Shadow Office Space "Leased but Empty" Haunts Commercial Real Estate

Shadow housing supply, foreclosed but not on the market as well as sellers who want out but cannot get out is one of the factors weighing on residential real estate. Similar supply issues weigh heavily on commercial real estate.

Office vacancies are widely reported, but few gave factored in the shadow supply, downsized companies with more leased space than they need, holding on to it hoping thing get better, or stuck in long-term leases with more space than they want or need.

Minneapolis StarTribune article Shadow space haunts office market takes a good look at this very issue.

That section of empty cubicles, the conference rooms collecting cast-off office furniture ... for employees, they're dreary reminders of layoffs, consolidations and shelved expansion plans.

To real estate professionals, it's "shadow" office space -- space that's leased or owned but largely empty and not officially listed anywhere as vacant. And brokers are fretting about the buildup of unprecedented amounts of it around the Twin Cities. All that idle square footage will likely prolong the recovery of the area's hard-hit office sector, already struggling with high vacancy rates. Slow demand for new space will likely mean a dearth of new construction, and all the jobs and building material sales that go with it.

NorthMarq's semiannual Compass Report, due out today, shows that the direct office vacancy rate in the Twin Cities has hit 19.9 percent -- a 19-year high, by NorthMarq's numbers. Fold in the space tenants are trying to sublease, and the rate jumps to 22.8 percent -- the highest since NorthMarq began tracking sublease space in 1995.

McCarthy and other brokers estimate that 75 percent of companies don't use about 10 percent of their space. By that measure, there would be about 5 million square feet of shadow space across the seven-county metro area -- enough to push the real office vacancy rate from 19.9 percent to above 25 percent and perhaps closer to 30.

The amount and scope is unlike anything he's seen in nearly 20 years in the business, he said. "It's across all types of buildings," McCarthy said. "It's just sitting there." It's a national problem, he said.

National Problem

Subleasing is not easy because of the glut of vacant properties, because walling off sections is impractical or impossible because of lease issues or physical constraints, and because of lease termination dates.

So the supply just sits and rental prices drop because of lack of demand. Companies with too much space respond by giving landlords notice of intent moving to smaller quarters, or demanding lease reductions.

Commercial real estate is going to be in a funk for years. Residential housing will pick up first, and lets' face it, residential housing looks miserable as well, also burdened by real and shadow supply.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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