By Jack Stubbs
“I see a healthy market. Demand is definitely not decreasing in Seattle at this time. If the economy continues to chug along, sublease space will continue to be a constant in the [office] market,” said Hughes McLaughlin, senior director at Cushman & Wakefield’s Seattle office, summarizing one of the central schools of thought behind subleasing activity in Seattle’s commercial market.
Subleasing rates are a metric by which the relative health of the office market can be assessed over time. It is an important indicator of the strength in the overall economy and by extension the office market, since it can indicate how optimistic the tenants feel about their ability to continue to grow.
Understanding the true amount of sublease space is a bit of an art form. According to a third quarter of 2017 MarketBeat Seattle CBD report by Cushman & Wakefield, the company is tracking approximately 326,000 square feet of sublease space, which represents approximately 0.66 percent of the overall inventory (49 million square feet) in the city’s central business district—comprised of the Financial District, Denny Regrade, Pioneer Square/International District, and Lower Queen Anne/Lake Union. But this is not the whole story. “The vacant sublet space is the only space that appears on this report,” said McLaughlin. “The sublet space that is currently occupied but not vacant and yet still marketed is not reflected here.” That additional space adds up to approximately 1.5 million square feet, or roughly 3 percent of the overall market inventory. But these numbers vary based on how the space is counted and what information each brokerage firm is able to extrapolate.
According to the report, overall available space is around 2.5 million square feet, which would imply market vacancy in the CBD at around 5.8 percent, however this figure only accounts for the lower, 326,000 sublease inventory, so total availability might be slightly higher.
According to McLaughlin, in the second quarter of 2009, in comparison, vacant sublet space stood at approximately 974,000 square feet, compared to 326,000 square fee today. At the time this figure comprised 2.55 percent of the inventory in the market, which totaled 38.15 million square feet. Overall vacancy in 2009 was 14.7 percent, and it currently stands at 5.9 percent, a trajectory that reflects a healthier market and more confidence in the regional economy. Looking at the office market longitudinally in Seattle, he added, there is “significantly less” vacant sublet space available now then there was at the height of the recession in second quarter 2009 in Seattle.
Overall, McLaughlin believes that the current amount of subleased square footage available in the market reflects a stable market. However, the implications of subleasing statistics—what they indicate about the current state of the office market—are difficult to definitively discern, since there is no one-size-fits-all motivation behind subletting space: different companies will sublet space for different reasons depending on their individual growth trajectories. “Each sublease scenario is for different reasons, [so] it is tough to determine the state of the market by just focusing on the sublease market,” he said.
Each company has a different set of motivations and pressures that lead them to consider subleasing, according to McLaughlin. “Some companies, like F5, are growing out of their space and don’t have space in their building to grow into, so they are subleasing space so they can get out of their existing obligation and into a larger space that fits their needs. Other companies, like Nordstrom, are going through a ‘right-sizing’ exercise whereby their total space needs are being decreased, and they are subleasing excess space,” he said.
Other companies like porch.com are experiencing a significant change in their business models—such as merger and acquisitions, consolidation or business closure—and therefore seek to cut costs by subleasing some of their office space. Ultimately, though, while subleasing rates are a means by which to examine vacancy rates and demand drivers over time, they do not necessarily reflect broader economic trends, according to McLaughlin. “It really is a case by case scenario now, and not a sign of pending economic shift in the region,” he added.
As has been the case over the last several years, the landscape of Seattle’s office market is still largely influenced by tech companies that continue to seek a foothold in a competitive market, according to Jake Bos, vice president at Kidder Mathews’ Seattle office. Bos also believes that subleasing activity and rates are dependent on company-specific strategies and infrastructural needs, and his company is tracking roughly two million square feet of total sublease space. “Demand in the Seattle office market is still predominantly [driven by] tech companies. The larger users are taking most of the new development projects, [while] some of the new users coming into the market are predominantly from the Bay Area and are looking at single-floor opportunities,” he said. According to Bos, higher subleasing rates indicate that companies are outgrowing their office spaces, and thus indicate a healthy market.
On the other hand, however, some companies turn to subleasing as a means to reinvigorate and refresh their business models when their current spaces don’t entirely fit their needs, according to Bos. “Some companies are subleasing because things aren’t working at a tech-startup level… some companies are being more conscientious about decisions for their space. Certain configurations work better than if the spaces are built out; construction costs are at an all-time high,” he added. Ultimately, different companies will sublease for different reasons depending on their individual business models and growth trajectories, with some companies looking to sign longer-term leases (five to seven years) and some shorter-term leases (two to three years). Various factors contribute to companies’ decisions to sublease their office space, including plans for expansion, the current size of the existing floor plan, and construction costs associated with customizing a space, according to Bos.
The inventory of available office space in Seattle’s market is constrained and limited at this moment in time, which means that companies are having to consider more creative solutions to grow their brand. “Given current market conditions, there are only so many creative office spaces available. A lot of new groups are trying to purchase new office buildings in Seattle and there isn’t a lot of supply available,” Bos said. In an increasingly competitive market—where the war for talent between tech companies, in particular, continues—many companies hope to test the waters before committing to a longer-term lease. “Given the current peak market conditions and low vacancy rates and high rental rates, [the question is] is [whether] there is a sublease space that’s available for a two to three years term to test the employment and hiring pool,” Bos added.
There have been several notable sublease transactions in third quarter 2017 in Seattle’s CBD, according to an industry report reviewed by The Registry. Oracle subleased 174,000 square feet from Nordstrom in the Russell Investments Center (1301 2nd Ave.), signing a roughly 13.5-year (161 month) lease. Google subleased two blocks of space from Tableau in the Lower Queen Anne/Lake Union submarket: 54,774 square feet in the Fremont Lake Union Center building (837 N. 34th St.) and 50,939 square feet in the former Tableau Building located at 437 N. 34th St. Both of these subleases were signed for 7.3 years (88 months).
Other notable sublease transactions include Sound Transit’s 49,724 square square foot sublease from landlord Unico Properties at 705 Union Station (705 5th Ave.) in the Pioneer Square/International District submarket. Finally, job search platform Indeed signed a 160-month (roughly 13-year) sublease for a 44,000 square foot block in Russell Investments Center from Nordstrom and another 34,225 square foot block in the World Trade Center East Building (2211 Elliott Ave.) in Denny Regrade from LaSalle Investment Management.
There are various spaces currently available in Seattle, according to another industry report. Smith Tower, a 256,481 square foot Class A office building located at 502-506 2nd Ave., contains space available for rent between $26 and $34 per square foot through September 2018. The 335,005 Class B Dexter Horton Building, built in 1922 and located at 710 2nd Ave, contains roughly 22,000 square feet available for $33.50 per square foot. The Millennium Tower, a 199,078 square foot office building located at 719 2nd Ave. has roughly 13,000 square feet of space available for sublease. There are between 100 and 5,000 square feet available in the Norton Building (801 2nd Ave.), a 247,161 square foot Class A office building built in 1959 and renovated in 1983. The Exchange Building (821 2nd Ave.) is a 300,508 square foot asset that contains roughly 32,000 square feet of space available for between $22 and $30 per square foot. 1201 3rd, a 1,128,575 square foot Class A building constructed in 1988, has between 8,000 and 13,000 square feet of space available for sublease. Additionally, there is up to 14,800 square feet available in Westlake Tower, a 369,996 square foot office building built in 1988, for whom WeWork is the landlord. Finally, there are up to 1,000 square feet available in the 1100 Dexter Building, which is located at 1100 Dexter Ave. N. in South Lake Union. Regus is the leasing company for the building, and the asking price is between $26 and $34 per square foot.
Over on the Eastside, subleasing activity indicates a healthy market, with both well-known and emerging tech companies looking to grown their footprint on the Eastside. According to Zach Zaborowski, senior vice president at Broderick Group’s Bellevue office, the majority of sublease deals in third quarter 2017 have fallen within certain space parameters due to limited inventory. “As it relates to sublease activity in particular, we saw a handful of subleases come out on the Eastside. But we haven’t seen big market-changing subleases [yet]. We’ve seen more [subleases coming to the market] in the 10,000-20,000 square foot range,” Zaborowski said.
According to Zaborowski, many of the subleases have been signed due to the expansion of specific companies who have outgrown their current footprint and are looking to relocate to different submarkets—either closer to downtown Bellevue or around the periphery, closer to Bothell or the I-90 corridor. One of the factors currently characterizing the Eastside market is a lack of office space, a reality that is causing tenants to consider options further removed from Bellevue’s urban core. “Right now, there are few big blocks of space in downtown Bellevue. There are still people calling around, tenants looking for space in the core,” Zaborowski said. “I think [activity] has moved out to the peripheral submarkets also, like Bothell and Redmond and the I-90 corridor, where there are still some big chunks of space [available].”
In the third quarter 2017, the Eastside office market has a balance of emerging and established tech companies looking to grow, according to Zaborowski. “[The market] is relatively stable. It’s probably a healthy mix of organic growth versus new requirements coming into the market. I have not seen a lot of subleases of size that reflect companies going in the wrong direction, who are looking to downsize,” he said. Zaborowski believes that the stats from a report—from one of Broderick Group’s third-party vendors—tell a similar story. “Square footage of sublease availabilities has increased, albeit minimally, over the past few years. But still nowhere close to recession levels,” he said.
For third quarter 2017, there are currently 256,332 square feet of vacant (available) sublet space. A year ago, in third quarter 2016, there were 172,792 square feet of available sublet space in the Eastside market. This increase of vacant available sublet space suggests that the Eastside market was relatively healthier at the end of last year, with less available sublet square footage on the market. However, both of these figures are down considerably since third quarter 2008—the heart of the recession—when there were 465,697 square feet of vacant sublet office space available.
Concerning activity during third quarter 2017, Zaborowski highlighted certain overarching patterns that might define subleasing activity moving forward. “Sublease availability rates were definitely higher during the recession. But looking forward, I think sublease availability will remain pretty consistent with past trends. For instance, if there is a pull-back in tech, there may be an increase in sublease availabilities from users in that industry,” he said. The numbers from Broderick Group’s third quarter 2017 Eastside Office Market Overview report reinforce the notion that demand for office space has returned, to some degree. In 2008, the available sublease inventory (the percentage of the total available inventory) was 1.56 percent and climbed to 1.72 percent in 2009. 2015 was the healthiest year, posting a 0.81 percent sublease inventory rate, and the sublease inventory rate presently stands at 1.3 percent, states the report.
According to Zaborowski, subleasing activity generally tends to map onto—rather than define—larger economic trends. “Historically, with every economic downturn, more space becomes available when companies downsize. We’re also experiencing one of the longest rounds of economic recovery in history, and so [subleasing activity, and what what may cause a company to do it] is difficult to predict,” he said.
The robustness and continued health of the Eastside market remains undercut by a shortage of larger blocks of space—which are prime real estate for companies looking to settle or expand their footprint in the market, according to Zaborowski. “There is high demand on the Eastside. But the one thing the Eastside lacks, particularly in core markets like downtown Bellevue, are big blocks of space,” he said. “On the Eastside, Bothell and I-90 have the largest amounts of vacancy, where [landlords] can do substantial leases with companies looking for between 50,000 and 100,000 feet,” he said.
Subleasing is a notoriously difficult metric to predict, especially longitudinally, as any subleasing transaction is necessarily dependent on the geographical location of the office property, the individual needs and growth demands of a particular company, its relationship to the landlord in question and larger economic trends that influence supply and demand. According to Hughes McLaughlin, the outlook for subleasing is largely dependent on whether national economic growth continues or a national downturn occurs. “A growing economy [will] spur the growth of companies, and therefore the need for companies to sublease will likely be caused by a general expansion of all companies’ ‘rising tide’ effect,” he said.
In a period of sustained economic growth—where competition for talent is increased—sub-landlords will need to discount their subleases to attract interest and compete with other sub-landlords in the market. Conversely, though, McHughes thinks that if the economy does start to experience a downturn—as it did during the recession—companies will generally experience a need to cut their costs and not grow. “In the last cycle, the companies that were quickest to react and market their spaces aggressively saw the best results,” McHughes added. Looking ahead, McHughes believes that subleases might eventually have a more direct impact on market dynamics. “Subleases will become a bit more of a threat due to their abundance, and this could even start to compete with direct alternatives, causing landlords to soften their economics to compete with subleases,” he said.
Zaborowski thinks that as a subject of scrutiny subleasing is beginning to become more and more prominent on both the regional and national scale. “We haven’t had many companies do larger [100,000 to 300,000] square foot sublease deals in this cycle yet, [so] subleasing hasn’t really been a huge discussion in this market yet,” he said. “[But] nationwide, there’s started to be more of a conversation around it, so it’s interesting. I don’t think subleasing is driving the local market right now, but that could change in 2-3 years,” he said.
