Chaos reigns in the office market but rents are still higher?

Tue Mar 26 2024
Ray Pierce (832 articles)
Chaos reigns in the office market but rents are still higher?

A record number of available sublease space, mounting defaults, and vacancy rates are all hurting the U.S. office markets. Office rentals, meanwhile, seem to be either remaining stable or even increasing.

According to research provider CoStar Group, average asking office rentals in the US are $35.24 per square foot, up from $34.92 in the fourth quarter of 2019.

The seemingly bizarre nature of the commercial real estate market is reflected in the higher asking prices. When calculating a property’s worth, rents are an important factor for lenders and others. Landlords will do whatever it takes to maintain their rental fees high and avoid decreasing them, even if it means the facility remains empty.

“Would significantly reduce the appraised values of their buildings” if landlords drastically cut rents to fill unoccupied space, said David Bitner, head of worldwide research for commercial real estate services firm Newmark Group. The result could be a covenant default on their loans or, at the very least, difficulties in refinancing.

The inevitable reorganization of debts or sale of troubled assets by owners and lenders would likely cause office rents to plummet.

Landlords are currently attempting to rationalize the higher rents by offering prospective renters enticing deals like free months of tenancy, elaborate interior build-outs, and other perks.

The national director of office analytics at CoStar, Phil Mobley, even mentioned a year of free rent for a 10-year agreement. Free rent used to be one month every two years in various areas.

There are those who believe the tactic is reaching its limit. Due to businesses reducing their space leasing during the pandemic, office vacancy rates are at historic highs and showing no signs of abating.

As to the data provided by CoStar, the number of square feet occupied by businesses has decreased by 200 million since the recession began. In the next two years, an additional 150 million square feet of this so-called “negative absorption” is anticipated to be added.

There was a 50 million square foot negative absorption total during the financial crisis.Mobley stated that our level is very different.

Trepp, a statistics organization, reports that the office default rate for mortgages that have been turned into securities has increased to 6.63%, more than tripling from 1.87% in January 2020.

The value of some properties will be reset to reflect market conditions, not the propped-up rents, as a result of these restructuring talks leading to sales or foreclosures. An MSCI index shows that between July 2022 and the beginning of this year, the average value of office buildings in core business districts decreased by over 41%.

The new owners won’t have to prop up rents because they paid these substantially cheaper costs. Indeed, they will be highly motivated to lower rents in order to entice tenants away from rivals.

Asking rents have dropped the most precipitously in San Francisco, a city that has witnessed some of the most troubled property transactions. According to data compiled by CoStar, the average price per square foot dropped to $53.78 in the first three months of 2019 from $75.93 in the last quarter of 2019.

The market has responded more rapidly to the current situation, according to Mobley.

When the worldwide finance company Adyen started searching for new San Francisco offices for its North American headquarters early last year, it had a plethora of appealing possibilities. “I had brokers all over me,” admits Davi Strazza, president of Adyen North America.

This month, the business made public its plans to sublet 150,000 square feet of premises. Even while Strazza wouldn’t talk about them, he did acknowledge that they were a reflection of the market strain. He stated that the stars had certainly aligned.

The prolonged era of increased rents is expected to be ended by subsequent transactions. According to Newmark, almost 70% of the office leases that are in place now were signed before to the epidemic. These tenants will reap the benefits of the current market conditions when their leases are up for renewal. Many companies have already committed to new space-saving hybrid office concepts.

The number of days that employees with hybrid plans were needed to be in the office in February increased slightly from 2.49 one year ago to 2.57, according to Scoop Technologies, a company that studies workplace strategies.

Companies that employ hybrid tactics often occupy less space when they renew their leases. The CEO of Scoop, Rob Sadow, predicted that lease renewals will keep putting downward pressure on prices.

Ray Pierce

Ray Pierce

Ray Pierce is a Senior Market Analyst. He has been covering Asian stock markets for many years.