With 900M SF Of Office Leases Expiring By 2025, Owners Are Getting More Aggressive

Office owners have been dealing with more than two years of uncertainty around the future of their properties, but the demand for their space is about to get an even tougher test. 

Roughly 11% of the leased office space in the U.S. is set to expire this year, according to JLL, which equates to about 243M SF — a 40% jump from 2018. By 2025, 900M SF of office leases nationwide is set to expire.

“There's an anticipation that so much space will become available over the next two years, and landlords are reacting by giving even more concessions,” Vestian Global Workplace Services Chairman Michael Silver said. “It's extraordinary how compounded the situation is, and fierce competition for tenants is breaking out into the open.”

Many tenants favored shorter-term lease renewals during the early uncertainty of the pandemic, putting off lease expirations to the point where a massive proportion of the office market could turn over in the coming years.

As more data emerges pointing to future distress and a loss of value, these owners are facing a looming supply crisis that may take years to resolve. Green Street analysts forecast a 15% reduction in office space demand. A New York University analysis this month forecast offices nationwide to lose $500B of value by 2029.

Financial concessions for leases are increasing significantly from just six months ago, Silver said. A soft market expected to soften further presents even more challenges in the current financial environment. 

Savills data provided to Bisnow found that, in Q1 2022, new leases for top-tier office space in Washington, D.C., typically got 24 months of rent abated; that compares to 14 months in Chicago, 13 in Houston and 18 in Midtown Manhattan. Numerous reports have noted that landlords are offering extensive free rent periods while maintaining or even raising their rents, in effect taking in less while broadcasting a higher asset value. 

Owners face the prospect of needing to refinance at some point in the future with less income and higher interest rates. Belt-tightening by firms feeling the pinch of difficult economic conditions could worsen the situation. Possible landlord distress means tenants may be even pickier, making sure they’re signing with a well-capitalized owner. 

Silver, an occupier services consultant, compared the future of the office market to that of shopping centers, a “gradual deterioration” with fewer and fewer people coming to the office, fewer tenants renewing and office real estate slowly but steadily losing value, a process that will unfold over the next decade. 

As talk of post-pandemic recovery and return runs headfirst into growing recession fears, office owners have seen plenty of recent data points providing reason for pessimism. Foot traffic still lags behind pre-pandemic norms in major markets. Placer.ai data found visits to San Francisco office buildings in May were down 67.8% compared to May 2019; visits in Chicago and New York were down 45.7% and 40.6%, respectively.

But leasing activity has been increasing this year, according to CBRE Global Head of Occupier Thought Leadership Julie Whelan, who said demand is stronger today than it was a year ago. New leases made up 75% of all Q1 leasing activity, suggesting “tenants are making longer-term decisions about their portfolios,” she said.

Brokers are seeing lease renewal discussions come up earlier and earlier in this environment, with landlords eager to keep tenants happy. CBRE Americas President of Investor Leasing Mike Watts said that as more tenants need office modifications requiring capital investment, they are willing to entertain discussions about lease renewals further in advance than they typically would.

“Stabilizing their rent roll is a positive thing for building owners,” Watts said. 

His brokers are spending more time with tenants right now, Watts added, seeking to both understand long-term needs and craft a “right-now” solution.

Firms are monitoring occupancy and data on office usage, and trying to figure out future prospects, Colliers CEO of Occupier Services Seth Nelson said. It’s not translating into dramatic cuts, like shrinking footprints in half, but companies expanding their footprint are the exception, not the norm these days. 

“There are discussions about what is the right time to make these commitments, because leverage is heavily in the tenants' favor in many places,” he said.

But companies are also looking to delay these decisions as long as possible as they try to formulate strategy amid the uncertainty around hybrid work and office schedules, Colliers Principal of Occupier Services David Burden said. Most are considering a ratio of less than one seat per employee, a shift meant to save money in light of the increasing prevalence of remote work, even though they may ultimately want everyone back on a more regular schedule.

“It’s penny-wise, pound-foolish,” Burden said of the shrinking footprint.

Real estate represents roughly 5% of expenses for many firms, whereas labor often totals 65% of total expenses before inflation and today’s more competitive labor market. Investing in real estate may ultimately save money when viewed as an investment in talent retention, Burden said.

But Silver suggests that the smart strategy is to ignore the arms race for better quality office space and set money aside, potentially raising capital by selling stakes in properties to create a cushion of cash for outside investors. However, he sees more owners and landlords, scared that the drive for new and renovated space will make their older buildings less competitive, taking the opposite approach, and “putting in fancy running tracks and things that tenants don’t care about” instead of sustaining capital for the long haul.

That may soon get more difficult. MSCI Real Assets found commercial property sales this past April, $39.4B, was down 16% year-over-year, the first decline after 13 straight months of increases. At least one major investor estimates commercial property values are already down up to 10% from last year.

“You’re going to have to find money somewhere to hold on,” Silver said. “And if you can’t find it, you’ll turn the keys back to the lender.”

There are positive indicators in the market. CBRE’s Watts expects 2023 to be a “fairly robust leasing market” as tenants better understand the pandemic’s impact on their business and finalize their go-forward plans for using space. 

But those observations also suggest that in the coming year or two, as many companies make more solid, long-lasting decisions about their post-pandemic office space — in the midst of an increasingly likely recession — there may be a long-term pivot to a smaller footprint. In the foreseeable future, office capacity will still grow at roughly 1% annually, based on what’s already in the pipeline. 

While owners may be sweating the next few years of a tenant-friendly market, companies that take too long to make final decisions may also regret it, Burden said, because there are only so many good relocation options. The tenants acting now in the current market are locking up good spaces with long-term leases. He’s seeing this in his home market of Chicago, where newer towers, or favored buildings near the Chicago River, see significant transaction velocity. 

“Many firms are looking at this with a different lens,” he said. “They say, ‘We're gonna step up the space and go for the good stuff right now.’ They’re looking, two, three years in advance, when the excuses stop.”