MARKET DRIVERS
THE SAN FRANCISCO OFFICE MARKET continues its sluggish recovery from COVID-19, reporting
its sixth consecutive quarter of negative net absorption. The city has not reported positive net
absorption since 3Q 2021 as firms continue to assess their current office needs. As a result
of most companies deciding they need less space, the first quarter totaled 1.3 million SF of
negative net absorption. Surprisingly, the sublease market reported 302,301 SF of positive net
absorption, indicating a level of activity that hasn’t been seen since the start of 2022—the last
time sublease absorption rates were positive. The quarter-over-quarter negative absorption
rate remained steady and has only declined slightly year-over-year from negative 989,183 SF.
LEASING ACTIVITY totaled 862,575 SF in 1Q 2023, roughly a 44% decrease from this time last
year (1.5 million SF). The majority of the market’s leasing activity throughout the quarter was
from Class A offices, demonstrating the continuing “flight to quality” trend. Direct vacancy
continues to grow, reporting 19.9%, an increase of 160 basis points (bps) quarter-overquarter
and a 33.6% increase from 14.9% in 1Q 2022. Sublease vacancy decreased by 30 bps
quarter-over-quarter to 5%. Class A office buildings are reporting a direct vacancy rate of
18.7%, slightly lower than their Class B and C counterparts. Class B and C offices have a direct
vacancy rate of 21.4% and 21.8% respectively. Throughout the market, average asking rates
continue to decline and currently sit at $54.35/sf full service. Despite the overall reduction
in rental rates, premier Class A offices with views and desirable in-building amenities are
highly competitive and have asking rates well over $100/sf full service.
ECONOMIC REVIEW
THE SAN FRANCISCO OFFICE MARKET throughout San Francisco ticked up to 2.9% in February from 2% in December of 2022. This figure is 10 bps lower year-over-year, supporting a healthy labor market. That said, it remains to be seen how the unemployment rate will be affected in future quarters by additional tech industry layoffs. Recently Meta announced another 10,000 employees will be laid off—totaling 21,000 total layoffs since November 2022. Other firms announcing layoffs which may affect the region include Twilio, Zoom, and Google, among others. While recession concerns are the primary driving factor to cost cutting, many of these firms are returning to their pre-Covid employment levels after expanding throughout the pandemic.
SILICON VALLEY BANK’S recent collapse is another major hurdle in the region’s road to recovery. This failure coupled with anticipation of a recession is driving demand for office space down even further and will hinder start-up formation and growth—a cornerstone of the region’s historical success. Interest rates continue to rise, further slowing down investment sale activity throughout the year, as well as lending in general.
NEAR-TERM OUTLOOK
HYBRID AND WORK FROM HOME MODELS are continuing to put a strain on the demand for office space, particularly with tech-based tenants. Many companies are assessing their need for office space and navigating current economic uncertainty. This is felt across the market as firms continue to shed space and “right-size” into less space than they previously occupied. Recently, Reddit announced it will vacate its Mid-Market headquarters and take less space than their current 78,000 SF lease. Reddit’s decision to reduce their office footprint comes from their flexible-work policy. Other firms that have recently shed space include DocuSign, Pinterest, Yelp, and others. On the other hand, the uptick in layoffs may lead to a stronger push from employers to return to the office.
NEWLY PROPOSED LEGISLATION from Mayor London Breed may generate serious discussions about office conversions to residential and other uses. The new legislation aims to provide more flexibility and incentives for conversions in commercially zoned areas. This could revitalize San Francisco’s downtown leading to a more robust market, though given the physical difficulties of office conversion and high construction costs, this will not be a short-term solution.
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