For tenants, the next two years will offer an opportunity to secure dramatically low cost office space. Here’s why:

CURRENT MARKET CONDITIONS

The unemployment rate increased from 8.1% in February to 8.5% in March. Adding insult to injury, January job losses were revised from 655,000 non-farm payrolls to 741,000. Since the recession officially began in December 2007, the economy has lost 5.1 million jobs with almost two-thirds (3.3 million) of the decrease occurring in the last 5 months. Many are saying we’re skidding across the bottom of this severe recession but I disagree.

Commercial real estate is just beginning to show weakness that will eventually cripple many owners and force a wave of bankruptcies. In fact, 525 W. Van Buren was the first building to be sold in Chicago’s central business district for $130 million, $6 million less than what the seller or investor paid for it five years ago. This transaction is the first example of a significant downtown commercial real estate property changing hands for less than the seller paid.

With office rents dropping by at least 25 to 30 percent from the top of the market, industry leaders are worried that these properties will not be able to meet their debt service resulting in possible bankruptcy and/or foreclosure.

Not surprisingly, vacancy and absorption forecasts by commercial real estate firms representing landlords have been much rosier than our current reality. However, a little over one month ago, REIS, a provider of impartial commercial real estate performance information and analysis, was forecasting office vacancy rates would reach 17.6% in 2010. Now they are forecasting 19.3%.

According to articles on PropertyWire.com and Bloomberg, the country’s 10 biggest banks have a total of $327.6 billion in commercial mortgages, which could prompt a wave of defaults as a result of increased office vacancies and bankruptcy of retailers. Real estate research firm Reis projects a tripling of the default rate, which would result in losses of about 7 percent of the total unpaid balances across the USA.

1 in 8 homes are being foreclosed across the nation, our car companies are out of touch with the latest fuel efficiency/green movements and will likely be forced into controlled bankruptcy, and our banks likely have trillions of dollars of toxic assets that cannot be valued based on cash flow today because of the high probability that many will default in the future.

Net operating income in all commercial assets is taking a hit and only so much sublease space can be absorbed by deals that are currently out in the market or projected to come into the market between now and 2011. Sublease space accounts for 2.5% of all available space in the downtown central business district–not yet near the ‘91 levels, but we continue to see companies retrench as more and more jobs are lost each month.

SO WHAT DOES IT ALL MEAN?

In summary, almost every sector of the economy is tightening its belt and that means continued sublease space and significantly less absorption of direct space. If landlord X purchased building A in 2006 with the assumption that rental rates would increase by $4.00 – $8.00 per square foot and leasing velocity would remain at it’s consistent ferocious levels as they were from 2005 – 2007, they’re going to be in trouble.

Businesses are contracting, space is being subleased, and only tenants that have to do a transaction are signing leases. As the debt that was secured in 2005 through 2007 in order to fuel the purchase and sale of so many buildings comes due in the next few years, landlords will be forced to lease out space for less than what will service the debt on their buildings. This may mean lender approval will be required for these owners to fully execute leases and foreclosure will be a reality for some that thought this could never happen.

For tenants that are well capitalized, have a solid business, little debt, and realistic growth expectations, the next three years won’t be about despair. They’ll be about opportunity.