In a report from Fitch Ratings, if the Work from Home (WFH) trend continues it could cause a permanent decline in demand for office space and have a severe impact on property values. They see average market-value declines from at-origination appraised values of ~44% to 54%. Already property values have fallen 38% on average in Fitch’s current rating analysis. A sharp decline in the value of commercial properties is expected to take a big bite out of city budgets when those empty buildings are assessed in the coming months. Large companies in San Francisco are appealing for reassessment of major commercial properties. Uber has appealed its headquarters building from the current assessment of $83.7 million down to $42.9 million. Dropbox, like just about all tech companies and many other companies in San Francisco, went on an office leasing binge in past years, leasing far more office space than they needed at the time. The logic was that there was a permanent shortage of office space in San Francisco, that rents would always go up, and that it was better to grab all you could get now, and sit on it vacant, and hope to grow into it over the years, thereby warehousing office space for later use. This leasing of massive amounts of unneeded office space caused the office shortage. Last November, Dropbox put about 472,000 square feet of its new 750,000- square-foot headquarters building in San Francisco on the sublease market.
As of Q1-2021 office space in the Los Angeles area has ~25% vacancy rate, the highest since the GFC in 2009. Available sublease space has increased over 90% since the pandemic hit last year and is at +9 million square feet and growing. In addition, so-called “shadow space” (space that is available but not yet advertised) is becoming a big issue as companies reconsider their office space needs with WFH more prevalent. Leasing activity in Q1-2021 fell by ~50% from Q1-2020. Street rents have not dropped significantly; however, effective rents are dropping as landlords are offering increased concessions.
According to Savills, a real estate service provider, “with the glut of available office space on the market, expect additional declines in coming quarters, as landlords shift from a ‘closed market phase into a repricing stage once tenants appetite for space begins to re-emerge in full and the sublease market becomes real competition. They predict a tsunami of sublease space coming to market. Sublease space rose to a new historic high in Q1-2021 of ~9 million square feet. Overall asking rents have dropped ~15% over the past year, along with lease concessions increasing. Total available office space on the market is approaching 25%.
In San Diego total available space on the market hit the highest level in 9 years at +20% in Q4-2020. The office market will remain soft and there will continue to be downward pressure on lease rates for the next few years. In Orange County office availability is ~22%, with sublease office space of+3.2 million square feet available, the highest since 2008. Asking rents are continuing to decrease and lease concessions are increasing. With the amount of lower priced sublease space hitting the market there will be continued reduction in effective rents in the foreseeable future. It’s a tenant market.