High Vacancy, Limited Options

With all the news about the high vacancy rate and ongoing uncertainty around return to office, companies beginning to explore the San Francisco office market expect to select from a wide range of site options and to realize substantial savings over their pre-pandemic lease costs.  Yet for tenants seeking certain types of space, the market experience is decidedly different, characterized by limited options and relatively modest levels of landlord concessions.  Why?

Bigger is Better

Landlords prefer full floor tenancies.  Average tenant size in San Francisco has grown considerably over the past 15 years with the surge in tech sector demand.  As a result, landlords have been able to avoid the cost of demising single floors to accommodate multi-tenant occupancy.  Average floor size in San Francisco is about 20,000 sf.  The overall effect is fewer space options for occupiers seeking spaces from 3,000 to 15,000 sf. 

Less is More

Professional service companies still use private offices.  But the availability of prebuilt professional service space is low.  This is because landlords have positioned their buildings to attract technology companies who prefer mostly open space.  The result is an abundance of 2nd generation tech/open space and a shortage of 2nd generation professional service space. 

Flight to Quality

In every downturn, tenants look to “trade up” to higher quality space.  This has the effect of creating out-sized demand in a relatively small segment of the supply, causing rental economics in these segments to be less soft than the in the overall market.

Sublease vs. Direct

A large portion of total supply is sublease space.  Until this supply begins to substantially lease at discounted rates putting pressure on direct landlords and/or converts to direct vacancy (e.g., becomes a landlord’s problem) its impact on direct space pricing will be muted.  Add to this the fact that some companies are electing to pull sublease space from the market in favor of keeping if for their own occupancy.

Ultimately, if demand remains soft and there is an aggregate reduction in occupier space need, landlords will respond by demising floors and becoming more competitive with rental economics, in particular, addressing the high cost to building professional office space (which has increased, not decreased during the pandemic).  But for some, the realities of the existing market dynamic will be disappointing relative to their expectations of post-pandemic negotiating leverage.