The good news for office landlords is that lease signings have been increasing this year.
The bad news is that the average new lease is considerably smaller than before. That means companies are committing to spend less on office space for years to come.
The need for less workplace space reflects how employers across the U.S. have embraced—or at least have come to tolerate—hybrid strategies that allow employees to work more from home. Consequently, firms feel they need less space and are signing deals of up to 15 years for fewer office floors.
In the second quarter, U.S. businesses signed new leases for an estimated 97.5 million square feet, up from 57.4 million square feet in the second quarter of 2020, the low point of the pandemic, according to data firm CoStar Group.
Yet in the second quarter, the average U.S. office lease size was 3,275 square feet, or 19% less than the average lease size between 2015 and 2019, CoStar said.
“If a tenant signs a lease for 100,000 square feet and they move out of 150,000 square feet somewhere else, that’s a negative event for the market,” said Phil Mobley, CoStar’s national director of office analytics.
Look for this trend to continue, Mobley said, since more than half the leases signed before 2020 have yet to expire. The U.S. office vacancy rate has increased to 13.2% from 9.5% before the pandemic. CoStar is forecasting that it will increase to more than 17% by the end of 2026.
Shrinking lease sizes are another blow to office owners during one of the industry’s worst slumps since World War II. That slump is hurting cities, wiping out billions of dollars in property values and putting pressure on the shaky banking system.
A number of large employers have recently sliced their office demand. Consulting firm Aon is reducing its space in Chicago by a quarter to 300,000 square feet, while International Business Machines leased 320,000 square feet for its Austin, Texas, office, less than half of what it used under its previous lease there. Smaller businesses also are leasing less space in renewals and when they change locations.
In some cases, companies are shedding space because their businesses have evolved. Fluor, an engineering and construction firm, will be cutting its office space by about 70% to 308,000 square feet in the Houston area, in part because the company no longer assigns cubicles to employees who work on the road. Fluor engineers also now use computers rather than drafting tables to create designs.
The facility Fluor is leaving “was built in a different time and era,” said Jennifer Kim, general manager of the Houston office. “Times have changed. You don’t need as much space.”
But many businesses are shrinking space because of hybrid workplace policies. Currently 61% of U.S. companies allow employees remote work part or all of the week, up from 51% at the beginning of the year, according to Scoop Technologies, a software firm that developed an index monitoring workplace strategies.
The number of companies requiring workers to be in the office full time has declined to 39% from 49% at the beginning of the year, Scoop said. That number will likely continue to decrease because newer companies tend to embrace flexible work practices more than older companies, according to Robert Sadow, Scoop’s chief executive and co-founder.
“As older companies age out, and newer companies come in and offer more flexibility, I think you’re going to end up with only 15% of companies full time in the office,” Sadow said.
Even fast-growing tech companies are giving up space in new leases. Seattle-based Hiya, a voice security software firm, is increasing its workforce more than 20% a year but decided to reduce its space from about 22,000 square feet to 19,000 square feet when it moved into a new location this year.
Hiya asks workers to come to the office two days a week. “Before the pandemic everything was about anticipating a future growth rate [in office space] looking to double your capacity every couple years,” said Kush Parikh, president of Hiya. “Now we have a much more conservative view.”
Office building owners had been hopeful earlier this year as businesses called employees back to the office a portion of the week and deal activity increased. Leasing in the second quarter rose to about 14% below the average quarter in the four years leading up to the pandemic, according to CoStar.
But many other office metrics are negative. The market is sagging under a record 216.8 million square feet of sublease space. The amount of occupied space declined in the first half of 2023 by more than 35 million square feet, CoStar said.
Some businesses, of course, are opting to take more space when they sign new leases. Law firm Davis Polk last week announced that it had signed a 25-year lease extension for its Midtown Manhattan headquarters that expanded its space an additional 30,000 square feet to 700,000 square feet.
Neil Barr, the firm’s managing partner, said Davis Polk is “packed to the gills” in its current space and is planning for measured growth in the coming years. The firm requires employees to be in the office four days a week, down from five before the pandemic.
Still, most law firms seem to be cutting back as they adopt hybrid work and jettison file cabinets, libraries, corner offices and other design features of the past. On average, legal tenants who renewed or moved locations within the same market in 2022 took 13% less space, according to a report by commercial services firm Cushman & Wakefield.
Law firm Katten Muchin Rosenman last year renewed its lease for its Chicago office taking 204,000 square feet, a 22,000-square-foot reduction. Some of the space was underused before the pandemic. The firm also negotiated an additional contraction option in case its flexible workplace policy resulted in more space efficiencies, said Chicago office managing partner Gil Soffer.
“We could see down the road that hybrid work was looming,” he said.
Source: “Office Tenants Are Renewing Leases—but for Far Less Space“
