Elgin Area Chamber Of Commerce: Return-To-Office Momentum Slows Nation's Record Sublease Surge

Press release from the Elgin Area Chamber of Commerce:

June 24, 2021

Fashion subscription service Rent The Runway joined a wave of companies trying to sublease unused offices last year in the largest amount of sublets ever listed in the nation at one time. Now, it's part of an expanding fleet of office users across the country withdrawing those listings as employees return to workplaces.

The company, based in New York City, closed all five of its retail outposts, laid off or furloughed most workers and lost its status as a $1 billion startup last year as the pandemic's economic disruption was at its peak. Rent The Runway was forced to cut costs by more than 50% and, as a result, put its new 83,000-square-foot headquarters in Brooklyn's Dumbo neighborhood — space it had only moved its roughly 500-employee team into at the beginning of last year — up for sublease.

With widespread vaccination progress, economic reopening and return-to-the-office plans prodding customers back toward their pre-COVID lives, however, Rent The Runway reported a 450% increase for its new subscriber base in the New York city area between February and May this year. As a result, the fashion platform said it ended its nine-month search for a subtenant and intends to ultimately keep its loft headquarter space at 10 Jay St.

Companies across the United States are reconsidering their subletting attempts, resulting in a wave of withdrawals that real estate brokerage CBRE Group said is a result of businesses bringing more workers back into the office. So far this year, about 2 million square feet of New York City office space has been pulled off the sublease market, with more than half of that concentrated over the past couple of months. Roughly 60% of sublease listings spanning 25,000 square feet or larger were withdrawn so that the original tenant could reoccupy the space, CBRE said.

"It's like learning to drive a stick shift," Matt Pacinelli, a managing director for Stream Realty in Washington, D.C., said of the return-to-office strategies and the effect on commercial real estate. "It's hard to figure out how to get it into one of those first gears, but after that, you'll be able to move through really quickly. The amount of sublease space will create some substantial headwinds for a while, but it will be a near-term sort of headwind as companies rightsize and figure out what they really need and want."

Office sublet availability across the United States has climbed past 200 million square feet, according to CoStar, representing an 80 million-square-foot leap over the past 12 months that has touched record highs. What's more, the share of total availability of sublet space is still climbing and now accounts for nearly 12% of the nation, a higher portion than what was reported in the aftermath of the Great Recession.

However, after almost a year and a half of operating remotely and trying to curb unused office expenses, companies that flooded cities such as San Francisco, New York and Boston with sublease listings are now reckoning with how and if they want to rebuild their post-pandemic footprints. The accelerating adoption of a hybrid work combining time in the office and at home has pushed some tenants to permanently downsize or do away with their office space altogether, while others — many of which are planning to bring workers back on a full- or part-time basis — have withdrawn their subleasing attempts entirely.

Take New York City, the biggest U.S. commercial real estate market. After hitting a peak with more than 1.8 million square feet of sublease additions back in March — the highest monthly addition since the onset of the pandemic — the amount of new sublet space dumped on the office market has slowed substantially, according to CBRE. About 800,000 square feet of new sublet space was added to the Manhattan office market last month, the lowest it has been for more than a year.

Changing Course

Large corporate anchors such as Salesforce, Twitter, Dropbox and Target that previously occupied massive swaths of space contributed to bulking up sublease availability in their respective cities, despite the companies posting record-breaking spikes in revenue and customer use throughout the dual health and economic crises.

Colliers senior vice president Nick Goddard, who works in the San Francisco Bay Area, said the burst of sublease listings that plagued markets across the country in hindsight appears to have been a knee-jerk response by tenants to the sudden workplace changes brought about by the onset of the pandemic. Companies, especially those in the Silicon Valley and San Francisco areas, began questioning the high cost of retaining their commercial real estate footprints, he said.

"As time dragged on, tenants started recognizing that while we could make remote work work, working from home was far from ideal," Goddard said. "People wanted to return to work, employers wanted people to return to work, and now we're starting to see more of those come-back plans. The general idea is that we will return to some kind of normal real estate market over the coming year, and a result of that is employers taking their sublease listings off the market."

Other tenants rethinking their earlier subleasing push include shaving products subscription provider Dollar Shave Club. The company decided to keep roughly half of the office space it put up for sublease in Los Angeles' Marina del Rey area. Educational publisher McGraw Hill, which initially put up one of New York's largest sublease offerings, ultimately decided to keep its 100,000-square-foot digs at 1325 Sixth Ave. as it gradually welcomes its employees back to the office.

The CBRE report said about 800,000 square feet of new sublet space was added to the Manhattan office market last month, the lowest it has been for more than a year. And New York City isn't the only sublet-heavy market where tenants are reconsidering attempts to offload their space.
Stream's Pacinelli said about one-third of the sublease availability marketed in Washington, D.C., has been taken off the market in recent months as companies begin to reoccupy their original space.

He said tenants tested the sublease market in the earlier months of the pandemic, but "ultimately a lot of them have decided not to move forward with the sublease listing, and I'd imagine that's similar in other gateway markets, too. As things reopen, tenants are deciding to reoccupy their original spaces moving forward."

No Shortage of Space

Even with more office tenants re-occupying their original spaces, cities posting record-breaking growth spurts prior to the pandemic are now left trying to absorb record amounts of sublet availability that threatens to weigh down their ultimate recovery.

After a decade of record rental rates and demand in San Francisco, for example, asking rates in the Bay Area city have fallen at the fastest pace of any market across the country over the past year. The city has suffered the most severe decline in office occupancy amid the pandemic, according to CoStar. Despite retaining its title as the most expensive office market in the United States, it is also the one with the highest amount of sublease availability.

Jesse Gundersheim, CoStar's director of market analytics for the San Francisco Bay Area, said the worst of the pandemic-induced punches to the region's office market appear to have eased. However, there is still a long road ahead before the tech-concentrated city returns to its pre-COVID levels of activity and demand.

"A few emerging green shoots suggest the market's free fall is subsiding," he said, adding that sublet availability appears to have peaked over this past spring. Over the past two and a half months, sublease availability has slid to about 7.3%, according to CoStar.

Even so, while new leasing activity has finally gained some traction after last year's lows, it is still about half of its pre-pandemic pace. Occupancy rates throughout the first quarter of 2021 slid at their sharpest rate since the start of the pandemic 18 months ago, and tenants have continued to shed space throughout the first half of this year. More than 12 million square feet of San Francisco office space has been vacated since the beginning of 2020.

"Some short-term sublease listings are probably rolling back to landlords rather than getting leased, as direct availability is still increasing," Gundersheim said. "Combined, total space availability in the market has never been higher. Vacancy is still rising as well, and I think it will take some time for leasing to reach more robust levels needed to offset tenant relocations and downsizing."

And other markets across the country are grappling with similar blocks of large sublease availability. Companies including website development platform GoDaddy and cloud computing company VMWare have helped push total sublet space in Austin, Texas, to more than 2.5 million square feet over the past year. In Chicago, sublease listings have recently hit more than 10.8 million square feet, marking a 50% rise since the beginning of 2020.

The spike in sublet availability has been even more pronounced in Boston, where more than 4 million square feet of office space has been added to the city since the start of last year, according to CoStar data. That represents an increase of more than 90%, and as of the second quarter of this year, there was about 8.7 million square feet of sublet availability throughout the city.

The future for sublease availability across the United States, both in terms of the eagerness of primary tenants to dump their space as well as the appetite of potential sublessors for it, hinges on one unknown factor: how companies are imagining their post-pandemic spaces.

"There is still a long way to go to absorb the large volume of sublease space currently on the market," CBRE said in its recent sublease report. "But with the volume of new additions slowing down, the pace of space withdrawals picking up and the economy adding back office-using jobs at a steady clip, there is more cause for optimism that the office market is nearing the beginning of the end of its downturn."

This press release was produced by the Elgin Area Chamber of Commerce. The views expressed here are the author’s own.