Big tech rethinks its space needs

Reports of technology companies laying off employees continue to roll in, as companies that a year ago couldn't hire enough workers are now tightening their belts.

Beyond job cuts, many tech companies are taking a hard look at their real estate to find savings, especially in the wake of the Covid-19 pandemic that enabled more widespread remote work.

A few examples of what this looks like in the Bay Area:

Salesforce.com Inc. executives said in an earnings call on Nov. 30 that the company would likely continue reducing its footprint.

It's all quite a reversal from pre-pandemic days and even late 2020 and 2021, when tech users continued to take down big chunks of office space -- although not at the clip the industry was gobbling space pre-pandemic. Some markets are seeing record levels of sublease inventory from real estate decisions led by, but not exclusively from, tech companies.

Leasing activity nationally by the tech industry remains 35% below pre-pandemic levels, according to CBRE Group Inc.'s Tech 30 report from late October.

What the tech industry more broadly does with real estate is a key bellwether for the office market's long-term health because tech has been the biggest leaser of office space for several years now. Tech companies also typically gravitate to the most premium office buildings in cities, for recruitment and culture purposes, which helps prop up those cities' rental rates and leasing revenue.

Office brokers and those who track the industry closely believe the bleeding hasn't stopped yet for technology company space reductions. It's hard to guess how much more office space tech users will put on the market, which leases they will look to exit or buildings they will list for sale. But with many economists predicting a recession in 2023, the next couple of quarters could be painful.

Savills PLC recently analyzed how much sublease space in key U.S. markets has come from tech. In the Bay Area's two biggest markets, the report found that 79% of sublet space in San Francisco on the market now was given back by the tech sector while in Silicon Valley that share is 69%. (By comparison, in Austin, Texas, 44.2% of sublet space on the market came from tech while in Seattle the figure was 36.3%.)

The sheer volume of sublease space that's hit, especially, tech-centric West Coast markets in a compressed time period means a majority of that sublease inventory will likely languish on the market amid an economic slowdown. A lot of it isn't even being toured right now, brokers say.

Colin Yasukochi, executive director of CBRE's tech insights center, said he thinks more sublease space is coming from tech companies, but he isn't sure if it'll be a dramatic rise from what's currently on the market.

David Bergeron, executive vice president and market leader of Savills' San Francisco and Palo Alto offices, said in an email that the addition of space on the sublease market is flooding tech office markets with too much supply, making it challenging for companies to monetize their subleases.

Brokers also report, unsurprisingly, leasing activity is down in tech-heavy office markets right now. Although VTS Inc.'s most recent monthly office-demand index found an 8.3% increase from the month prior, leasing across major U.S. markets is 14.8% down from a year prior and, with an index of 52, is at about half of typical pre-pandemic leasing activity.

"The number of total tours up and down the Bay Area by quality potential subtenants is down drastically," Bergeron said. "When underwriting a sublease deal, the majority of tech companies putting their space on the sublease market today should be prepared to not find a subtenant prior to their lease expiration date. Until we see an increase in the demand side, there will be many subleases that simply never transact."

The expectation among brokers who work with tech companies is that most of the sublease space listed this year, or that's been sitting on the market since the pandemic's onset in 2020, will go back to the landlord once the term expires. Those expirations will, in turn, bump up a building's direct vacancy rate, a key indicator of an asset's health and financial standing by lenders.

Outsized impact for tech cities

The wave of sublease space hitting the Bay Area and other tech-heavy economies prompts questions of how difficult it will be for those office markets to recover amid, or after, a slowdown.

Even if an economic recovery happens sooner rather than later, as some are predicting, tech's embrace of remote work could result in a more distributed workforce, meaning its future hiring may not all be based in markets that have or require a local office.

In fact, in the first half of 2022, U.S. office leasing across all industries was up by 28% year-over-year but tech industry leasing only grew by 1%, CBRE found. That decreased the tech industry's share of total office leasing from 21% in 2021 to to 16% in H1 2022.

Between Q2 2020 and Q2 2022, 476,000 high-tech jobs were added and 54 million square feet of new office leases were signed by tech companies. Compare that to the nine quarters prior to the pandemic, between Q1 2018 and Q1 2020, when fewer new high-tech jobs (381,000) were added but more office space was signed (79 million square feet) by those types of companies.

When asked whether there's still a correlation between job growth and space requirements for an industry like tech, CBRE's Yasukochi said it's definitely changed since the pandemic but figuring out space needs has become a less straightforward assessment.

"It used to be be, for every employee, you'd need 150 or 250 square feet per employee," he continued. "We know it's less, but ... it's not that same metric we've used in the past, and it's probably not going to return to that kind of a level in the foreseeable future."

Even though tech-heavy markets will be challenged as a result of tech's real estate downsizing, Nick Slonek, principal and regional managing director at Avison Young, who is based in San Francisco, said there's so much intellectual capital in a place like the Bay Area that, eventually, the region will beget another Salesforce or a Google. That will, in turn, prompt need for office space, Slonek predicted.

Although tech companies have embraced remote work, many chose to lease and purchase a lot of office space even after the pandemic hit. In September 2021, Google LLC agreed to buy a Manhattan office building for $2.1 billion and Meta signed on for more than 700,000 square feet of office space in Sunnyvale's Moffett Park area about a year ago, taking over NetApp Inc.'s former headquarters space.

Yasukochi pointed to the robust business growth experienced especially by Big Tech as demand for digital services and products boomed during the pandemic while people sheltered in place and limited in-person activities. U.S. high-tech software and services employment grew by 1.5 million jobs between 2010 and February 2020, which was one of every four new office-using jobs, according to CBRE. Although tech companies initially slowed their hiring at the beginning of the pandemic-induced economic shutdown, that rebounded quickly.

By June 2022, about 76,000 high-tech industry jobs had been added, which accounted for one of every three new office-using jobs.

In 2021, there was an anticipation of a big return to the office around the third quarter, Yasukochi added, which may also be a reason for leasing by tech earlier in the pandemic. That never materialized, thanks to the onset of the Delta and Omicron variants of the virus. Covid-19 vaccines were at that time still rolling out to all age groups and populations, too.

The return-to-office push was reignited again this fall, to some success, although many markets remain meaningfully below pre-pandemic levels of physical occupancy on a daily basis. The tech industry has widely continued to embrace remote work, at least in part as a labor retention and recruitment strategy, which had made physical occupancy in tech centers anemic.

The week prior to Thanksgiving, the San Francisco metro area's physical office occupancy averaged 43.1%, according to Kastle Systems LLC, which tracks swipe-access activity at buildings it secures. The San Jose metro that same week was 37%. Compare that with Austin, a growing tech rival to the Bay Area where office occupancy hit 62.7% during that time period.

Slonek said, as a real estate strategy, Big Tech companies are typically playing defense.

"They're trying to figure out where they can have beachheads, where they can do the NYU real estate strategy -- being in several buildings in close proximity" to one another, he said. "There were some moves made because they were a little bit of land grabs -- there's 500,000 square feet here, let's grab it, we're going to need it one day."

While companies are shedding some of that space now, offices they're hanging on to are an insurance policy of sorts for space they'll eventually need, he continued.

A time to make office moves?

The current downturn means unique opportunity for companies to lease space at a competitive rate or move into buildings that've historically been fully occupied.

"If you're a tenant in the market right now, the world is your oyster," Bergeron said. "Rarely, if ever before, has there so much available, high-quality, fully-furnished office space waiting for someone, anyone, to come along and scoop it up. Rents are dropping while concessions like free rent, phased-in rent schedules and tenant-improvement allowances are all swinging in favor of the prospective tenants."

But whether tech or tenants in other industries are even willing to consider such deals right now is another matter.

Slonek said he isn't seeing many tenants engaging in long-term transactions, with most deals being short-term renewals to kick the can down to the road to what's hoped to be a more certain time.

In his market, there are four or five companies in the market seeking their own building, or between 100,000 square feet and 200,000 square feet.

"Those are few and far between but, in a market like this, they can probably find it," Slonek said.

Yasukochi said he expects tech leasing activity to continue to be slow for the next couple of quarters. A more optimistic view is there'll be a big rebound in office-space demand once the economy improves and robust job growth comes back for tech companies.