Subleasing is when a primary tenant leases out all or a portion of its unused office space (or direct lease) to another tenant. The national office vacancy rate peaked at 17.1% at the conclusion of 2020 with millions of square feet temporarily empty, but not contractually vacant. Previous stay-at-home orders, reduced workforces, and decreased revenue streams have put pressure on physical occupancy and resulted in subleased space increasing 55% over the past 12-months and topping 188.2 million square feet. Nearly 21.2 million square feet was added in Q4 2020 alone. With the increased availability and distribution of the COVID-19 vaccine, recovery appears to be imminent and the sublease market has the potential to be a win-win for all parties involved.
Benefits of Subleasing
The most obvious benefit for a tenant entering a sublease agreement is the allure of lower rent prices: sublease space at Class A office properties in prominent business districts are estimated to be discounted by an average of 23.9% compared to direct leases. This is due in part to sublease vacancy and new competing office product. The savings is not just money in their pockets but is also an opportunity to migrate to a top-tier property and the associated benefits without the heavy price tag. Additionally, subleases are flexible in nature with short-term commitments.
There is still uncertainty about what the future of work will look like, including telecommuting policies, and many companies are unsure of how their office space needs may change going forward. “Most organizations recognize that there is a shift in the way work is going to get done,” said Julie Whelan, head of occupier research for the commercial real estate firm CBRE’s Americas division. “They have recognized it, and no matter how traditional they are about their views, they understand that there is going to be a level of flexibility that they now have to contend with, in terms of office planning.”
While many companies like the Midwest law firm Fredrikson & Byron, who recently leased approximately 178,000 sq. ft. at KBS’ RBC Plaza at 60 South Sixth, are not planning to reduce office space long-term, there is still consideration for hybrid in-office and work-from-home set ups for the next several months. For existing or primary tenants, leasing out a portion of their office footprint creates flexibility that can help buffer some of this uncertainty because it allows them to temporarily downsize space and have part of their rent paid without the potential risk of lease termination penalties. They can also reclaim that subleased space for future use when needed again.
Landlords and Subleasing
For landlords, gaining new long-term tenants in today’s leasing environment can be challenging as many tenants are still hesitant to make major office decisions or changes until office use becomes more consistent and comfortable for employees. Subleasing is a great alternative to keep buildings leased and cash-flowing without the added expense of trying to locate a new tenant along with improvement allowances. While landlords typically are not involved in subleases (these transactions typically occur directly between tenant and sublessee). When the market stabilizes and office-using employment resumes, the potential to turn these subleases into expanded and full-obligatory direct-lease agreements may be ripe for the picking and will help the market rebound faster. Many experts also predict the coworking/flex space trend to be stronger post-pandemic because of the realized value of a remote workforce. The COVID-19 crisis has shown us that some professions thrive on a telecommuting model and can easily tap into talent pools across many states, making coworking space hot in demand. Studies suggest coworking and flexible space will at least double within the next five years. But don’t be misled: the need for physical office space will continue to be a priority for many businesses to operate and maintain culture, a critical component in the workplace.
As we look ahead, the influx of sublease space is simply a byproduct of the crisis and will eventually wane. But for now, it offers revenue-producing opportunities, or at least offsets rental fees, to help the office sector and its users navigate uncertain conditions and keep businesses running.