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Corporate CRE tenants look to sublease unused office space

The COVID-19 pandemic has forced industries across the U.S. to be creative and flexible in how they generate or save money for the past several months. Companies with extra office space are no exception as many of them are now looking to lease it to other tenants, The Wall Street Journal reports. As more employees plan to continue to work remotely, big corporate tenants are saddled with a lot of unused office space. They’re often locked into leases that are as long as 20 years without much room to break them. Even large, well-known companies like Airbnb, Twitter and Expedia are looking to sublet their excess space.

CoStar Group noted that corporate tenants put a record 42 million square feet of space on the office market during the second and third quarter of 2020. That addition brought the total amount of subleased space in the U.S. to approximately 157 million square feet—1.7% of the total office inventory, which is highest rate since CoStar began measuring it 15 years ago.

Recent reports of progress in a COVID-19 vaccine development helped raise office and commercial real estate stocks, but the recent spike in cases could mean employees will continue to work remotely for the foreseeable future, even after the pandemic subsides.

How subletting impacts the overall office space market

The good news for the office space industry is it’s faring better than lodging and retail. While hotel guests and conferences have canceled trips and many retail tenants stopped paying rent, most office tenants have managed to keep paying. The average office asking rents have not dropped much in 2020, according to CBRE senior research director Ian Anderson.

The downside to those figures is that they don’t account for how much office space is vacant and available for sublease—tens of millions. The extra supply could negatively impact office rents when leases are up for renewal, according to analysts. The situation becomes more complex because corporate tenants are usually OK offering their space at a lower rent price just to generate some income. Sublease discounts have usually been about 20% below market rate, but there’s a chance they could be bigger now, Jonathan Adelsberg, a partner and chair of the leasing department at law firm Herrick Feinstein LLP, told The Wall Street Journal.

“There will be cases where tenants and landlords are going to be competing for the same business,” Adelsberg said.

Currently just 2.5% of office mortgages that were changed to mortgage-back securities were more than 30 days past due, according to data firm Trepp, LLC. That’s quite small compared to the retail real estate (14.3%) and lodging (19.4%) industries. However, increased subletting could decrease the value of office buildings by tells of billions of dollars, which could create more defaults and losses, according to analysts.

“The heightened amount of sublease space suggests that tenants’ positions are more precarious than the vacancy rate would suggest right now,” CoStar senior analyst Nancy Muscatello told The Wall Street Journal.

Post-pandemic outlook for the office space industry

Economic downturns often lead businesses to sublease unused space before reclaiming the space once recoveries start. There are brokers and landlords that think the office space industry will follow suit once the COVID-19 pandemic is deemed under control.

“The bulk of sublease space is coming from the (COVID-19) recession and not a structural change in the way that people work,” Boston Properties owner Douglas Linde said.
However others think the combination of a recession, pandemic, remote work and technological changes at the office make this specific downturn unique from others. There’s a chance businesses may sublease space with no plans to take it back.

“People are realizing that remote work is working better than they imagined and saying, ‘You know what? Let’s get rid of some of our space,’” Anderson told The Wall Street Journal.

Joe Dyton can be reached at joed@fifthgenmedia.com.

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