San Francisco Financial District: The Destination for Elite Tenants

High costs & low availability are driving value-focused firms out of the Financial District

Posted In — Market Research | Trend Article

San Francisco has seen very strong economic growth since the end of the recession, and continues to outpace virtually every other office real estate market in the country. The city’s Financial District, in particular, has been defined by very low availability of space and very high rent. Currently the average rent in the Financial District is $65 per square foot annually, which is 52% higher than its pre-recession peak and easily leads all other districts in San Francisco’s urban core. Rental rates in the Financial District have historically been and continue to remain high, despite the stagnation in rental rate growth since 2016.

Annual growth in rental rates exceeded 10% for each year from 2011 to 2015. Yet, by the end of 2016 growth in rental rates dropped to essentially zero, and two years later growth in rental rates are still relatively stagnant. As growth in rental rates flattened, the vacancy rate also rose nearly two hundred basis points from 2015-2017. The two main culprits for the recent relative stagnation in the Financial District are a lack of available supply, and the growing abundance of high quality office space in nearby submarkets and the East Bay.

The trend of low availability in the Financial District can be traced back to Proposition M, a 1986 ballot measure that limited office development that the city can approve to 950,000 square feet per year. The measure does allow the city to roll any square feet under the cap that were not approved over to the next year. More than thirty years later, there are upwards of 6 million square feet pending approval in the city, but by October the city will only be allowed to approve under 3 million square feet. The city’s Board of Supervisors is attempting to pass a new ordinance to bring more office inventory into the Financial District by allowing 1.3 million square feet of office space that was converted into residential space in the Financial District to be reconverted back to office property. The Financial District has been in high demand for decades which, taken together with the artificially low supply, caused rental rates to grow rapidly and led many tenants to exit the market.

Due to the high rental rates in the Financial District, nearby submarkets such as the South of Market (SOMA) district have increasingly become more popular among office tenants. SOMA is situated in the urban core of San Francisco, well served by public transportation, and depending on the submarket within SOMA, can offers rents that are on average $5-$10 cheaper per square foot than the Financial District. In 2016, LinkedIn and Bain & Co. decided to vacate a combined 205,000 square feet of office space in the Financial District, in favor of space in SOMA. Additionally, San Francisco’s Board of Supervisors recently passed the Central SOMA plan in a unanimous vote, which is projected to add 5.5 million square feet of office space. Following the rental rate growth of 2011-2015, some tenants opted to leave San Francisco entirely to occupy skyscrapers in Downtown Oakland where they can rent space at a roughly 25% discount relative to San Francisco’s urban core. Blue Shield preleased 200,000 square feet in the top stories of the 601 City Center high rise in 2017, which was one of the largest office leases in Oakland history and is expected to save the health insurance giant millions of dollars. Delta Dental also decided to downsize its presence in the Financial District from 188,000 square feet to 43,300 square feet by moving the headquarters from 100 First St. to 560 Mission St., while they significantly increased their presence in Oakland by leasing 82,000 square feet at 1333 Broadway.

While rental growth rates may have leveled off in the past three years, the Financial District remains the most expensive part of San Francisco’s urban core in which to procure office space. There have only been two major deliveries in over fifteen years in the Financial District, which were both developed by Lincoln Property. The first developed one of the few remaining vacant lots in this district, a 67,000 square foot building at 500 Pine St. in 2016, which is now fully leased to Blend Labs. The other delivered a 447,000 square foot tower at 350 Bush St. earlier this year, with Twitch preleasing half of the building, shortly followed by Atlassian and Publicis, which leased the rest of the building. Despite little new development, many building owners in the Financial District have performed tenant improvements to their properties in the range of $130-$150 per square foot to entice office tenants to relocate to their buildings. While many large established tech companies, financial institutions, and management consulting firms still covet the prestige of having offices in the Financial District, many other firms more focused on value are flocking to cheaper spaces in nearby submarkets.

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