This is becoming the year of the large tech lease. Dropbox just leased the largest amount of space in San Francisco’s history weeks after Facebook said it would take up all of 181 Fremont’s office space. This year is becoming the most active leasing year since 2014, when activity reached 9.8M SF, according to a report from Cushman & Wakefield.
During Q3, leasing activity was 1.8M SF with year-to-date leasing activity reaching 5.6M SF. With tech companies pursuing blocks of 100K SF or more, competition will remain high and could push other companies out. Additional large space will likely be absorbed quickly. The market will have about 15 blocks of 100K SF or more through 2020, according to Cushman & Wakefield’s data.
Currently, existing and new tenants are looking for 5.5M SF in San Francisco. Of these tenants, 14 of are looking for at least 100K SF as either expansions or as part of a relocation, according to Cushman & Wakefield Regional Director, Northwest U.S. Research Robert Sammons.
Much of the new space is delivering pre-leased. Salesforce Tower and 350 Bush St. are expected to deliver during the fourth quarter, but well over half of this space has already been pre-leased. With many users in negotiations for the rest of the space, it is likely the buildings could deliver with full occupancy, according to Cushman & Wakefield.
Breaking Down The Numbers
Despite the large leases, net absorption was essentially flat during the quarter due to lack of large move-ins. Sammons said there will be a boom in net absorption next year when large offices begin their initial occupancies. Cushman & Wakefield measures net absorption at the time of move-in.
Asking rents increased to $70.51/SF in Q3 2017 compared to $69.21/SF in Q2 2016. Because data on asking rents does not includ e pre-leases for buildings under construction, Sammons said average asking rents could actually be $5/SF to $10/SF higher.
Vacancy is above 8% and could rise as more large developments deliver, but the high demand will temper any increases and push vacancy lower in the long term. Building large blocks of space will be more difficult in the near future, and Sammons said the market will butt up against Prop M allocations, which totaled about 2.1M SF as of early October.
The San Francisco Giants’ Mission Rock project and Forest City’s Pier 70 have both been approved and do not have to go through Prop M allocation to get building permits, but their office space will still come out of the allocation. Pier 70 alone could have up to 2.3M SF of commercial space once it delivers. This could push out any potential Central SoMa projects, Sammons said.
“Once we get to sub-5% vacancy rate and big blocks are gone, where are tenants going to look?” Sammons said. “There are some developments in the East Bay, but there are still only three or four truly big blocks in Oakland over the next two years.”
Tenants might start to look elsewhere and not necessarily in the Bay Area, he said. “It’s going to be a tight market for the next couple of years here, no doubt about it,” Sammons said.
What About The Little Guys?
While large tech tenants gobble up huge blocks, startups are finding plenty of small offices available. Smaller commodity space is providing options for startups and non-tech. While there are only 62 vacancies for space over 20K SF, there are over 600 active listings for space under 20K SF.
This amount of smaller space will provide some wiggle room for startups as they figure out their growth patterns, Sammons said. Sublease space also is going pretty fast as is built-up space with short terms left on the leases.
The biggest challenge for startups may be the cost of the Class-B space, and San Francisco demands the highest rents of any major metro for Class-B space, according to a report from CommercialCafé. Tenants paying $5K/month can receive 827 SF in San Francisco. Comparatively, that same rent in Manhattan will pay for 1,023 SF.
WeWork, which has been marketing itself to startups, also has been one of the most active tenants and is one of the top 10 tenants in San Francisco, according to Sammons. It leased 84K SF at 44 Montgomery from Beacon Capital Partners during Q3.
Instead of paying long-term expensive leases, startups and small companies can enter short-term leases for various types of spaces and expand as the company expands. WeWork’s well-located spaces have done really well, he said.
Startups all want to be near transit and are looking for space along Market Street in the Mid-Market and Financial District neighborhoods, according to Sammons.
“Startups want to be in the San Francisco urban environment and want to be around the big players, too,” he said.
Will The Future Still Be Full Of Tech?
Despite the challenging rents and diminishing availabilities, tech will maintain a stronghold in San Francisco for years to come. With many companies having some form of tech integrated into how they do business, Sammons said he expects tech to be a continued driver in San Francisco since the tech workforce is here.
“Those companies generally still want a presence in San Francisco because this is where the workers are,” Sammons said.
Transit issues and housing costs will continue to be problematic, but San Francisco and the East Bay are starting to get a handle on housing, he said.