By Meghan Hall
San Francisco continues to be a mecca for growing companies; its centrality, walkability and proximity to amenities and public transportation make it perhaps the most sought-after location in the Bay Area. Over the past several years the office market has become particularly constrained, with growing firms signing leases that will not begin for years into the future. According to CBRE’s fourth quarter San Francisco office report, while office leasing activity was moderate during the fourth quarter, the tight nature of the office market will continue to impact market fundamentals, with low vacancy rates and climbing rental prices expected in 2020.
“The fourth quarter, I would say, was maybe a little less exciting than the fourth quarter of 2018. In 2018, we saw a fair amount of deals and such,” explained CBRE’s Director of Research and Analysis, Lexi Russell. “The end of 2019 was really an elongated trend of what was happening throughout the year: high rents, low vacancy, companies just trying to find space—or maybe not finding it. As far as trends go in a tight market, all of the little fluctuations, move-ins or move-outs, or smaller deals, are going to start affecting those statistic numbers.”
Russell continued, “I think we’re reaching a high point, and it will be interesting to see what happens in 2020.”
The main driver of San Francisco’s office market has been its rapidly growing economy: According to a separate CBRE report released this month, San Francisco led the nation in office-using services job growth in 2019. In 2020, San Francisco is also to lead the nation in office-related job growth, only second to Austin, Texas.
Office-using service jobs, including those who are tech-related, are projected to grow 2.5 percent over the next year, bringing around 6,800 workers that would occupy 1.2 million square feet of space to the market.
Moving forward into the year ahead, Russell estimates that there are about 7 million worth of office requirements in the city of San Francisco. During Q4, transaction volume totaled more than 1 million square feet, including three leases over 100,000 square feet. Visa signed the largest deal of the quarter, taking 302,920 square feet at 1051 3rd Street. Latham & Watkins, a an international law firm, and tech firm Nextdoor each took 119,812 square feet and 115,766 square feet, respectively. The leases brought CBRE’s annual large transaction account to 16. However, the brokerage firm notes that many of the transactions were renewals or commitments to new construction projects.
“New construction availability has been really far out, which is where a lot of transactions have been, even over the course of 2019,” stated Russell. “A lot of large transactions were pre-leases for new construction that is now just getting underway rather than move-ins to exiting space. All new construction is preleased through 2022, depending on when FIDM delivers, so some of these companies are looking at occupancy out in ’23, which is crazy to think about.”
Of the top 25 leases of the quarter, 33 percent were tech tenants. The next largest chunk of the pie was occupied by financial institutions, who accounted for 31 percent of leases, while the legal sector took 20 percent. Real estate and advertising firms each accounted for four percent of the largest leases of the quarter, and those classified as “other” accounted for eight percent of the top 25 leases during Q4.
At the end of the year, vacancy throughout San Francisco dropped to 3.7 percent; Class A vacancy was even lower according to Russell, at around 2.5 percent. According to Russell, it would be difficult for vacancy to lower much more.
The city’s supply and demand imbalance has continued to push asking lease rates even higher, increasing rents by 0.6 percent year-over-year, with rent at the end of the year reaching $88.19 per square. Large blocks of space, for which are in the highest demand, see the largest increases; CBRE states that asking rents for blocks greater than 30,000 square feet have shifted from $80 to $89 per square foot in 2018 to between $90 and $99 per square foot by the end of 2019. And, in the past four years, more than 26.5 million square feet has been leased at or above $70 per square foot, which is more than five times the amount of space leased by tenants during the dot-com era. The square footage also represents one-third of the overall market.
Given that no supply relief is in sight, rental rates will continue to rise, and at levels that many analysts would not have predicted ten years ago, notes Russell.
“It has been, more or less, unprecedented growth over a long period of time, so it’s not something that I would have predicted,” said Russell, who has been in the San Francisco market for more than a decade. “I have been impressed to see not just how long this cycle has gone, but the employment growth and the industry growth and [what] the resiliency of the city [has been].”