Companies are dumping record volumes of office space on to the sublease market, flashing a potential warning sign over the long-term health of the office properties that comprise the biggest chunk of US real estate.
The amount of sublease inventory in many US markets is at or exceeding levels reached in the aftermath of both the dotcom bust and the 2008 financial crisis, according to brokers, with expectations that it will expand further.
That development — coupled with a flurry of recent announcements from companies such as Bank of America and SalesForce that they will require less office space as more employees work from home — is leading some analysts to conclude that the damage to the office market wrought by the coronavirus pandemic will not be fully repaired even when the economy heals.
“The nation just underwent what will end up being close to a year-long work-from-home experiment and the results continue to show for themselves. You have a company every other week saying how successful work-from-home has been for them, and their plans to reduce or shrink their total office space needs,” said Daniel Ismail, the office analyst at Green Street Advisors, a real estate research firm.
Mr Ismail believes that demand for office space could be down 10 to 15 per cent even after the economy recovers, with rents in large US cities like New York and San Francisco taking an even greater hit. Changes in work habits that Green Street expected to unfold over four to five years were instead happening in a matter of months. “We’re turning on a dime,” Mr Ismail said.
Office owners have been somewhat cushioned from the pandemic’s economic blow because their tenants are generally signed to long-term leases. New leasing activity has largely been put on hold. Still, some recent transactions have provided a glimpse into the market’s weakness.
SL Green, which recently cut the tape on one of the city’s most ambitious office towers, the $3bn One Vanderbilt, beside Grand Central Station, told analysts this month that its asking rents were down 5 to 10 per cent. It is also having to grant prospective tenants more generous concessions, such as covering remodelling costs, the developer said.
Brokers’ data on sublease space tends to vary. But all report sharp increases in major US markets over the past year.
In New York City, by far the largest office market, Cushman & Wakefield estimated that subleasing space was just shy of 18m square feet as of November. That was an all-time high, and up from 10.5m square feet the previous November.
Savills estimated that Manhattan sublease space had swelled to 16.1m square feet by the end of the third quarter, up 46.8 per cent from the beginning of the year, and nearing the all-time high of 16.3m square feet recorded in 2009.
The Bay Area of San Francisco, home to the technology industry, has been particularly hard hit, with sublease space increasing by 148 per cent through September, according to Savills. In late August, Pinterest cancelled a 490,000 square-foot lease at a building it was developing in the city — incurring a charge of $89.5m to do so. A month later Twitter put 105,000 square-feet of space up for lease. Earlier this year the company told employees they could work from home indefinitely, if they desired.
“If you listened to developers in March, they were pounding their chest and saying, ‘This is an aberration. Everything is going to come back to the way it was.’ It’s not,” said Michael Silver, chairman of Vestian, which advises companies on commercial real estate.
Mr Silver estimated that many companies would require only half their pre-pandemic office space, eventually pushing sublease space from around 200m square feet at present to 300m square feet. His own firm has embarked on a radical shift to working from home. Doing so, he argued, had made the firm stronger, while saving money that could be invested in salaries.
“The end result of this is a reset,” Mr Silver said.
One of the biggest uncertainties for the office market is the fate of co-working companies like WeWork, which became New York City’s biggest commercial tenant just a few years after it was founded.
“If co-working blows up in favour of working from home, that’s going to have a big impact on the market,” one large real estate investor said.
Julie Whelan, an analyst at CBRE, argued that the downturn had confirmed the utility of flexible office space: “That is in large part because flex space can provide companies the agility to accommodate a workforce that values more choice over where and how they work.”
But in the short term, Mr Ismail viewed it as an accelerant on the market’s slide, with many co-working offices sitting empty during the pandemic and the future of some co-working companies in question. “Co-working throws a little more fuel on the fire here,” he said.