Coronavirus Concerns Spur Office Subleasing, Space Downsizing

As the coronavirus-fueled economic uncertainty and emerging construction labor shortages put corporate expansion and relocation plans on hold, office and industrial landlords suddenly have another thing to worry about: their own tenants.

Some office and industrial brokers say they are getting increasing requests from their tenant clients to sublease space as they downsize their footprints. Many are dropping their rates to get the space filled quickly, and that's creating a climate where office property owners could be forced into competition with their own tenants to lease out empty space.

"When tenants become competitors to landlords with space to sublease, it always ends badly for building owners," said Jason Hughes, CEO of commercial brokerage Hughes Marino in San Diego.

The U.S. and global economies have been reeling from the effects of the coronavirus, which has closed businesses and sent cities and countries into isolation and lockdowns as officials try to slow the pandemic's spread. Job losses are becoming widespread across industries, and demand for office space is diminishing quickly.

That puts landlords in a difficult position as they work to try to keep their offices full and income flowing. Competing with tenants who act as sublandlords within their own buildings presents landlords with an additional hurdle in an already-challenging environment.

The true impact of it all may depend on how long the current restrictions on movement last, as government and health officials work to contain the virus. But Hughes told CoStar News his tenant-focused company's West Coast offices are seeing escalating requests from office and industrial clients to sublease space, a trend that had already begun to rise in the past year before the virus crisis hit.

"We are getting deluged by tenants asking us how they can get out of some of their space, or get help in renegotiating leases," Hughes said. "It's happening all along the West Coast, and we also just started getting multiple requests in our New York City office."

Analysts at Hughes Marino, which has several offices in California, Washington state and New York, found that office, industrial and combination "flex" space available for sublease this year has spiked most significantly in Los Angeles, rising 39% to 13.9 million square feet on March 13 from 10 million square feet on Jan. 1.

Significant spikes in that period were also seen in San Francisco (28%) and Orange County (24%), with lesser increases in Seattle (13%), Northern California's East Bay (12%) and San Diego (10%). Total sublease space nationally in those categories has increased 14% year to date, going from 232 million to 264 million square feet, according to Hughes Marino.

Hughes said office and industrial neighborhoods nationwide are likely to post similar results, a trend that could significantly raise space availability in older buildings already suffering from higher vacancies. Parts of downtown San Diego, for instance, already had an office availability rate, including space available for sublease and buildings under renovation and currently vacant, topping 30%.

Shelter in Place

Ron Miller, senior vice president in the San Diego office of brokerage Colliers International, said he's so far not seeing office space going for bargain-basement rental rates in the West Coast cities where he serves tenant clients in multiple business sectors.

However, he is seeing tenants having to put the brakes on move-outs, move-ins and office renovation projects because of factors fueled by the pandemic. For instance, several Northern California counties have issued shelter-in-place warnings that prevent construction workers from getting to job sites.

And several cities in that region have closed or scaled back government operations, including departments that process the building permits that are necessary to begin work on tenant improvement projects.

It was not immediately clear how project work would be affected by last week's stay-at-home orders, but the impacts could include work stoppages on nonessential construction projects. If labor is unable to do projects, more office tenant work could be placed on hold. Tenants, including many who have already decided they need extra space to meet long-term customer demands, won't be able to move out of current offices or bring on new hires until the improvements in their new locations are completed.

Brokers nationwide have already reported that office users are in contact with landlords for temporary breaks on rental rates or payments because of cornavirus-related revenue effects. Miller said West Coast landlords are now also being asked to waive or reduce costs, such as penalties imposed on tenants who fail to vacate a space by a certain date when leases haven't been renewed.

Hughes said rising office subleasing trends have traditionally been a harbinger of past U.S. economic downturns, as tenants look to boost efficiency and put excess space on the market. Depending on the neighborhood and how long ago the lease was signed, the sublease space could be coming online at rental rates that are 20% to 30% below current market rates for new leases.

In response, landlords might need to drop their current rates to compete. "Historically this process of rent deflation has taken up to two years to hit bottom and doesn't happen overnight," Hughes said.

David Marino, executive vice president and co-founder of Hughes Marino, said the next 60 days could see subleasings spike even higher as thousands of small businesses call it quits on the West Coast and elsewhere because of business losses spurred by coronavirus-related restrictions.

"We're concerned that lots of these businesses will go under before they even have a chance to turn the space back over for subleasing," he said.