types most likely to suffer the most as the recession continues are–logically enough–office and retail. Fewer people are going to those offices these days, thus taking up less space. Also, fewer people are leaving those offices with paychecks, which provides the necessary household liquidity to visit retail locations. The NAR is predicting that by the third quarter of this year, office vacancies nationwide will rise to 16.7 percent, compared with 13.4 percent during 3Q08. Though not a lot of new construction will come on line this year, there will also be surge of office sublease space in many markets, the likes of which hasn’t been seen since the early 2000s. For example, according to a fourth quarter 2008 report by Chicago-based MB Real Estate, sublease vacancy in the Chicago CBD edged up from 3.08 million square feet to 3.15 million square feet between 3Q08 and 4Q08, and now stands at its highest level since 2005. Total sublease space in the market still has quite a ways to go before it equals the roughly 6 million square feet available in 2001, but the trend is clearly upward. “The keys to successful subleasing are timing, target market and pricing–packaging the deal appropriate to be well received by the market,” David Wilson, executive vice president and managing director at Chicago-based HSA Commercial Real Estate, told CPN. Wilson recently worked on a sublease space deal in which Cremer Spina Shaughnessy Jansen & Siegert L.L.C. subleased nearly 3,800 square feet of space at 180 N. LaSalle St. to DN Partners. Wilson stressed the importance of detailed market and submarket knowledge in getting such deals done. “If the broker isn’t attuned to the market, the space might be overpriced, which turns prospects away, or underpriced, which works against minimizing the loss of income to the client.” The equity markets bounced upward at the beginning of the trading day on Thursday, but slumped after that, with the Dow Jones Industrial Average sinking 89.68 points, or 1.19 percent, to its lowest level in six years. The S&P 500 was down 1.2 percent and the Nasdaq lost 1.71 percent.