Northrop Grumman Information Technology is the sort of firm on which the local real estate industry has pinned its hopes for a brighter tomorrow. Telecommunications and other tech businesses may be reeling and businesses in most other sectors coping with slow growth, but government contractors are still hiring in large numbers. That improves the odds of filling the empty office space in the region.
Not so fast. Northrop Grumman IT is indeed hiring hundreds of workers, mostly computer programmers. But it has no intention of leasing more space, said spokesman Mark Meudt.
The reason: The firm already has more space than it needs, having inherited many leases from acquired companies. Much of that empty space isn't being sublet. In some cases the company wants to hold onto it just in case; in others there are security reasons to keep other tenants out of Northrop's space.
The upshot is that even though Northrop Grumman IT, a Herndon subsidiary of the Los Angeles defense behemoth, has extra space, it doesn't show up in Herndon's already huge office vacancy rate of 30 percent. Many companies are in similar situations, which could spell bad news for commercial real estate in the year ahead.
It's called shadow space: office space that tenants aren't using, but which they do not formally put on the sublet market so that others might occupy it. It might be a couple of unoccupied offices at the end of the hall, or even a whole building on a secure corporate campus.
There's no way to quantify it -- by definition, shadow space doesn't end up in vacancy numbers -- but some who research local real estate say there is more shadow space out there now than normal. That could mean that even if the local economy recovers in 2003, the commercial real estate industry would lag behind.
"No one is going to lease new space until they use the space they already have, and there are a lot of tenants in that situation right now," Richard W. Reynolds, a principal of Spaulding & Slye Colliers, said recently.
Fundamentally, say those who research local real estate, industry conditions won't improve until the region has significant job growth. Shadow space puts a lag in the cause-and-effect relationship between job growth and real estate demand.
Unlike the spectacular bankruptcies and mass layoffs that have produced a lot of the region's vacancies, many stable, reasonably successful enterprises have shadow space -- not necessarily because they have shrunk, but merely because they haven't grown at the pace the boom years led them to expect.
For a company with a handful of empty cubicles and rooms spread across a large office, it may not make financial sense to sublet, explained Tom Fulcher, a senior broker at Julien J. Studley.
First, a company might have to rearrange its staff to consolidate the empty workspaces into one area.
Then new walls or other construction might be necessary to make the unneeded space usable for another tenant.
Then that subtenant must be found, in a market already glutted with space.
Further, many companies with shadow space plan to use it eventually when their own business picks up.
"There's a level of pain to going through the process of subleasing, so if you go from 30 employees to 20, it's probably not enough space to bother," said Fulcher.
Fundamentally, the problem is that real estate is not all that flexible; buildings take years to construct, leases are often for 10 years or more. Few tenants know exactly how much space they'll need 10 years later, or even two. And if they overestimate how much they will need, even by a little, they must either sublease the leftover space or eat the cost.
Some experts, though, believe the shadow space issue is overblown.
Law firms often make a practice, in good times and bad, of keeping extra space on hand so that they can add staff quickly.
On the other hand, said Mark Minich, a senior director at Cushman & Wakefield, they tend to be able to easily sublease extra offices to other lawyers after cutting staff.
So the 8 to 10 percent of extra space he estimates law firms now have that is not on the sublet market is average, he argues.
And in tough financial situations, some tenants may have all the more incentive to squeeze whatever money they can out of their real estate.
"I haven't seen any tenants large or small that have cut back staff but aren't marketing the space formally," said Eric West, of West, Lane & Schlager Realty Advisors.
Law firm Winston & Strawn has signed a lease for 150,000 square feet in a new building to be constructed at 1700 K St. NW. Charles E. Smith Commercial Realty is developing the 400,000-square-foot building on the site of two older buildings, at a prime downtown spot on the corner of Connecticut Avenue and K Street. US Equities Realty and West, Lane & Schlager represented Winston & Strawn; Kent Gubler and Jim Creedon represented the ownership group.
Neil Irwin writes about commercial real estate and economic development every week in Washington Business. His e-mail address is email@example.com.