Thursday, June 24, 2021

Office Sublease Space Momentum

Here's an interesting article from Costar this morning discussing office sublease space:

The jist of the article is that employers may have been a bit quick/reactionary when they put their office space up for sublease during the pandemic. Now, with employees slowly but surely returning to the office, these companies are starting to delist their sublease space and keep it. It's certainly true that there is momentum in employees coming back to the office and employers likely are deciding to keep space that they had been marketing, but I would note the following:

  • Right now, return to the office momentum is likely close to the max it will be. People who want to be vaccinated have all now been vaccinated, covid seems to be out of everyone's mind, cities are all opened up and employers are starting to make employees go back to the office. Employers are trying to go from 0-10% employees in the office to, let's say, 50% (total swag number) in the office. Definitionally, this will be the moment of greatest acceleration/momentum. Going from essentially 0% to, whether it's 20%, 30%, 40%, or whatever, overnight is certainly the quickest acceleration there will be in the return to office. Over the next few months this momentum is guaranteed to slow down. The potential issue here is people may extrapolate this return to the office momentum going forward and overshoot how quickly the return to the office happens. I.e., it may not necessarily be that informative to extrapolate on the overall health of the office market in the future based on what's happening with the sublease space market at this exact moment in time.
  • Sublease space rapidly loses its value over time. A sublease with 5 years of term is much more valuable than a sublease with 1 year of term. This is especially true as the space SF gets bigger. I.e., a 5k SF space may be sub-leasable with 2 or 3 years of term. However, no one will sublease a 100k SF space with only 2 or 3 years of term. These employers may have had their sublease space on the market for a year now and, for example, if the term on that sublease space went from 4 to 3 years then it may now be in a completely no-bid situation. They may realize it and just pull the sublease space from the market (probably at the broker's suggestion--broker's want to get as much sublease space off the market as possible). My point here is sublease space being pulled form the market isn't necessarily due to the employer now being able to utilize it.
  • Similar to the point above, an employer may have only been willing to sublease a space if they were able to get, for example, $1 million in rent payments from it. Otherwise it may not be worth it to them to sublease the space. As discussed in the previous point, a sublease space rapidly loses its value, both due to the fact that there is less demand as the term of the sublease decreases and, definitionally, there is less term to collect rent on. I.e., if an employer a year ago thought they could get >$1 million in rent payments from subleasing their space, losing a year of term could have tipped the rent payments below the $1 million threshold. Again, the point is that removing sublease space may not necessarily reflect an increase in expected utilization of that space.
Despite these debbie-downer caveats to the momentum that's being observed in the sublease market, there certainly are reasons to be bullish on office, as described in my previous post: To me, it's going to be informative what the momentum looks like in November 2021-February 2022. My gut says covid is going to make a bit of a comeback (between vaccine effectiveness likely leveling off by then, variants making the rounds and the overall seasonality of covid) and employers and employees are likely going to be in the midst of a massive negotiation (employees pushing for more work from home and employers pushing for more return to the office). Place your bets. There's a lot of money to be made in office if someone smart and willing to take on risk gets it right.