Subleasing Shuffle

The mania that sucked away virtually all the available office space away in most U.S. markets and had potential lessees waiting in winding lines has now been reversed in the predictable manner of most economic cycles. As companies downsize or close down completely, they are subleasing their space in huge quantities. With would-be lessees doing the same thing, though, success is not easy to achieve.

Geographic location is not a determining factor. Deals are closing from coast to coast. In the decimated San Francisco Bay area, where office sublease space outweighs demand, Yahoo! Inc., a poster child of the technology boom, had roughly 500,000 square feet of space to dispose of last year. Unlike some of its silicon-juiced brethren, it succeeded in subleasing the majority of its space, including 213,000 square feet in its Sunnyvale, Calif., headquarters to Marvell Semiconductor Inc.

With the assistance of CRESA Partners L.L.C., it subleased an additional 109,000 square feet in Santa Clara earlier this year to Covad Communications Co. In an interesting twist, Yahoo itself had occupied the space as a sublessee of Amdahl Corp. Yahoo also recently subleased 89,000 square feet in Sunnyvale to Oak Technology Inc. and 47,000 square feet in Santa Clara to Virata Corp.

More complicated deals are closing, too. Celerity Consulting Group Inc., for example, signed a sublease for 14,100 square feet at 150 California St. in San Francisco, taking over the last year of CriticalArc Technologies Inc.'s sublease with master lessee Tenfold Corp. Tenfold, which had leased the space through 2008, was then able to negotiate a two-year extension with Celerity.

Other subleases across the U.S. are likewise encouraging. Comdisco Inc. took 70,000 square feet in Chicago; The Boeing Co. subleased 78,000 square feet from Stamps.com Inc. over a seven-and-a-half-year period at Factoria's Sterling Plaza II in Bellevue, Wash.; and Simpson Investment Co. sublet an entire floor in downtown Seattle's Rainier Tower to Washington Mutual Inc.

Deals still in the works include the 58,000 square feet Merrill Lynch & Co. is adding to San Francisco's market, the more than 150,000 square feet Sun Microsystems Inc. dumped in Austin and the 129,000 square feet Motorola Inc. is trying to sublease in South Florida.

New York City did not suffer as much from an an inordinate amount of sublease space as San Francisco, which had more than 35 million square feet of office sublease space available as of Jan. 1, but the Big Apple has not exactly remained rosy-cheeked. Between January and September 2001, 10 million square feet of sublease space was put back on Manhattan's then-fragile market. More of that space would likely remain on the market still were it not for the loss of millions of square feet in the Sept. 11 attacks on the World Trade Center towers. As it is, although several million square feet of space?most of it subleased?was gobbled up in the fourth quarter of 2001, because of the ailing economy and major corporate consolidation activity nationwide, ample blocks of office space remain.

Drew O'Malley, managing director at Credit Suisse First Boston Corp., is involved with wheeling and dealing large chunks of such space for his own company, which has been cutting headcounts and streamlining operations. In late December, he was passing on a couple hundred thousand square feet of office space at 120 Broadway to two tenants. Up the block, at 280 Broadway, he had recently subleased 90,000 square feet and had another 90,000 square feet still available.

Most of O'Malley's work, however, is occurring at the company's new corporate campus headquarters at 11 Madison Ave., where there is significant ongoing consolidation. "We figured we'd have a little overhang," he said. At the adjacent 1 Madison Ave., The Port Authority of New York and New Jersey took 150,000 square feet from Credit Suisse First Boston.

As if that were not enough, O'Malley has been in discussions with other displaced World Trade Center tenants looking for everything from 75,000 to 200,000 square feet, and hopes to sign quick deals to absorb some of his company's overhang. "It would take care of short-term excess space," he said.

Credit Suisse First Boston is not the only financial titan giving back space, particularly after Sept. 11. "It's easy to misinterpret needs. You're now seeing all the banks trying to shave excess revenue off," O'Malley explained. For example, although he had overseen some 275,000 square feet at 5 World Trade Center, he is in no hurry to replace it.



Successful Subleasing

What makes some companies more successful sublessors than others? Yahoo subleased a great deal of space in an especially tough region. For Yahoo senior director of real estate facilities Kevin Gerrity, several factors helped make those deals successful.

One might seem obvious, but it is not always put into practice: Yahoo planned ahead. "A critical first step is to have a good exit strategy," explained Gerrity. And it kept its plan in up to date with the times. "The corporate real estate team at Yahoo understands the changing market dynamics in the industry ? and their flexibility and foresight have paid off," said David Tipton, a CRESA Partners principal who works exclusively with corporate tenants.

The strategy situated Yahoo well for potential subleases and dispositions, allowing the technology bigwig to balance its fluid real estate portfolio with corporate budgets.

Another important element was Yahoo's relationship with CRESA Partners. "It's important to work with a corporate real estate firm that puts your interests first," said Gerrity. "CRESA has helped us ? through contingency planning and due diligence, including site selection and disposition clauses in our original contract."

In New York City, Getty Image, working with Plymouth Partners Ltd., took another tack in the disposal of its 150,000 square feet. The Internet image provider had not intended on getting rid of such a large chunk of product. After it acquired several companies, though, it found itself with more excess space. It began marketing the space to both the brokerage community and to corporations from an array of industries. "They really had to know how to position space," said Tim Kucha, senior director at Plymouth Partners, who assisted Getty throughout the process.

The two focused on the building. "Our strategy was to focus on larger corporate users because there are 75,000-square-foot floorplates," said Kucha. They eyeballed higher-credit tenants and in October found Morgan Stanley Dean Witter, which subleased 150,000 square feet at 1 Hudson Square, also known as 75 Varick St. With so many other companies striving to attract quality users, Getty had to be on top of its game. "You have to know the local competition," said Kucha.

The deal closed just a few weeks after Morgan Stanley had been displaced from the World Trade Center. "We would have found somebody. It was just a matter of when," Kucha said confidently. Incidentally, Banc of America took 140,000 square feet from StarMedia in the same building after it too was displaced from the towers.

Whatever specific conditions sublessors find themselves in, they have to play hardball today as they are often now in direct competition with with landlords. "If you have space on the market, you have to work it," said CRESA Partners principal Matt Feeney, who works in the Philadelphia region. "It's all about speed."

It is also about differentiation. "You need to try to separate (your) space from the pack," said Feeney. Beyond rental rates, he noted, sublessors must accentuate improvement allowances and any unique features their space may sport?superior technological capabilities, for instance.

Items that might be taken for granted, such as having space in move-in condition, may help considerably, added Franklin Speyer, executive vice president at Cushman & Wakefield Inc. "People are looking for a bargain. They want flexibility and less capital expense."

Sublessors are ahead of landlords in offering incentives, according to Speyer, but landlords are increasingly offering concessions and dropping rental rates to compete. "Not publicly, but in negotiations, landlords are dropping rates," he noted. "They are being forced to get more aggressive."

Landlords, however, prefer higher rent on the books, so sublessors often still have an advantage.

But landlords' control over any space in their buildings can add another wrench. For example, landlords can choose to enforce or ignore negotiating rights. "The status is critically important," said Speyer. If a landlord has low vacancy rates, which remains the case in many areas, it is not as urgent. "They're betting that this market will last only a short while," said Speyer.



To Sublease or Not to Sublease

Deciding whether or not to sublease space to begin with can be tough. "(Users are) loathe to give up space if they don't have to," said Greg Gill, president of Newmark & Co. Real Estate Inc., who has been working with eToys.com to sublease space in West Los Angeles. "If you have to unload, you try to find short-term users," he said.

For large corporations such as Yahoo!, CSFB or Thomson, orders usually come from the top. "Corporate issues to bring results to the bottom line quickly are far more intense than most institutional landlords would sense in terms of their own needs," said Speyer.

Because of the urgency involved, companies do not have the luxury of waiting for the right sublessee to come along, so they are more likely to accept a company that an institutional owner might not. "If the credit is O.K. and the terms are reasonable, deals are done," he said.

Thus, many companies are passing their space on to technology firms, many of which are seen as anathema by institutional owners. Charles Schwab & Co., for example, is subleasing space out to Instinet, a Reuters-owned entity; United-Healthcare is letting go of 67,000 square feet in Chicago to e-peopleserve, a joint venture between British Telecom-munications P.L.C. and Accenture; and Nokia is subleasing more than 65,000 square feet of office product to InterGen in Burlington, Mass.

Often, corporations want the space back at some point in the future, anyway. "You try to build in lease terms where you can get space back or similar space to accommodate," Feeney said. "The key is to get rid of non-core space. In an ideal world, you get rid of more pricey premium space."

Thomson Corp. has been taking a different approach as it subleases space out as a result of its two-year-old, large-scale consolidation. Ray Meglio, vice president of real estate, who has approximately 17 million square feet under his direction at any given time, is taking advantage of cheaper subleased space where he can when specific locations are not as essential. "That open-mindedness allows us to do this best."

In New York City, where he is selectively employing this tactic, the company occupies almost 1 million square feet in more than 20 locations. "It's very inefficient," he said. It is involved with similar consolidation activities in London.

With the acquisition of Harcourt Inc., Thomson added several million square feet to its portfolio around the United States, a lot of it redundant. Fortunately, Thomson has another advantage: "When we've focused on more significant consolidation activity, we've always made money ? because we originally negotiated a while ago at very favorable rates," Meglio pointed out, adding that this is the case with the majority of Thomson's New York City leases.

As for space that proves more difficult to dispose of, Meglio is not desperate. "We're not giving anything away," he said.