Shadow space haunts office market

Office vacancies, already high, are actually much worse because of untold "shadow" space -- space that's leased but empty.

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.

The rates would be even higher if what the report describes as a "significant" amount of uncounted shadow space weighing on the market was counted.

The trouble is, while employees can clearly see the mothballed spaces, no one knows how much of it there is.

"We can't quantify the shadow space," said John McCarthy, senior vice president of brokerage services at NorthMarq. "That's what's so lurking and mysterious about it."

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.

The market already has to burn off three to four years of backed up office vacancies -- not including the unlisted space.

"This could really prolong the real estate cycle or certainly the next development cycle," said McCarthy, while acknowledging that it's "a necessary piece of a recovery."

The shadow vacancies built up because they're tough to deal with, brokers say.

Subleasing one-quarter of a building is harder than it looks. A tenant wanting to sublease extra space might only have 18 months remaining on the lease. There aren't many companies willing to take the trouble of moving for an 18-month lease, McCarthy said.

Plus, some spaces just aren't that easy to wall off. More often than not, tenants simply hold onto their space and wait until their leases, which typically run five to seven years, come up for renewal.

Larry Chevalier, a senior vice president at Cassidy Turley and veteran of the downtown Minneapolis office market, said the excess space just isn't that marketable.

"The sublease market has been a poor performer," Chevalier said. "They just wait it out."

Some companies use their dead zones as "their own internal flex space," he said.

"You don't want to look like you're vacant when your guests walk through," Chevalier said. "You strategically have the empty offices out around the perimeter."

Companies are starting to unload excess space as leases come due, according to NorthMarq. Brokers there say that many tenants who renewed leases during the first half of 2010 shaved off an average of 10 percent of their space.

Some companies aren't waiting.

MoneyGram International Inc., for instance, is now trying to sublease about 40,000 square feet of the space it rents at the MoneyGram Tower at 1550 Utica Av. S. in St. Louis Park as it continues consolidating and mulling whether to move its headquarters to Texas or Colorado. The company has employees on seven of the building's nine floors, spokeswoman Jody Hinkle said.

Retailer Best Buy Co. Inc. is one of a number of Twin Cities companies trying to shed excess corporate space in buildings they own. Best Buy, which shed more than 500 headquarters jobs early last year, has been quietly marketing five of the six floors of one of its headquarters buildings in Richfield since last year.

McCarthy said he's been marketing up to 150,000 square feet of Class A office space at the headquarters of ADC Telecommunications Inc. in Eden Prairie, although news last week that ADC will be acquired by Tyco Electronics could change things.

"We've been kind of thrown a curveball here this last week," he said.

Jennifer Bjorhus • 612-673-4683

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