Commercial office real estate rental rates are decreasing across the country as sublease space floods the market.

During the first two quarters of 2001, an unprecedented amount of sublease office space hit the market as high tech and other companies tried desperately to cut costs and stave off additional layoffs. Unfortunately, the trend continued in the third quarter, which saw sublease space increase 18.5 percent in downtown markets and 22.8 percent in suburban markets, according to Colliers International.

The bleeding does seem to be slowing, however. According to Colliers, during the first half of the year the increase in office subleasing was an astonishing 123.3 percent in downtown markets and 92.2 percent in suburban markets nationwide.

This additional supply raised the national vacancy rate 1.1 percentage points to 12.8 percent, resulting in a downtown vacancy rate of 11.3 percent and a suburban vacancy rate of 13.6 percent. High-tech markets showed the greatest increases in vacancy, with Austin, Boston, San Francisco and Seattle showing some of the greatest increases in vacancy.

For tenants, there is an upside. All of this spare office space is putting significant downward pressure on rents. Overall, the average rent went from $42.44 to $39.70 per square foot for Class A downtown office space. Some markets, however, showed precipitous drop-offs during the quarter, with San Francisco down 32.6 percent, Seattle down 17.8 percent and Minneapolis down 17.6 percent.

"Continuing a pattern that began in the first half of the year, vacancy rates are increasing, primarily because of the plentiful supply of sublease space available in nearly every market across the U.S.," said Ross Moore, vice president and director of research at Colliers. "While the rate at which sublease space is being delivered to the market has slowed, we don't see the pattern reversing in the fourth quarter or even the first quarter of next year.

"However, corporations can't keep downsizing forever, and we expect that by the second quarter of 2002, the supply side of the market will have stabilized," Moore said. "There is a window of opportunity for tenants to strike very attractive deals over the next 18 to 24 months with supply so plentiful and rental rates falling."

The suburbs are really taking it on the chin, and should continue to suffer in the coming months. More than 77 million square feet of additional space is under construction in suburban markets nationwide.

"Approximately 25 million square feet of space per quarter, for the next three quarters, will be added to the suburban market against a background of zero to negative demand," said Moore. "This will push vacancy rates up almost another 4 points, from 13.6 percent today to 17 to 18 percent by mid-year 2002."

So what does all of this mean for sublessors? These businesses are being forced into becoming landlords, making them take on roles they may have never dealt with before. They are having to offer higher brokerage commissions and promotional incentives to attract real estate brokers to bring clients into their spaces, according to Hans Hansson, president of Starboard Commercial Real Estate.

And since a lot of sublease space once was used by high-tech companies, it is customized for a specific industry. So sublessors are having to offer tenant improvements as well, Hansson said.

So while sublessors may recoup some of their rent expenses, they likely cannot find any way to make up for all of their costs. Remember, with downward market pressure on rents, it's not possible for these companies to lease out space at a profit. They are lucky to only experience a small loss.

The winners in this scenario are small companies looking to sublease space. It's too bad that the current economic climate has resulted in so few of these companies being out there.

For more articles by Lesley Hensell, please press here.

Published: November 14, 2001

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Lesley Hensell covers commercial real estate and financial issues for Realty Times. Based outside of Dallas, Lesley works with high-tech and real estate clients as an independent marketing and public relations consultant. She also writes for several publications, including the Dallas Morning News. E-mail Lesley at: lhensell@earthlink.net