How this mess came about is actually kind of funny, in a costly way.
By Wolf Richter for WOLF STREET.
Availability rates in the office sector – office space that is on the market for lease either by the landlord directly or by a tenant as a sublease – keeps getting worse in nearly every major office market.
To set the mood, here is a chart that shows the availability rates in 18 large office markets. Data by Savills. Red shows the availability rates for Q4 2023; gray for Q1 2021, and blue for Q1 2019, which were the Good Times.
San Francisco, after having been the hottest office market in 2019 with an availability rate of 7.9% amid constant hype about the “office shortage,” has become the worst office market with a record catastrophic availability rate of 36.7% in Q4 2023.
The deterioration in Q4 came despite two major lease signings by, you guessed it, OpenAI for 486,600 sf, and AI startup Anthropic for 230,325 sf. But the AI hype is just not enough?
Major companies have put vast amounts of office space on the market as sublease, including Salesforce, Meta, Microsoft, Twitter, Amazon, etc. Charles Schwab has been shrinking its way out of the City for many years, and in 2019 finally moved its headquarters to Texas, and it continues to shrink its footprint.
Houston had been the worst office market since the Great American Oil Bust that started in late 2014. Within a few years, availability rates were over 30%, while San Francisco’s were in the single digits. But it has recently been benefiting from the renewed oil and gas boom, and from the export boom of petroleum products and LNG. The US has become the largest producer of crude oil and natural gas in the world, and in 2023 became the largest exporter of LNG in the world; and it has the largest petrochemical industry in the world. Much of the oil and gas industry is headquartered in Houston, and so Houston was the only one of the 12 office markets that has improved since Q1 2021.
But Houston’s market is still in terrible shape, with an availability rate of 28.7%, one of the worst in the country, but less bad than San Francisco and Atlanta.
Silicon Valley’s availability rates have lost their grip, after hanging in there for a while, and in Q4 jumped to 27.5%, despite all the AI hoopla about hiring and office leasing.
The issue is actually kind of funny, in a costly way.
San Francisco, Silicon Valley, Manhattan, etc. went from super-hyped “office shortage” in the years through 2019 to office glut overnight because in 2019 and the years before, companies were grabbing office space as soon as it came on the market because there was an office shortage, and no one could get enough office space because there was no office space on the market because as soon as something hit the market, some company would lease it in order to get ahead of the others, and they didn’t need the office space at the time, and they didn’t think they would need it for years, but they needed to grab the office space because these people were paid bonuses on how much office space they could grab? And they were hogging office space that then stood empty and unused in order for the company to grow into sometime in the future.
But the future didn’t come, and instead Covid came, and the executives sat around the house and took a deep breath, and with lots of time to think between Zoom meetings, this question occurred to them – to all of them at the same time: “What the hell are we going to do with all this unused office space?”
And that precise moment, the office shortage swung to an office glut. And we’re now deeply into this new era of the office glut – endless amounts of often highly leveraged empty office space.
It was called “The War for Space”
So back in Q1 2019, when San Francisco’s office market availability rate was 7.9%, making it the hottest office market in the US, Savills’ quarterly office market report laid out the issue this way:
“New supply is limited with only a handful of projects underway, and all new product completing this year has already been pre-leased to-date. The technology, advertising, media and information (TAMI) and coworking sectors continue to dominate the war for space.
“Rapid rise of coworking offers flexible options WeWork, HQ by WeWork, and Knotel accounted for five of the ten largest leases in San Francisco during Q1. These leases alone added 260,000 sf to an already robust coworking inventory.”
May I interrupt here for a moment to mention a detail about both coworking companies named here: Knotel filed for bankruptcy in January 2021. And WeWork, with billions of dollars in bailout funding from SoftBank, was able to drag out its bankruptcy filing until November 2023.
Part of the reason they filed for bankruptcy was to get out from under the ridiculous amounts of office leases they’d taken on during the “office shortage.”
Back to Savills, Q1 2019, San Francisco:
“The rapid growth of coworking provides a variety of options for all types of users seeking flexibility. It provides smaller companies and start-ups with the ability to have office space in a price-restrictive market. It also allows larger, more established companies the flexibility to maneuver employees into offices while waiting for bigger blocks of space to open up in such a tight market.”
And Savills went on in Q1 2019:
“Even with the rapid pace of coworking expansion, tech companies and the TAMI sector still account for the bulk of leasing activity in the market. This quarter, Google took an additional 189,000 sf at One Maritime Plaza, mere weeks after taking 300,000 sf at One Market, backfilling Salesforce’s prior headquarters. Asana snapped up the last significant block of space in the construction pipeline, taking all 272,000 sf available at 633 Folsom Street.
“The supply demand imbalance is pushing tenants to look well into the future to stake their claim on new space. Both Salesforce and Pinterest have recently secured buildings that have not even received entitlements to begin construction yet, with Pinterest committing to 490,000 sf at 88 Bluxome Street this quarter.”
In August 2020, Pinterest paid $89.5 million to get out of the lease and walked away from the unbuilt high-rise project at 88 Bluxome Street.
Those were the Good Times – grabbing office space that hadn’t even been built yet, to keep others from grabbing it, even though no one actually needed it or could see any use for it. This kind of game was played in all major office markets. But it was played to perfection in San Francisco.
It was also played to perfection in Houston during the prior oil boom until it began to deflate in late 2014. Years of that oil boom had triggered a huge wave of new construction of office towers amid endless optimism about oil going to the moon. And even as the vacant office space got piled on the market, new towers were still getting built. The flight to quality caused older office towers to be vacated and end up getting sold in foreclosures auctions with something like 80% haircuts for the creditors, the CMBS holders.
In San Francisco, construction on a two-tower mega project, the Oceanwide Center, with an original budget of $1.6 billion was halted in 2020 after it reached grade. By that time, it was hopelessly over budget. Commercial viability was in doubt. The Chinese developer, China Oceanwide Holdings, ran out of money. The general contractor withdrew from the project. Unpaid contractors filed for mechanics liens. The project defaulted on the debt and was seized by creditors. In October, a court in Bermuda ordered the liquidation of China Oceanwide Holdings. And the project has turned into a big ulcer.
The photo by Wolf Richter, taken on May 24, 2021, shows only part of the project. And it still largely looks like that except the last remaining construction crane has been removed. In the background is the gleaming Salesforce Tower, the City’s tallest building, with big portions of its space on the sublease market.
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