A Market Divided: Cresa Research Shows a Tenants’ Market in San Francisco

Cresa, San Francisco, Bay Area, Salesforce Tower, Boston Properties, Transamerica Pyramid
Natalie Chaney

By Kate Snyder

Nearly three years after the pandemic began, and nearly two years since the first COVID-19 vaccines were available, San Francisco’s office market is still contending with the effects of a post-lockdown world. Namely, according to research by Cresa, a global real estate firm, that the rise of remote work has contributed to what is essentially a tenants’ market and that until landlords start considering lower rental rates and increased economic concessions, tenants are not going to want to sign leases.

“The market fundamentals of today’s market just really don’t support where the landlords are trying to transact at, and it’s really just kind of paralyzing the market,” said Andrew McShea, who oversees research & analytics for the Bay Area at Cresa. 

According to the report by Cresa, leasing activity to date remains 50.2 percent below 2019 levels during the same timeframe, and in the last year, 3.6 million square feet of direct space has been added to landlords’ availability, including 2.6 million square feet added since February.

The current in-demand office spaces are trophy assets, such as the Salesforce Tower, the tallest building in San Francisco, which is owned by Boston Properties, or the Transamerica Pyramid, the second tallest building in the city. Although those types of buildings are about 95 percent leased on average, McShea said they also only make up about 10 percent of the market, so when some landlords lean on trophy assets as a metric for leasing success, while it’s not a lie, it’s also not necessarily the whole story.

Janna Luce, Cresa managing principal in San Francisco, said while the report’s data is citywide, much of the office space in their market is in the city’s Financial District. And the vast majority of office space is either Class A or Class B buildings, which aren’t seeing the same kind of leasing activity that trophy assets are experiencing. In contrast to a normal eight or 10 percent, more than 30 percent of the market is currently available, including all the subleasing space, the report shows, and most of that is for Class A and B properties, which are approximately 83.8 percent and 82.7 percent leased, respectively.

“The trophy assets, which are just over 10 percent of the market, the rents are doing really well,” Luce said. “Doing great, in that area, from the landlord’s perspective. They have maintained and exceeded the 2019 rent levels they were achieving. Their occupancy is pretty good in those buildings and so there’s nothing inaccurate about what landlords are saying with respect to that little segment of the market that they control. And then 90 percent of the market is all the other Class A and B buildings, and that’s where the vacancy is very high.”

Technology companies have also been some of the major drivers in continuing to offer remote work, McShea said, because those businesses have the infrastructure and workforce in place to handle that kind of operation. Because San Francisco is home to many large tech companies – tech companies make up approximately 40 percent of non-government tenants – it drives the office market availability even higher.

“You’re seeing a ton of tech companies say, ‘Hey, we’re going remote first,’” McShea said. “So if you’re going to end up being remote first, then the real estate footprint that translates from that is likely going to be much smaller because you’re going to have a whole section of your workforce now that would rather just work from home and you may not need to house as many workers in your workplace.”

The report argues that while remote and hybrid work is here to stay, in-office work will likely gradually increase even as companies renew leases for less square footage and continue adding space to the sublease market “as they aim to right-size.” The report goes on to state that negative absorption will likely continue into 2023 and 2024. However, the blow from right-sizing will likely be offset, in part, by new startups taking advantage of low sublease rates and new tenants entering the market. Luce said there’s an opportunity now for entrepreneurs of smaller businesses and startups to help restart the business cycle.

“Until the landlords realize that a lower rental rate and then increasing concessions in order to encourage those tenants to sign new leases – meaning concessions are things in the form of tenant improvement allowances, a rent abatement period, other economic motivations in order to sign this lease – until those change, tenants are not wanting to sign up for these leases, and it’s causing a lot of tenants to sit on the sideline,” Luce said.  “Which exacerbates the situation of the market. And then once we can finally get a tenant and a landlord to agree on what fair value is in lease terms, then we can start doing transactions again. But right now from our perspective, it’s just difficult to get anyone interested in leasing space when they don’t feel they’re getting a fair transaction.”

West Coast Commercial Real Estate News