By Meghan Hall
The impact of COVID-19 only began to take full effect at the end of the first quarter of this year. However, in just a short amount of time, office activity within the city of San Francisco has largely ground to a halt, with signs of softening very likely to continue into the second quarter, according to a recent report released by Savills Research. Released at the end of the first quarter, the report outlines that even prior to COVID-19, the San Francisco office market was showing some signs of a slowdown, which has only evolved more rapidly in light of the recent pandemic.
San Francisco was one of the first cities to take measures in an effort to slow the pandemic, efforts which in turn shut down the physical operations of many businesses as the city’s state of emergency and shelter-in-place orders took effect. Prior to those measures, however, Savills notes that overall market availability increased 160 basis points over the quarter to 11.2 percent. Class A availability also rose 190 points to an even 10 percent over the same period of time. By comparison, the first quarter of 2019 saw an overall availability rate of 7.7 percent. Across the board, however, asking rates for office space did increase: Overall rents rose by 2.2 percent quarterly to $83.50 per square foot, while Class A rents inched up to $88.78 per square foot.
Nevertheless, Savills expects the impacts of COVID-19, which are only just emerging, to be profound. “In February, the city declared a state of emergency and by mid-March was one of the first major metro areas to institute a shelter-in-place order, bringing much business to a halt,” Savills explains in the report. “Market impact will be significant, and the severity is dependent on how long current circumstances extend.”
According to Savills, the rise in availabilities is largely due to the amount of sublease space that has “flooded” the San Francisco office market over the course of the past several months. As of the report’s writing, there was 3.7 million square feet of sublease space on the market, an increase of more than 300 percent when compared with the previous year.
“The rise comes as companies either look to reserve space for future growth, shed space as they downsize, or to move out of the city in search of cheaper rents,” Savills said. “As organizations reevaluate workforce needs in light of the evolving circumstances, it is likely that sublease availability will increase further – placing downward pressure on overall asking rents.”
Further compression of rental rates is likely as leasing activity overall had slowed to its lowest levels in more than two years. Just under 1.6 million square feet of space was leased during Q1, the lowest quarterly total since mid-2017. At the beginning of 2019, quarterly leasing activity totaled 2.7 million square feet.
These factors, explained Savills, are already putting pressure on the city’s landlords to increase concessions such as tenant improvement allowances and free rent, especially as additional sublease space is expected to come to market. By comparison, Class A rents in San Francisco declined by 8.5 percent from 2008 to 2009 during The Great Recession, while concessions increased 37.8 percent, combining TI allowances and free rent.
Despite these factors, there were still several larger leases that were signed during the first quarter of 2020. The largest, which included both a renewal and expansion, was Deloitte, who solidified its commitment to 229,000 square feet at 555 Mission Street in the South Financial District. The next largest new deal was Knotel’s decision to take 82,830 square feet at 301 Brannan Street in the Rincon/South Beach neighborhoods. Skillz, a competitive mobile games company, followed behind Knotel, taking 51,684 square feet at 505 Howard, also in the South Financial District.
According to Savills, eight of 10 of the quarters major transactions were for new locations, and 70 percent occurred in San Francisco’s South Financial District. Overall, technology tenants accounted for 45 percent of major transactions.
In the future, Savills predicts the San Francisco office market will continue to slow as sublease space continues to increase and general pullback in demand will cause rents to plateau. Tenants, as a result, can expect increased flexibility in term conditions, while landlords will feel continued pressure to up concessions in a bid to remain competitive.
As of this writing, Savills had not yet returned The Registry’s request for comment.