Office Slump Gets Ugly in Houston, San Francisco, Los Angeles, Manhattan, Chicago, Washington DC
This is not a problem.
Through Wolf richter for WOLF STREET.
Houston has been the toughest office market for homeowners for years, after a historic boom in office tower construction collided with the Great American Oil Bust that began in 2015 and reached a climax. crazy in April 2020, with the benchmark WTI for crude oil. briefly collapsing at minus $ 37 a barrel in the futures market. In 2020, hundreds of oil and gas companies filed for bankruptcy, mostly in Texas. On top of that, there has been the shift from the pandemic to working from home.
It is becoming increasingly clear, as companies have announced their plans, that there is a long-term shift to a hybrid model, with some employees working permanently from home, others working in the office almost all of the time. time and many others working from home. of the time, and showing up in the office some of the time, with warm desks and large lounge-style meeting spaces taking control of office farms. And businesses can reduce their office footprint.
And now Houston faces stiff competition in terms of vacant office space in large, expensive office markets, such as San Francisco, Los Angeles, Manhattan, Chicago, Washington DC, and others.
Houston, still the toughest office market.
the available office space grew to 54.8 million square feet (ft2), or 31.6% of total inventory in the first quarter, according to property management and investment services provider JLL. Available space includes vacant, sublet and still occupied office space currently marketed as available for lease. JLL cited the causes: “bankruptcies, downsizing and layoffs”.
Total office vacancy rate increased for the fifth consecutive quarter and reached 26.2%. Of the 19 submarkets, 15 suffered occupancy losses during the quarter (chart via JLL):
“Large blocks of sublet space continue to come into the market,” JLL said. In the first quarter, the availability of sublets increased to 6.4 msf.
When businesses rent office space that they no longer need due to downsizing, or never needed initially and were simply renting for potential future use, they can save the space. on the market as a sublet. And since they’re just trying to cover some of their costs and don’t need to make money on sublets, they can do so at much lower rents than direct landlord rentals. And this is happening en masse.
Overall, asking rents have started to decline (red line) to $ 31 per square foot (lb / ft2) per year, but asking sublet rents are 26% lower, at $ 22.93 lbs. / ft2. The rents requested are the advertised rents. But landlords can make a more attractive deal with their tenants, including concessions, free rent, and improvement allowances (chart via JLL):
Total market-wide rental volume in the first quarter fell 66% from the five-year average to 1.3 mcf as “tenants continued to postpone rental decisions.”
San Francisco, once one of the hottest office markets, suddenly approaches Houston.
Sublease inventory increased by an additional 200,000 square feet to a new all-time high in the first quarter of 8.9 square feet, according to real estate service provider Savills. Last year, San Francisco’s sublet space blew by 6.4m2 of Houston, although Houston’s office market is twice the size of San Francisco’s.
The total availability rate has risen to 23.6%, compared to two years ago (graph via Savills):
“Current conditions will present an unprecedented opportunity for occupants to secure space in a once insanely tight rental environment, as owners will soon have to compete with the tsunami of sublet space,” Savills said in his report. San Francisco Market Report. So a suspected office shortage suddenly turns into a majestic office glut.
Overall, asking rents have decreased by 13% and asking class A rents by 15% year over year. According to Savills: “With the glut of space available in the market, expect further decline in the quarters to come as homeowners move from a ‘closed market’ phase to a once price review phase. that the tenants’ appetite for space begins to reappear fully and that the sublet market becomes a real competition. (Graphic via Savills).
The rental business collapsed, with just 0.4m² rented, down 75% from 1.6m² in Q1 2020 and down 85% from 2.5m² in Q1 2019. Of the leases signed, more than half were lease renewals.
Office availability rose to 23.6% in Q1, the highest since 2009, according to Savills’ Los Angeles Market Report. The sublease space climbed to 9.0 msf. And the availability of ‘shade’ – space available but not currently announced – will be a bigger issue in 2021, especially in trophy buildings, ”the report says (graph via Savills).
Leasing activity in Q1 fell 49% from a year ago to 2.0 mcf. But asking rents “remain stubbornly high” and have soared to $ 3.85 per square foot per month (or $ 46.20 per year)
“As we have seen in recent quarters, the currently high asking rents are misleading because landlords will have to be aggressive to secure tenants in the face of more flexible market conditions. Concessions such as reduced parking and contraction rights [a right in the lease to reduce the size of the office at a future date] have become prevalent again and are not expected to go away anytime soon, ”according to Savills.
Manhattan, the biggie.
In the largest office market in the United States, uptime soared to 17.2%, “the highest level in at least three decades,” according to Savills, “With direct spaces and sublets continuing to flood the market.” The availability of sublets jumped from 3.4 msf in the first quarter to 22 msf. And an additional 7.9m² of direct space was brought to market, including “notable additions from a few closed coworking locations”. (Graphic via Savills).
Q1 rental activity fell 48% year-on-year and 13.7% from Q4, to 4.0 mcf.
The average asking rent fell 9.1% year over year to $ 76.27 lb / ft2 per year. Concessions which, for new long-term category A leases, “have increased considerably” are not included in the rents charged; In addition, the average tenant improvement allowance increased 15.5% to $ 124.85 sq. Ft., And the average free rent increased 17.4% to 13.5 months, according to Savills.
Total availability climbed to 21.6%, showing ‘no signs of slowing down’, according to Savills’ Chicago Report. In the central loop, availability jumped to 24.3% (graph via Savills):
Despite rental activity in the first quarter firmly blocked in collapse mode, down 73.5% year on year, lessors have not moved much on rental requests. But “many landlords have shown an inclination for sharply discounted rents, increased concessions and significant flexibility for occupants who are active and ready to make rental decisions,” the report says (chart via Savills).
Washington DC, the government is still praising.
Amid the surge in sublet space, total availability soared to 20.4%, “the highest in at least three decades”, as “tenants wait to rent space, to rent less. space or put space back on the market, ”according to Savills. Washington DC Report.
Total leasing activity fell 33% year over year to 1.2 mcf. Of this activity, almost half came from federal and local government agencies.
The overall asking rent has been reduced to $ 55.53 lb / ft2 per year. But “landlords are aggressive in pricing, concessions and flexibility to attract and retain tenants,” the report says. “New long-term Category A leases receive an average of $ 148.00 sq. Ft. In tenant improvement allowances and 21 months of free rent, for a total value of $ 260.00 sq. by $ 50.00 sq. ft. since the start of the pandemic – significantly reducing the effective rent for tenants. “(Graphic via Savills).
As Houston has shown, office markets can be in crisis for years to come, as developers continue to build the newest, best performing office towers. In Houston, despite years of slump, there is still more than 3m2 of office space under construction, although that’s a 28% drop from the 10-year average, according to JLL.
And when this type of long crisis occurs, there is a flight to quality, with companies move to newer and larger towers at the end of their old lease and abandon old office buildings, whose owners could ultimately opt out of the mortgage and let lenders worry about the collateral.
The question is not what to do with the latest and greatest office towers, because they will always find tenants. The question is what to do with older office buildings whose tenants move out when the lease allows them, as part of the flight to quality. It is these old office towers – or rather their creditors – that are in trouble when the crisis continues.
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