Epic Office Glut Hits Records in San Francisco, Atlanta, Chicago, Los Angeles, Seattle, Washington DC. Dallas availability rate drops to 30%, Houston increases to 29%

The pre-pandemic “war for space” is leading to the biggest office glut ever.

By Wolf Richter for WOLF STREET.

The oversupply of vacant offices in the rental market, as represented by availability rates, rose to new records in many major office markets in the third quarter, despite landlords announcing that office oversupply had bottomed out. The availability rate is the office space on the market that can be rented either by the landlord directly or by a tenant as a subtenant, expressed as a percentage of the total office market.

Of the 15 office markets for which Savills released data today, these five recorded the greatest office oversupply:

1. San Francisco: 36.6%
2. Atlanta: 30.6%
3. Dallas-Ft. Value: 30.0%
4. Chicago: 29.4%
5. Houston: 29.0%

Of the 15 markets, six reached new records and one equaled its previous record:

1. San Francisco: 36.6%
2. Atlanta: 30.6%
3. Chicago: 29.4%
4. Los Angeles: 28.3%
5. Seattle: 28.2%
6. Silicon Valley: 27.6% matched the previous record
7. Washington DC: 24.4%

They were just a hair's breadth away from their record Dallas-Ft. Worth (30.0% versus 30.1% in the first quarter and 29.8% in the fourth quarter of 2023) and Philadelphia (25.2% in the third quarter vs. 25.3% in the first quarter).

The diagram shows the availability rates at three different points in time: red = Q3 2024; purple = 1st quarter 2021; gray = Q1 2019.

The year 2019 (gray in the graphic above) was when the CRE industry was still touting the “office shortage” to lure companies into renting office space they didn't need and would never need, and they pounced on everything , what presented itself to them in the market, just so that they can save it for later when they grow into it. This stockpiling of office space took office shortage propaganda to the next level. But during the pandemic, CEOs initiated a major rethink – and these vacant office spaces suddenly appeared on the sublease market.

Since then, much of the leasing activity has consisted of renewals, moves and downsizing – with no positive impact on availability rates. There is also a flight to quality, with the newest and best office buildings drawing tenants away from older buildings that are then doomed.

These older buildings then experience high vacancy rates, do not generate enough rent to meet their interest payments, and fall into default. These older office properties sold at a discount of 50 to 70% from the previous price.

And in some deals where the building was separated from the land, the land had value and the building was essentially worthless, which was the case with this 925,000-square-foot office tower in Manhattan, among others, where the land value was the final value of older ones office towers.

San Francisco was the hottest office market in the US in 2019with an availability rate of 7.9% amid the deafening industry hype about the “office shortage” that led to epidemic overuse of office space by the likes of Meta, Twitter, Google and many others.

Back in the first quarter of 2019, Savills' quarterly office market report called it “the war for space”:

“The supply of new products is limited with only a handful of projects underway and all new products to be completed this year are already pre-leased. The technology, advertising, media and information (TAMI) and coworking sectors continue to dominate the war for space.

“The rapid rise of coworking offers flexible options. WeWork, HQ by WeWork and Knotel accounted for five of the 10 largest leases in San Francisco in the first quarter. These leases alone added 260,000 square feet to the already robust coworking inventory.”

Unfortunately, Knotel filed for bankruptcy in January 2021 and WeWork finally filed for bankruptcy in November 2023.

In the third quarter of 2024, despite all the AI ​​hype, San Francisco's office glut set a new record with an availability rate of 36.7%. Savills:

“While there was cautious optimism in 2024 that the office market may have bottomed out as AI companies continued demand, corporate occupiers have continued to consolidate their office space, such as X Corp., which announced its intention to acquire both Market Square North and also to vacate Market Square South of this district.”

Leasing activity increased slightly to 1.7 million square feet (msf) in the quarter, with 315,000 square feet (sf) leased by OpenAI, the largest deal in the quarter. A significant portion of the remaining leasing activity consisted of relocations and renewals, which had no net impact on the market, unless they were downsizings that would exacerbate the oversupply.

Asking rents for Class A space have fallen about 24% since 2019, but still remain very high at $68.22 per square foot (psf) per year, which is part of the problem.

And yet San Francisco is one of the exceptions. In most other office markets, asking rents continue to rise despite the enormous oversupply of offices. Landlords are often bound by their loan agreements and the fact that if they cut rents to the point where the building is full, the lower rents will not be able to pay the interest on the loan and they will default anyway.

Atlanta has the second largest office glut of these markets here with an availability rate of 30.6%. Sublease space in the market remains at about 8.6 msf, including “notable large blocks of space from IBM, Elevance Health and Cox Automotive,” Savills said in its Atlanta office market report.

Of the 10 largest leases signed during the quarter, 6 were renewals and relocations for a total of 438,000 square feet, with no net impact on availability rates. Only four leases were for new locations, totaling 256,000 square feet.

Despite the office oversupply, asking rents continue to rise, which is obviously part of the problem, rising 4% year-over-year to $32.57 per square foot per year in the third quarter, up from about $20 per square foot in 2019, which is crazy. Landlords try to compensate for the high rents with large incentives such as tenant improvements and rent discounts. And so flooding remains at record levels.

In Dallas-Ft. Worth, the third largest office glut In these markets, availability rates have been around 30% for over two years.

There was a fair amount of lease signing in the fourth quarter, with 4.2 msf signed, roughly in line with 2019 levels. However, 8 of the 10 largest contracts were extensions and 1 was a move, with no impact on office overload. Only the smallest of the ten deals was a new location.

And yet, asking rents rose 8.4% year over year in the third quarter to $30.92 per square foot per year. But here too, according to Savills, landlords are trying to compensate for this with incentives such as tenant improvements and free rent.

Downtown Chicago set a new record for its availability rate of 29.4%. There is a flight to quality here too: high-end space in great locations is finding demand and Class A availability has fallen to 24.2%.

But everything else fell even deeper into trouble, with Class B availability hitting new record highs “while renter demand waned and landlords found themselves at a crossroads, lacking the capital to secure leases or make monthly loan payments.” said Savills.

And overall asking rents continue to rise, up 3.8% year-on-year, with Class A asking rents up 6.0%.

For years, Houston had the worst office oversupply in the United States due to the American oil crisis This began in late 2014 and eventually pushed availability rates above 30% while San Francisco was still bathed in the aura of office shortages. Houston was just recovering from all of this when the pandemic hit, with availability back above 30% by the first quarter of 2021.

In the third quarter of 2024, Houston's availability rate deteriorated to 29%, compared to 28.1% a year ago. Of the top 10 leases, the largest eight were renewals and relocations. And yet asking rents rose – you guessed it – 1.8% year-over-year to $36.70, including in the third quarter.

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