MARKET DRIVERS
Given the numerous challenges experience by the San Francisco office market over the past four years, the market may finally be at the cusp of a correction and recovery period. There is cautious optimism due to a 9% increase in leasing activity, year-over-year and positive net absorption in 4Q 2024 – for the first time since 2019. The technology industry is poised for growth, companies focused on artificial intelligence remain active, and businesses are beginning to implement return to work mandates for their employees – all positive drivers for future office growth in San Francisco.
Regardless, there are still many hurdles to overcome with more than 32.2M SF of vacant space across all classes (31.0%), compared to 7.4M SF prior to the onset of the pandemic (7.3%). At the current rate of leasing, it would take approximately 4-5 years to return to a similar state of vacancy. However, a more realistic time frame is much longer than that, given the current dynamics of the office market. While there continues to be a flight to quality to Class A properties due to location, amenities and discounted rates, a bifurcation remains with varying performance among asset classes and submarkets. On an annual basis, Class A properties accounted for 65% of the total leasing activity in 2024, followed by 30% in Class B. Additionally, more than 62% of the leasing activity occurred in the Financial and South
Financial Districts, with both submarkets leading the recovery.
Sublease space, which has recently been a key catalyst for increasing vacancy and availability, decreased by 3% in 4Q 2024, dropping to under 8M SF for the first time since 2022. All told, sublease availability accounts for approximately 21% of the total available space on the market – significantly lower than the 40%+ in 2020, but still notable higher than the longer-term pre-covid average of 14%-15%. The drop can be attributed to both new leases occurring in 2024 as well
as tenants taking back some of their space to accommodate employees returning to the office.
While the investment market picked-up in 2024, volume and activity remain muted with a continuation of underperforming results. Total volume in 2024 was $660M compared to $596M in 2023 but $7.1B in 2019. In total, 41 transactions occurred in 2024 totaling 871,064 SF. The recent rate cuts may bring additional activity to the investment market, investors will be cautious about the recovery path of San Francisco, likely looking for opportunity and value.
ECONOMIC REVIEW
Economy uncertainty remains across the Bay Area, with lukewarm job growth, increasing unemployment and elevated interest rates. The unemployment rate for San Francisco County was 3.7% in November, a decrease compared to last quarter but a slight increase from one year ago. However, the labor force participation has declined versus the previous year, meaning total employment has fallen to a larger degree than unemployment figures suggest. Recent layoffs from the Technology-Information sector and the Professional-Business Services sector layoffs have driven the majority of job losses during the past year according to the California Employment Development Department.
Although inflation rates have recently stabilized, many expect core inflation to remain above the Fed’s target of 2% in 2025. With that said, the overall economic outlook is relatively positive for 2025 with many employers projected to hire during the first half of the year. A softening labor market coupled with inflation led the Federal Reserve down a path of rate cuts in 2024, while 2025 is expected to see additional interest rate cuts, but at a relatively slow rate with two cuts being the most likely scenario.
NEAR-TERM OUTLOOK
In early 2025, there will be a few trends worth monitoring. First, more and more companies are beginning to implement return to work mandates that are expected to revitalize most office markets across the country, including the Bay Area. While work from home and hybrid work policies will persist, there is expected to be a conscious shift to a more balanced workforce. If this trend continues to gain momentum and employees continue to fill office buildings, the office market will likely shift to recovery and growth mode sooner than expected. Additionally, the upcoming administration change will likely bring new policies impacting both the economy and commercial real estate – with potential tax breaks and a notable shift to a business-friendly environment that could spur future growth in the office market. Lastly, expansion in both the technology and AI sectors is expected to provide a spark for future tenant demand activity, while modest growth across all other sectors will likely assist in filling additional voids in vacancy.
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