CRE Grapples With 'Nuclear Winter' As Sublease Inventory Rises

One of the effects of the coronavirus pandemic appears to be an increase in sublease inventory up and down the West Coast, which is itself a harbinger of recession, tenant brokerage Hughes Marino said this week.

Since the beginning of the year, the Los Angeles, San Francisco and Orange County areas have seen available sublease space jump by 39%, 28% and 24%, respectively, while other markets like Seattle, the East Bay Area and San Diego have seen increases of over 10%, data from Hughes Marino, which largely tracks office, industrial and flex space, shows.

Hughes Marino Executive Vice President David Marino, who is based in San Diego, said social distancing measures came after the end date of Hughes Marino's sublease data, meaning that hundreds more companies are now scrambling to manage space, especially small and midsized ones.

As companies large and small deal with efforts to contain COVID-19, the disease caused by the coronavirus, countless businesses are on the verge of financial ruin and looking for ways to cut costs, Marino said.

“As a company, we’re talking to hundreds of other companies on the West Coast, and everyone is in crisis,” he said. “For commercial real estate, this is nuclear winter. You’re going to have tenants that do survive putting significant amounts of their space on the market for sublease across all product types.”

Following Bay Area-specific, shelter-in-place mandates at the beginning of last week, California Gov. Gavin Newsom issued similar stay-at-home restrictions for the entire state on Thursday, closing thousands of shops, offices and other properties up and down the state, except for essential services like grocery stores and pharmacies. That has left many companies scrambling for relief for plummeting revenue.

“[Small and midsized] companies don’t have the cash to last for 90 days without revenue coming in,” Marino said. “Pretty much every company we’re talking to is struggling with how they’re going to pay April rent.”

A handful of municipal governments have taken steps to address this. Last week, San Francisco issued a moratorium on commercial evictions for companies with less than $25M in annual gross receipts, and Los Angeles rolled out similar plans for companies unable to pay rent because of the pandemic.  

All the while, unemployment throughout California has surged. While the state finished January with an unemployment rate dipping below 4%, daily unemployment filings across California reached 135,000 claims on Thursday and 114,000 on Friday, both up from a daily average of about 2,000, Newsom said Saturday.

As of Friday, Avison Young Principal and Managing Director Nick Slonek said he hadn’t heard of a rash of Bay Area office tenants in crisis mode, though a softening of the market may have started to materialize even before March, he said.

“We saw sublease space hitting the market before the coronavirus was even an issue,” Slonek said. “It’s too early to tell. What’s way down are tours, obviously. People are more concerned about their health and families than they are about their office lease.”

Cresa Senior Vice President Brandon Leitner said he too thinks it is a little too early to say how impacted San Francisco leasing activity will be by COVID-19, especially with a lack of certainty on how long the pandemic will last.

“We’re in the early innings of understanding what the potential outcome will be,” Leitner said. “I do believe we’ll see some softening as a result of this. To what extent, I’m not sure yet.”

Like Slonek, CoStar Bay Area Director of Market Analytics Jesse Gundersheim said S.F. was already seeing some headwinds by the beginning of 2020, and CoStar has tracked even more office sublease inventory coming online since then. In the S.F. metro area, it has grown by about 15% to 5.8M SF since late January, according to Gundersheim.

“We were actually already heading for a pretty negative quarter,” he said. “It’s going to be a temporary occupancy loss from our perspective, but we’ve got [net absorption] being fairly negative for the San Francisco office market right now.”

For most of the Bay Area and California, like the rest of the country and much of the world, how far CRE falls from its late-cycle peak is a question of how long business is interrupted.

“How the economy reacts to this is how [transaction] velocity is going to go,” Slonek said. “Again, how long does this carry on? That’s the million-dollar question.”