Sublease inventory in the Greater Boston office market is growing at a quickening pace. Rents – already battered by tepid tenant demand – are feeling more downward pressure as sublease inventories pile up.

The pain from rent deflation won’t be spread around evenly. Most long-term landlords will be able to weather a downward swing in rents. Short-term investors, those that bought into the region’s market just as the office boom crested, are another story.

Late-boom deals were often characterized by high leverage, or underwritten with aggressive rental growth assumptions, or both. Investors who had hoped to hold assets for a couple years, flip them and reap a tidy profit, are now stuck operating buildings. What’s more, they’re operating those buildings at reduced margins. If subleases exacerbate rents’ downward motion or cut landlords out of leasing deals, it could push dozens of suburban buildings to choose between fire sale and foreclosure.

“The only rent you can achieve is market rent. Pro formas don’t mean a lot,” said Jonathan Davis, CEO of the Davis Companies. “The higher your basis is, the more pain you’ll suffer when the air comes out of the balloon.”

In Davis’ view, the current spate of declining rents and increasing vacancies shouldn’t be enough to sow widespread distress. He does expect to see distress tied to the deflation of bubble pricing, as investors pay for buying “at yields that look more like the yield on U.S. Treasury [bonds] than speculative long-term assets.”

“You hear declines of 30-40 percent [in value]. That’s really about the market coming back to stability,” he said. “It’s not 40 percent off of values that people that maintained discipline ever paid. So many pieces of real estate were purchased with crazy assumptions of rent growth.”

Any And All

Privately, brokers say every brokerage house in town likely has clients who could fall into danger. “This definitely does not discriminate,” one whispered. “There’s no entrepreneur who doesn’t have something that might be shaky. You take a building in Waltham expecting $40 rents, underwriting it with 5-percent growth, and all of a sudden you’re getting $32 – that could be anyone.”

Consider the volume of sales that closed at the boom’s zenith, from 2006-2007: Jones Lang LaSalle figures have nearly 7.7 million square feet of commercial office space changing hands in prime Route 128 markets during that time period. Boston’s downtown market saw $3.4 billion in commercial sales during that window, according to data from The Warren Group, publisher of Banker & Tradesman.

The office market’s erosion has been quickening. Greater Boston’s office market posted 2.4 million square feet of negative absorption in the first quarter of 2009, according to data from brokerage CB Richard Ellis. Downtown Boston’s share of that loss was 1.3 million square feet. By comparison, negative absorption for the entire region’s office market in the fourth quarter of 2008 was a little more than 1.3 million square feet. Sublease inventory in Boston swelled by 500,000 square feet and marched north of 1.5 million square feet, according to CBRE. Average asking rents in the city fell by $5.73.

The Route 128 West submarket posted 682,000 square feet in negative absorption, and a 170,000-square-foot uptick in sublease availability. Asking rents are now averaging $26.50, CBRE said.

A recent report by CoStar found that 464 buildings in the Greater Boston office market had vacancy rates of 40 percent or greater. It labeled 4.7 percent of the market’s office buildings as being in distress.

A CBRE sublease survey found the average term remaining on subleases in 128 West and 128 North is 36 months. The figure is comparable to short-term extensions many tenants are currently signing. Three sublease offerings from the brokerage illustrate the steep discounts landlords are competing with. More than 21,500 square-feet of space can be had at 230 Third Ave. in Waltham, through March 2012, for $22 per foot. Tenants can get into One Wall Street, Burlington, through January 2016, for $23. At 70 Westview St., Lexington, 45,000 square-feet of space is trading in the low $20s, with a negotiable lease term.

Discounts on sublease space along 128 are currently running in the 20-percent to 30-percent range.

“On the demand side, there’s still decent demand, and people are looking at the built space,” said Stephen James, an NAI Hunneman broker who works the 128 markets. “It’s a demand that says, ‘We don’t want to focus on custom solutions.’ The typical tenant will say, ‘Show me options.’ If it works, they’ll first go with space that’s finished, that has furniture and phones.”

REITs with deep balance sheets and established players in the market have the cushion of resources to survive chasing a downward market. Matt Harvey, a broker with CresaPartners, noted that long-term owners “can meet the market today and put themselves in a good position to renew tenants at higher rents when the market swings back in their favor.” Renewals, he said, are typically more lucrative transactions, “so they’re willing to take the hit today if they need to, in order to make money down the road.”

The Breaking Point

The numbers look different for investors caught between falling rents and aggressively underwritten debt.

“The leveraged investor can do below-market deals, but all of a sudden – they’re either going to capitulate, renegotiate, or give the keys back,” said Jon Varholak, a broker at Richard Barry Joyce & Partners. At a certain point, the economics underpinning some of their assets won’t work anymore. The breaking point is different for these investors, Varholak said, because the landlords they’re competing against “don’t have to achieve such a high-water mark” as they do.

The irony in all of this is were it not for the specter of over-aggressive financing and underwriting, sublease space wouldn’t look nearly as scary for area office owners.

“We’ll get close to 2 million square feet in Boston by the end of the year, and then level off,” predicted Joe Sciolla, managing principal at CresaPartners. “I don’t think we’ll see anywhere near what it was in the early ’90s, or after the dot-com bust. It won’t get to that level. Inventory downtown is still pretty restricted.”

Even 2 million square feet downtown would be well below the last office crash, which saw 3 million square feet come online. The 3.5 million square-feet in suburban sublease inventory remains more than two-and-a-half times below 2001-2002 levels.

“We’ve only had six months, but my gut tells me that while we’ll continue to see more come along, it won’t be the precipitous falloff that it was before,” Varholak added. That’s mainly because the 2001-2002 sublease flood was caused by over-aggressive space commitments, he said. Tenants have learned from that mistake, and have demonstrated more discipline in their real estate plans. “This doesn’t match 2001-2002 in velocity, and in size. It’s not the dozens of listings weekly that it was then.”