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U.S. Industrial Sublease Space Trends

The State of Sublease: Big Deal, Pending Timebomb or Nothing to Worry About? 

In 2022, the pandemic spending boom started to wind down, which has since been reflected in an ongoing deceleration in e-commerce sales and (real) nondurable goods spending growth, and in an outright decline in (real) durable goods spending and import flows. 
Word of excess inventories and a slowdown in leasing momentum (albeit from historically high levels) started to ripple through the market. Sublease space came on the radar as several companies announced plans to rescale their footprints (i.e., reduce footprints). Sounds a little ominous, right? Should this really be a concern for investors and is there possibly an opportunity for occupiers? This article takes a deep dive into the numbers to reveal what is going on in the world of industrial sublease space and to answer those very questions. 

Let’s start with the big picture. As of Q4 2022, vacant available sublease space in the U.S. accounted for 0.2% or 29.0 million square feet (msf) of industrial inventory, a small fraction of the year-end vacancy rate of 3.3%. This is effectively a drop in the proverbial ocean of a 13.7 billion square foot market. Let’s now compare this to historical cycles: the highest level of sublease space in the past decade (2012-2022) only reached 0.2% of inventory, or exactly where it is today. The highest rate in this century was 0.7% in 2002. One key takeaway is that sublease space is fairly small and most of industrial vacancy is direct (both now and historically). 

 

What is ACTUALLY available for sublease? 

When observing sublease space, it is important to note that there is vacant, available sublease space and there is space that has been made available but is currently still occupied, so it is not counted in current vacancy rates. When reviewing a sample of 51.6 msf of space in the sublease universe, vacant available space makes up 56.3%, or 29.0 msf, leaving the rest still occupied with future dates of vacancy. Over the next three years, 29.9% of the vacant available sublease space will expire and will become direct space, while the percent of expirations in the non-vacant sublease space is 40.3%. This brings us to a total of about 34.5% of sublease space in the observed sample that will be coming online in the next three years as direct vacant space. This may sound like a sizable impact, but this only represents 17.8 msf over that three-year period (since only the non-vacant portion is omitted from current vacancy rates). As mentioned before, vacancy could tick up by (a whopping) 20 bps if it hits the market. The reality, though, is that some of this space may be leased prior to hitting the market, so this is more of an upper bound.  

 

Sublease Breakout 

The nominal amount of space is one thing, but what are the characteristics of the assets where sublease vacancies or availabilities exist? Where is this space? The majority of this space is warehouse/ distribution (W/D), accounting for 80.9% of all sublease space, with minimal manufacturing, office service and high technology space on the market for sublet. This is unsurprising as W/D space comprises over 70.8% of the total market inventory and about 76.5% of all vacant available space. Most expirations of subleases are W/D. Over the next three years, 32% of W/D sublease space is scheduled to expire. However, the bulk of manufacturing sublease expirations are not scheduled to expire until 2025 to 2027. As minimal as the volume of manufacturing space is—averaging only about 258,000 sf of expirations per year—the effects will be felt later than in the W/D market. Again, that is still really a drop in an otherwise large bucket. 

A decent amount of sublease space is in Class A W/D space—perhaps a shock for those familiar with the significant demand for high quality options. Class A subleases—both those that are vacant available and those that are available—account for 37.2% of all sublease space. When we think of sublease space on the industrial side, we typically assume that the tenant vacating wants a new updated space to better fit their business needs that some of the lower quality spaces don’t offer. But in this case, we believe that some of this space is due to companies expanding their footprints. As the industrial market has boomed over the past several years, many occupiers have experienced greater growth and success than ever before. In most cases, this calls for more or larger space. Another contributing factor could be a reevaluation of their supply chain real estate models. And with a company’s new growth, they may need to relocate to different geographically spaced buildings to optimize their supply chains. We’ve actually observed some tenants whose footprints are too large and are rightsizing, although this is only happening in some cases. The key point here is that a good share of the sublease space is of a higher quality than one might expect.  

The majority of these buildings are also on the “newer” side. Half of sublease square footage is within facilities built in 2001 or later (22 years old or less). To take this point even further, of the space built in the past 22 years, 51% of all sublease space is concentrated in facilities that were built in 2018 or later. This segment will include some of the highest quality space on the market. Still, it only amounts to 14.0 msf in total, and just 8.5 msf of that is currently vacant. Viewed on a relative basis, newer assets built since 2018 are 12.2% of inventory, contain 66.7% of overall vacancy and 29.9% of sublease vacancy. Again, we can likely attribute the sublease space in these younger buildings to factors like company growth, rightsizing, and supply chain optimization. There are likely a few companies that are giving back space due to overcommitting in certain markets, but these occupiers are not in a majority when it comes to subleasing their space.  

 

When examining the sublease market by available size range, blocks of space ranging from 100,000 sf to 250,000 sf accounted for 27.4% of all vacant and available sublease space (based on the count of subleases). But when looking only at currently vacant space, the 10,000 sf to 50,000 sf cohort made up the greatest share (24%). For spaces that are occupied but available, 100,000 sf to 250,000 sf made up the majority with 32.6%. The distribution of the square footage, however, is highly weighted towards larger blocks (i.e., 100,000 sf to 499,999 sf), as shown in the chart below. 

 

 

One of the most common questions asked when it comes to sublease space is, where is it located? What markets are “feeling the effect” of sublease space reflected in their vacancy rates (if we can even call it that, given how minimal sublease space really is)? In terms of square footage, the primary markets (i.e., Atlanta, Chicago, Dallas/Fort Worth, Inland Empire, Los Angeles, New Jersey, and the PA I-81/I78 Distribution Corridor) make up 50.6% of the vacant available sublease space.2 The market with the largest amount of sublease space by pure square footage is Dallas/Fort Worth with 5.5 msf—a mere 0.5% of total inventory in the market. Similar percentages of inventory are reflected in the other primary markets ranging from 0.3% in the Los Angeles market to 0.7% in the Inland Empire. Relative to the size of these markets, this space is just a small fraction of the total. 

The non-primary markets contain a higher share of sublease space as a percent of inventory. Raleigh/Durham for example has a 2.2% sublease rate as a percent of inventory and an overall vacancy rate at 5.4%. However, that number amounts to 3.0 msf in total overall vacancy, meaning sublease space in the market is just 1.4 msf. Oakland/East Bay is a 215 msf market with a 1.4% sublease rate (roughly 3.0 msf). A decent share of Oakland/East Bay sublease space (72%) is in non-W/D (in high-tech and manufacturing) space. These examples help illustrate that even for markets with sublease rates above the national figure of 0.2%, the degree of supply risk from sublease is still incredibly minimal. 

 

It’s Not All Supply; There Is Demand for Sublease Too 

In 2022, there were 30.9 msf of sublease deals completed. This was 5.6% of new leasing activity for the entire year, slightly above the 2015-2019 average (5.1%) and in the middle of its historical range (which ranges from 4.0% to 6.5%). Sublease space leasing skewed “newer” with 47% of it occurring in buildings built between 2001-2022, and 23% of leases in buildings built after 2018. In terms of sizing, the majority of subleasing occurred in the 250,000 to 500,000 sf range, accounting for 36.4% of total sublease leasing activity for 2022.  

Over the past two years, Dallas/Fort Worth recorded the most sublease activity, which is in line with the fact that it had the most overall leasing activity over the same period. But in each year from 2014-2020, Los Angeles yielded the greatest sublease activity by volume, only losing first place in 2016 to Inland Empire. Those two southern California markets recorded the highest overall leasing totals of any market in the U.S. during those years as well. Not unlike the vacancy rate, sublease demand does not make up a significant portion of total leasing activity. 

 

 

What Does the Future Hold for Sublease Space? 

The data has historically shown that sublease space in the industrial market is statistically insignificant in the grand scheme of leasing and availability. While entering economic uncertainty, sublease rates do tend to rise (albeit slightly delayed as most industrial trends do). However, it is unlikely to surpass the historical height seen in 2002, which was only 0.7% of all vacant space. The effects will be most strongly felt on the market and submarket level over the national level. It will be important to watch markets with large supply pipelines and climbing vacancy rates to see what opportunities can arise around the space. There will be impacts to both investors and occupiers when dealing with the sublease market, but they will likely remain minimal overall. 

1 This analysis includes data for 55 markets, representing 84% of the industrial stock in the 81 U.S. markets tracked by Cushman & Wakefield Research.
2 It should be noted that these markets make up 39.0% of stock and 36.3% of total vacancy.

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