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Commercial Real Estate

Shadow inventory threatens office vacancies

For months, real estate experts have been whispering fearfully of “the shadow inventory” in residential sales. Now, we’re starting to hear rumblings of shadow inventory threatening the commercial market, particularly with respect to office vacancies. Shadow inventory  is the inventory of homes that are probably going to be for sale really soon, but are not on the market just yet.

For example, many bank-owned foreclosures sit vacant for months before becoming officially listed for sale by a real estate brokerage.

Some real estate experts believe banks are purposefully holding off on listing properties because they don’t want to flood the market with their foreclosures. They’d rather hold them a bit and feed them out to the market in a slower, more controlled fashion, rather than dumping them quickly and depressing prices even further. Banks believe prices will be kept more stable by this technique. Experts fear if banks do suddenly open the gates and put all their foreclosures on the market as quickly as they acquire them, this shadow inventory will devastate prices.

Vacant offices, empty cubicles

So far, we haven’t seen this happen in residential sales. Now we are starting to hear the same kind of terminology, and logic, applied to commercial properties, not in talks of foreclosures, but in regards to office space.

Shadow inventory, in this sense, is commercial property that is currently vacant (completely empty or sections of an office), yet not on the market. Picture a large office building with chunks of vacant space. Or one company’s office with entire sections of empty cubicles or conference rooms gathering dust.

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These spaces are underutilized or vacant, yet not officially listed with a broker. Since it’s not being marketed, experts cannot count or quantify just how big this shadow inventory is, or how big a potential problem it could be in the future. No matter how much is there, everyone can agree that if it was added to the known office vacancy numbers, the commercial leasing sector would certainly look even bleaker than it is now.

Why aren’t they listed?

If you have excess office space, why wouldn’t you list it for rent? Well, for one, if it’s only part of a floor or a section of your office, it can be hard to subdivide and sublease unless you find the perfect tenant that meshes with your own use.

If you have 10-25% vacant space in your current office, could you take in another company to share the rent or not? Maybe at 25% of more you’d have to do it, to survive and pay the rent. But at a lower rate, would it be worth the hassle? Maybe not. Many companies would cut costs and struggle to pay the rent alone rather than take in another company under their own roof.

If you do go this route, you have to think about fitting out the space to match the needs of the new tenant. How many months are left on your lease and do your needs and future needs fit with their needs? What about logistics and even the legal ability to sublease, with your lease terms?

Hanging in until leases renew

As leases come up for renewal, many tenants are looking hard at their leases and how much space they are truly using. If you’ve had downsizing and layoffs, does it make sense to also downsize the office space? Many business owners are hanging in there, waiting for their lease to expire. Then what?

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I represented one client who tried to negotiate their lease renewal by downsizing their space (and rent) with the landlord. Negotiations failed. That client came to me and I found them a larger space for a significantly lower price. We even negotiated landlord financed fit out into the deal.Yes, they got more space at less money. They moved.

I have another tenant who has feelers out there looking for a cheaper retail space. She’s been in her space for years, and has several more years on her lease left. The landlord won’t allow her to renegotiate the rent, despite the fact she is clearly struggling every month to pay on time. He won’t allow her to cut the space, either. She may go under and then both parties lose.

On the flip  side, another landlord allowed his professional tenant to break the lease early (years early in fact) with a small payout to the landlord, rather than holding him to the terms. Both walked away from the deal and now the property is ready to be rented again. This landlord has an excellent reputation of working with tenants, and I anticipate re-renting that space shortly.

Be flexible, or fear the shadow!

Landlords who are open to negotiations, willing to work with tenants and help them through the tough times will prosper and won’t be faced with increasing vacancies.

Landlords unable or unwilling to make accommodations during this rough economy will suffer higher vacancies. And as those leases expire and more and more office spaces become vacant, eventually they will find their ways to the market. When that happens, office rental rates will fall even further.

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Wouldn’t it be better to suck it up and help tenants through the rough patch than see them pack up and move? During these trying times, everyone is taking it on the chin. The shadow inventory may or may not come to haunt us later. Who knows. But from what I see in my market, tenants are quietly downsizing and making plans to move when leases expire.

Flickr image courtesy _e.t

Written By

Erica Ramus is the Broker/Owner of Ramus Realty Group in Pottsville, PA. She also teaches real estate licensing courses at Penn State Schuylkill and is extremely active in her community, especially the Rotary Club of Pottsville and the Schuylkill Chamber of Commerce. Her background is writing, marketing and publishing, and she is the founder of Schuylkill Living Magazine, the area's regional publication. She lives near Pottsville with her husband and two teenage sons, and an occasional exchange student passing thru who needs a place to stay.

13 Comments

13 Comments

  1. 4BostonOfficeSpace

    July 26, 2010 at 8:59 pm

    Hi Erica, This is a terrifically clear description of what Shadow Space is for the uninitiated. Bravo! I am noticing more frequently in my Greater Boston office space marketplace where many larger tenants (typically with 20,000sf or more), with significant term remaining on their leases, are holding on to their presently underutilized space in anticipation of the recovery. Compared to many areas of the country, we’ve been somewhat insulated from the worst effects of the recession because of our fairly diverse local economy, with heavy concentrations of higher education, biomedical / pharma and technology, but financial services has taken a hit just like in most markets.
    I enjoy your posts!

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