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Sublease space abounds, but so do the pitfalls

Special Report: Commercial Real Estate   Downsizing firms find old, built-out offices a tough sellBY MATTHEW FLAMMIt sounds simple enough: In an economic slump, companies that need to cut costs will downsize their operations and sublease unwanted offices.The strategy makes use of a company's vacant space and generates some income to help preserve the bottom line.If only it were actually that simple.With corporate belt-tightening widespread, companies have dumped huge volumes of sublease space on the market at a time when demand is low. And brokers say the worst is yet to come. Good news, bad news Of course, the oversupply of space is great news for prospective tenants looking for offices, as deals abound around the city. Rents may be discounted by as much as 50% and are likely to stay that way for a while. But for those businesses trying to off-load space, the market conditions-along with the nuances of handling sublease space-are creating myriad headaches. A company that wants to become a sublandlord has to jump through hoops to offer the right deal sweeteners and promote the property effectively. Even then, finding a tenant that is interested in secondhand offices is a challenge."The only sublease space that's moving is space that's built the way someone wants it," says Philip Sprayregen, managing director in corporate services in the New York office of CB Richard Ellis Inc.Low demand for sublease space in New York City is a real problem. CoStar Group Inc. reports shows that of the total space available in Manhattan's main business districts in the third quarter, some 30%-about 15 million square feet-was sublease space. In 2000, when the real estate boom was at its peak, only about 15%-roughly 6 million square feet-was sublease space.The predicament is going to get worse before it gets better. With more and more direct space hitting the market, sublandlords will have to be more competitive with sublease space, says Mr. Sprayregen. Less desirable Sublease space is hard to move today, as opposed to 18 months ago during the dot-com bust, because it tends to be located in older offices that are available as a result of corporate downsizing, rather than new space vacated by failed Internet companies. While dot-com offices were often unsuitable for traditional businesses, like law firms, the older space is unsuitable for installation of new technology."There's a lot of space that people don't know what to make of," says Peter Turchin, managing director for Insignia/ESG Inc.'s agency group. The fact that offices are already built out can be a major obstacle. Even if space is going for a song, there might be no interest because of the property's existing fixtures. "Generally in the marketplace, people put value on buildings, but with sublease space, it's the installation," says Mr. Turchin.Many companies trying to sublease part of their offices also make the mistake of offering the less appealing part of their space. "They are most likely to pick a floor to put on the market that's least functional for them, but it may be the one that's least functional in the marketplace as well," Mr. Turchin points out.As a result, finding a tenant requires aggressive marketing. But therein lies another problem: identifying the right broker to promote the property.Companies that are desperate to move space are offering particularly generous terms to whoever can help them.Brokers in driver's seat"We are constantly seeing (sublandlords) offer brokers bonuses-double commissions, plus they'll lease your Mercedes for two years if you can sublet their space," observes Scott Panzer, principal in corporate advisory services at Newmark & Co. Real Estate Inc.Though that practice is increasingly frowned upon, brokers do need to be motivated, since finding a tenant might require everything from canvassing the neighborhood for companies that need space to e-mailing images of the sublease space to likely prospects. "You've got to take these deals from conception to birth," says Robert Billingsley, vice chairman of real estate services firm Colliers ABR Inc."Sublease deals are not going to close on their own."Selecting a broker that doesn't have conflicting interests is also crucial for companies that are subleasing space. Brokers might represent the building's principal landlord, which may have direct space available for rent in the same property. While that's acceptable-and sometimes even mandated-it does create obvious problems.John Orchulli, chief executive of fashion house Michael Kors, found that out when he was looking to sublease a 4,500-square-foot space at 1450 Broadway after the company consolidated operations at a Seventh Avenue location. Under the terms of the Broadway building's lease, Mr. Orchulli was required to use the property's leasing agent for the first three months of his search for a subtenant. "Nothing ever happened," he
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