Work-From-Home vs. Commercial Real Estate Office Sector

Office leasing activity plunged as companies dumped huge amounts of suddenly unneeded office space on the sublease market.  Optimistic landlords have been slow to lower asking rents. But the gap between asking rates, and taking rates, is widening, Concession offerings are increasing too.

In third quarter 2020, the commercial real estate segment of office space in Houston, Manhattan, Chicago, San Francisco, and Los Angeles were all hit hard by the shift to work-from-home (WFH), and the sudden corporate realization that they need to get rid office space.

Many companies are considering permanent work-from-home policies and downsizing office footprints.  In quarterly earnings calls, more than 80% of S&P 500 companies expressed positive sentiment about WFH.  Although full time WFH for most employees is losing favor.  If the permanent shift to WFH ends up being just one or two days per week, that  could reduce office space demand by 10% to 20%.

Cities vary, but all have lots of sublease space, available for lower than market rents, driving down overall rents. The  surge of sublease space is bad news for commercial real estate. “Total availability”, which is sublease availability, plus space DIRECTLY leased by landlords availability, has soared in all five urban markets mentioned earlier. So has the “total availability rate” (available office space divided by total office space), as new leasing plunged.

Average concessions by landlords have risen to about one year free rent. Tenant improvement allowances also rose. But with so little new leasing activity, rent price discovery has been weak. The quoted rents remain artificially high (in relation to the huge sublease inventory and rapidly rising space availability).

Q3 202 overall office availability in Houston, for one example, ended at a new record of 27.9%. The Q3 2020 Class-A (highest class of offices) asking rent in Houston was $33.67 per square foot per year,  down about 6% from 2014, not adjusted for inflation.