Not 2001…

The last time San Francisco office vacancy hit 20% was 2001.  Asking rents dropped by more than 60% in the early 2000s.  As of 2Q 2001, overall vacancy is 20.1%.  This is up from about 4% in 1Q of 2020.  Yet Asking rents for direct space are down only ~10% from their pre-pandemic high.  Why?    

Firstly, 45% of overall vacancy is sublease space.  Landlords have yet to feel the pain of the pandemic.  Rent collections and occupancy levels within their assets have remained high, buying them time to avoid competing in a down market.  Secondly, landlords are being strategic about when and where to lower rates.  They are (mostly) choosing to let the competition for tenant demand play out in the sublease market, betting that in 2-3 years when many of the subleases have gone away (the weighted average remaining term of all sublease space is ~3 years), demand will have sufficiently recovered to mitigate rental declines in the direct space market. 

In contrast, in 2001, landlords felt immediate pain because many of their tenants went into bankruptcy and handed back the keys to the space.  This caused direct asking rents to begin a steep (and rapid) decline as landlords sought to shore up vacancy and get ahead of falling rates. 

While landlords may be able to come out the other side of this with comparatively limited damage, tenants seeking to sublease space can’t avoid competing heavily for subtenants, as the value of space having 3 years or less of remaining term generally declines as the expiration grows nearer.  Unlike in 2001, for the time being, this downturn has afforded landlords the luxury to bet on a brighter future.