The Race to Dress Up Space

South of Market Mission Bay Mid-Market Salesforce Tower The Exchange on 16th Colton Commercial & Partners Adam Felson Bay Area

Empty concrete hall interior

By Adam Felson

[dropcap]S[/dropcap]an Francisco’s office environment is going through two trends that should be a call to action for landlords.

On one hand, downtown neighborhoods South of Market, Mission Bay, and Mid-Market are flooded with cranes to develop new office space in San Francisco’s growing economy. Over the course of the coming years, new projects such as 415 Mission (Salesforce Tower), 535 Mission, and 1800 Owens Street (The Exchange on 16th) will add millions of [feet of] new product for prospective tenants to choose from. The roster of new towers were green lighted after being fully pre-leased, partially pre-leased, or in some cases without any tenants signed up yet at all.

Meanwhile, dozens of big office users are shedding square footage by listing their premises on the sublease market. Some of these tenants include Twitter, Square, Morgan Lewis, and Rocket Fuel. As noted by Bloomberg Business, Charles Schwab “is subletting about 300,000 square feet as it combines its two San Francisco offices into one, while boosting staff in other states, including Colorado and Texas.” According to Amar Mann of the Bureau of Labor Statistics, the local tech industry job growth in January 2016 was about half of January 2015.

It’s only natural to consider the possibility that within the coming years, or even as soon as later this year, a market that once had a vacancy rate in the low single digits will trend in the opposite direction, with rents at highly discounted rates.

As we start to see a turn of the economic cycle with the number of tenants touring the market decrease and the amount of space for lease increase, landlords will need to change their attitudes towards how they deal with their vacant space. “When a market shifts towards becoming more favorable to tenants in terms of not just price, but available options, landlords will find themselves under extreme pressure to have their vacant space as plug and play as possible,” says Jay Shaffer, co-founder and partner of Colton Commercial & Partners.

With so much brand new Class A space coming to market in the coming year, counting on your building’s great location or beautiful architecture will clearly not be enough for empty floors to lease themselves. When supply is about to swell, it behooves building owners to make sure all of their available office space is excellent condition for touring. A landlord who is about to undergo a space prep project should keep a number of things in mind:

  1. Get started early. Waiting until spaces become vacant before taking action to improve them just results in lost rent in the future. On a project I was involved with over the past year, the demolition crew mobilized and began working the day after the space became available. This was made possible because several months before the lease expiration date our design team had developed permit drawings and we had on boarded a contractor after a thorough bid process.
  2. Clearly define goals and scope. It is best for the landlord, architect, brokers, and other stakeholders to collaborate to determine how much work is appropriate during the design process. If not everyone has the same expectations of the new product it is possible that the scope of work may end up changing midway through the project, therefore providing some costly backpedaling and delays.
  3. Survey before hammers swing. To minimize surprises, prior to the demolition starting, have your contractor conduct a series of field surveys to better understand the existing conditions above the ceiling system, wall details and the extent of hazardous materials you will be dealing with. This is especially valuable from properties in which as-built drawings can sometimes be limited.
  4. Don’t over do it. The game of speculative space prep is more of an art and than a science. When determining the scope of a space prep project, it is important to do enough work to allow for touring tenants to envision their company leasing the premises and for the cycle time of their tenant improvements to be minimized because much of the legwork has been taken care of for them. That said if a landlord does too much work, they run the risk of not just spending too much money, but potentially spending money on improvements that may not suit the needs of the future tenants. Years ago I did a speculative suite for a landlord client who insisted we install carpet to make the space completely ready for a future move-in. A tenant ended up signing a lease but hated the carpet, resulting in thousands of dollars down the drain.

When the market is red hot, some landlords may not be motivated to quickly improve vacant spaces when mobs of groups are knocking at the door begging for a tour. Conversely, at a time when supply and demand of San Francisco office space may be starting to equal out soon, the cream of the crop will be the first to be selected at the highest prices. A proactive approach towards investing in converting undesirable office space before waiting for the market to react to older product is wise in an environment where there is an increasing level of competition in the area.

Adam Felson leads Colton Commercial & Partners’ Project Management Division in San Francisco.

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