“Expect more distress from some owners as loan defaults and relinquishing of assets could increase going forward.”
By Wolf Richter for WOLF STREET.
The biggest office REITs — publicly traded landlords that specialize in office properties — have gotten massacred in the stock market since March 2020, after having already had a hard time before. Some of them had hit their all-time highs in 1998 or 2000 or 2007, and they’re down 65% and 75% from those highs. And some of them are now back where they’d first been in the 1990s and even the 1980s.
But it’s the problems in the office market since 2020, since the large-scale arrival of working-from-home, and with it the largest office glut ever, with record amounts of office space vacant and on the market for lease, that these REITS have taken the most recent hits.
Interestingly, they plunged during the March 2020 crash, but then they recovered partway up toward their February 2020 level, only to let go again in a very systematic manner this year to either reach new decade lows or get close to them. We’ll get to those big office landlords in a moment.
These landlords face office gluts.
Commercial real estate advisory Savills today released the first batch of its Q3 quarterly office market reports on the major markets in the US, 12 markets in total. Houston tops the list in terms of the largest share of vacant office space on the market, with an availability rate of 30.7%. San Francisco is second with 28.9%, and shooting higher.
A big issue is sublease space. This is space for which companies are still paying rent to the landlord, but they’re not occupying it, and instead they’re trying to find sublease tenants for it to help defray the expenses of that space. These companies will price their sublease space aggressively since they don’t have to make a profit on this office space, but just want to lower their costs of holding it until the lease expires. Sublease space puts downward pressure on effective rents – even as landlords are tying to hold the line.
Houston has long been the hardest-hit of the big office markets due to the oil bust that started wreaking havoc in 2015, followed by the pandemic and the shift to working from home. But things are getting slightly less bad. The construction boom that took off during the oil boom kept throwing the latest and greatest office towers on the market at the worst possible time, with projects that had been planned years earlier. These fancy office towers triggered a flight to quality, with companies leaving their old digs when the lease expired.
Here is the fate of some of those older Class A office towers built in the 1980s, after the tenants moved to one of those new fancy towers: The landlords defaulted on the loans and let the old towers go back to the lenders – the CMBS investors – which then sold those towers in foreclosure sales at gigantic losses of 82% and 88% (which I analyzed here earlier this year).
It’s the old towers that get into existential trouble – not the latest and greatest. But even the owners of the latest and greatest have to deal with the glut, and they can’t get the rents that make those towers work. And in the tech sector, such as San Francisco, it’s even the latest and greatest towers, such as the Salesforce Tower, owned by office REIT Boston Properties – which we’ll look at in a moment – that have huge availability rates. Tech is moving out of the latest and greatest, and no one is moving in behind it.
But in Houston, the worst may be finally over. The availability rate dipped to the still worst in the US of 30.7%, but that’s down from 31.1% a year ago. But available sublease space rose again, after falling, to 7.7 million square feet (MSF)
Leasing activity jumped to 3.8 MSF, roughly in line with pre-pandemic activity. But a number of those deals were downsizing moves by energy companies that moved from larger spaces in older buildings to smaller spaces in new buildings, some of them consolidating offices spread over several buildings into one. And their current (larger) digs in these older buildings will come on the market, adding to the pain — and to availability. This is going on all over the place.
San Francisco, until 2019 the hottest office market in the US, is closing in on Houston. Availability rate rose to yet another all-time record 28.9%, up from 26.2% a year ago. Back in the Good Times, Q3 2019, availability was 7.1%. From red-hot office shortage to the worst office glut ever in three years, as tech companies realized that the vacant office space they were hogging for the future wouldn’t be needed because that future wouldn’t come. It has been cancelled by the shift to working from home.
Sublease space dipped to a still huge 7.7 MSF. Leasing activity fell to 1.0 MSF, the lowest since the lockdowns, and less than half the activity during the last three pre-pandemic Q3s.
Asking rents had peaked in 2019 and have been sliding since then. In Q3, the average overall asking rent dipped to $71.25 per square foot (psf) per year.
“Expect continued downward pressure on average asking rents and effective rental rates as landlords aggressively fight for occupancy amidst sluggish demand,” Savills said in its San Francisco report.
“The pullback in leasing in the technology sector this year has added another headwind to any office market recovery which has struggled as many office workers have continued to work remotely,” Savills said. “As a result, expect record high office availability to continue to increase through the end of the year and into 2023.”
New Office Towers continue to be added.
The table below shows the 12 office markets for which Savills released its Q3 office reports today, in order of the availability rate.
The right two columns show the total office market size in Q3 2021 and in Q3 2022, in million square feet.
The bold column shows the net amount of office space added since Q3 2021, in million square feet – a total of 19.3 million square feet of net new office space was added in these 12 markets in one year.
The most office space was added in Seattle/Puget Sound (5.2 MSF), Boston (3.3 MSF), and San Francisco (2.2 MSF) over the past year. This will continue for years as office projects are being completed. But Houston, a market over twice the size of San Francisco, added only 500,000 sf, as the building boom has run its course.
|Office space, MSF|
|Availability rate||Increase YOY||Total Q3 2021||Total Q3 2022|
|Total office space added in 12 months||19.3|
In Chicago Downtown, the availability rate jumped to 24.5%, from 22.4% a year ago,
In Los Angeles, the availability rose to a record 25.4%. And sublease space jumped to 9.6 MSF, from 8.2 MSF a year ago as Netflix and PayPal put some of their vacant office space on the sublease market.
In Seattle/Puget Sound, the availability rate rose to 20.3%, the highest in the data. Class A availability jumped to a record 20.5%. Sublease space rose to 5.7 MSF.
In Silicon Valley, the availability rate dipped 10 basis points to 20.8%, based on one large deal: TikTok’s parent Bytedance subleased 658,000 sf from Yahoo. And so available sublease space dipped to 4.5 MSF, as that Bytedance deal removed 658,000 sf. Leasing activity in Q3, driven by the 658,000 sft Bytedance deal rose to 1.7 MSF, from 0.9 MSF a year ago.
In Washington D.C., the availability rate rose to 21.5%, and sublease space jumped to 3.4 MSF. Leasing activity in Q3 fell to just 1.1 MSF, the lowest in many years, lower even than during the lockdowns, and about half the five-year average activity.
“Hefty concession packages are indicative of landlords being forced to do more to chase potential tenants and keep existing ones,” Savills said in its office report for Washington D.C. “Class A new leases average now $150 psf in tenant improvement allowances and 24 months in rent abatement, totaling $282 psf in concessions.
“With office market fundamentals remaining soft, expect more distress from some owners as loan defaults and relinquishing of assets could increase going forward,” Savills said.
Shares of office landlords plunge.
The shares of the five largest office REITS by market cap have all plunged from their recent highs – and some of them much more from their distant all-time highs. Many investors buy REITs for their yields, but taking a 50% or 70% capital loss to get a 5% yield is not a good deal.
Boston Properties [BXP], the biggest of them, reached an all-time high in February 2020, and then plunged in March 2020. During the subsequent mega-QE era, it regained much of what it had lost in March 2020. But in April this year, as the Fed’s rate hikes were beginning to do their magic, the shares began to plunge again.
Today, despite a mild gain over the last few days, shares are down 48.7% from their February 2020 high, barely above their March 2020 low, and just a tad away from carving out a 12-year low. And they’re back where they’d first been in 2005 (data via YCharts):
Kilroy Realty Corp [KRC] today closed at $43.37, down 50.9% from its high in February 2020 (which was about level with its prior high in February 2007). Most of that plunge came since April 2022. Shares are now back where they’d first been in 2005 (data via YCharts):
Vornado Realty Trust [VNO] shot to an all-time high in February 2007, before plunging during the Financial Crisis, and then reached a lower high in February 2015, where this chart starts. Since then, the shares have plunged 74%. And since their most recent lower high in January 2020, shares have plunged 66%.
These misbegotten shares are now back where they’d first been in 1997 (data via YCharts):
Cousins Properties [CUZ] had spiked to their all-time high during the dotcom bubble, then plunged, then reached a lower high in 2004 and then again in 2007, and then collapsed. As of the close today, shares have plunged 81% from their all-time high in August 2000. From their lower high in February 2020, shares have plunged 45.5%.
Shares are now back where they’d first been in 1986, good lordy. But if you bought back then, and collected the yield since then, you’re in pretty good shape because at least you got the dividend yield. If you bought during most of the time since then, your dividend yield was a lot lower, and your capital loss was high, and that’s just a bad deal (data via YCharts):
Highwoods Properties in February 2020 got close to matching their all-time high of 2016. Since February 2020, shares have plunged 48.6%, most of it since April 2022, with a big trough in between, and last week they hit $26.41, the lowest price since 2011. Today they closed at $26.98. These shares are now back where they’d first been in 1995 (data via YCharts):
The somewhat smaller office REIT Equity Commonwealth [EQC] is down 31% from February 2020 and down 65% from its all-time high in February 1998. SL Green Realty Corp [OFC] is down 60% from February 2020 and down 75% from its all-time high in 2007. Turns out, these office REITs, once among the hottest stock trends, weren’t such great deals after all – and they really don’t like working from home and higher interest rates.
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