MARKET DRIVERS
THE SAN FRANCISCO OFFICE MARKET saw premier Class A space continue to be in high demand in the second quarter, while most of the rest of the market remained stagnant. Quarter to date leasing activity totals 1.1M SF—roughly half the leasing activity year-over-year. Sales activity grew 275.2% year-over-year to 409,504 SF which indicates some level of demand despite the slowdown in recent leasing activity.
MANY FIRMS are continuing to rebalance their office footprint amidst the rise in hybrid work models. Typical tenants are looking to right-size while taking, at most, as much square footage as they had pre-COVID, with many leasing less space than before—anywhere from 20-30% less space on average as compared to 2 years ago. This is resulting in another quarter of negative net absorption of 809,714 SF. Quarter-over-quarter the total net absorption dropped slightly from negative 984,616 SF, while year-over-year negative net absorption roughly doubled.
“RIGHT-SIZING” of space has resulted in an uptick of 80 basis points (bps) in the overall vacancy rate to 20.9%. Most of the vacancies are in Class B and C buildings reporting a direct vacancy rate of 18.7% and 17.8% respectively. The direct vacancy rate for Class A offices is only 14.8% supporting the continuing trend of flight to quality. Availability of premier Class A offices with water views remains tight, reporting asking rates above $100/SF for some of the best suites in the city. Commodity, middle of the road spaces in Class A offices are struggling to find tenants, even with rates in the mid $50s to $70s per square foot. Class A buildings are reporting an average direct asking lease rate of $68.74 per square foot full service and Class B buildings are reporting $54.55 per square foot full service. Sublease vacancy rates are 4.4%, 90 bps lower year-over-year and steady quarter-over-quarter, demonstrating the continuing relative attractiveness of shorter term, typically plug & play suites.
THERE IS 819,920 SF OF OFFICE SPACE currently under construction. The largest project is Mission Rock buildings B and G totaling 613,952 SF slated for delivery in Q3 2022. Due to continuing supply chain issues and rising inflation, construction costs have increased, delaying projects even further.
ECONOMIC REVIEW
THIS APRIL, San Francisco’s unemployment rate dropped to 2.2%, 130 bps lower than the start of the year. Despite the recent news of some San Francisco based companies laying off their staff, the labor market remains very strong.
THE ONGOING COVID PANDEMIC AND RISE IN INFLATION has continued to strain the supply chain directly causing the cost of raw materials used in construction to increase, further delaying delivery times and tenant improvement projects. Landlords that can provide significant TI dollars will be able to charge rents much closer to their initial asking rate to offset the cost of construction.
NEAR-TERM OUTLOOK
SAN FRANCISCO is showing some flickers of life, as Bay Area Rapid Transit has reported a steady increase in ridership since the start of 2022. BART reported a monthly ridership of 3,543,655 in May of 2022, up 5% from April. Even though this is only 36% of expected monthly ridership from pre-COVID, the increase in ridership is promising for the future of San Francisco.
DESPITE THE 20.9% VACANCY RATE, companies that are rightsizing are driving the demand for top-shelf Class A offices, creating a competitive market for these premier spaces. With COVID’s impact diminishing (at least for now), touring activity has picked up as many prospective tenants are looking at more open-office creative spaces instead of the more traditional office floor plans.
RECENTLY UBS Asset Management’s 455 Market St, a 374,200 Class A Office building came to the market for the first time. When the sale of this property occurs, the pricing should gauge demand for office building investment sales in this new post-COVID market.
Click here to subscribe to Kidder Mathews market research.