Report: Rental Rate Growth in San Francisco “Obliterating” Tenant Operating Budgets

San Francisco, Bay Area, Sony PlayStation, Autodesk, Glassdoor, Marin, Sausalito, GlassDoor, First Republic Bank, Paramount Group, Beacon Capital Partners

By Meghan Hall

The San Francisco office market is always active, but the second quarter of 2019 was hot by many broker accounts, thanks to numerous large leases and history-making transactions. However, office availability across all size ranges is low, according to a second quarter report released by Robert Larscheid, a Bay Area real estate advisor and tenant negotiator. In fact, office availability is so constrained, that only the firms that are at the top of their game are able to secure space.

“It’s been an 11 year, full-run real estate cycle that we’re in,” explained Larscheid. “City-wide vacancy is at its lowest it has been in several years, and it looks like it will continue to trend downwards. In 2009, a tenant could have three or four legitimate options outside of their building to create a negotiating platform for their tenancy. And that has basically fallen to the wayside.”

Office vacancy in San Francisco has dropped to 3.2 percent, states the report, down 100 basis points so far in 2019, and leasing activity city-wide came in at 1.7 million square feet. Currently, there are more than 20 tenants in the market looking to fulfill requirements of greater than 100,000 square feet. 

And, in the second quarter alone, numerous companies inked leases greater than 100,000 square feet, including Sony PlayStation, who took 130,000 square feet of space at 303 Second St., as well as Autodesk and Glassdoor, who leased 150,000 square feet and 120,000 square feet, respectively, at 50 Beale Street.

“There has been so much activity, it is hard to pick,” said Larscheid of his perspectives on some of the most significant leases this quarter. “I think a noticeable event was Autodesk deciding that their long-term future is not going to be in Marin; it’s going to be in San Francisco. And same with GlassDoor that has been in Sausalito. Those are two tenants that are in growth mode, and they are expanding their presence in San Francisco.”

According to Larscheid, an increasing number of companies founded and established outside of San Francisco are making the city their home base, as opposed to past cycles where companies founded there, simply stayed there. San Francisco-based First Republic Bank, however, expanded its presence its home city, leasing an additional 265,000 square feet at Paramount Group-owned One Front Street in May, bringing its total footprint in the building to 515,000 square feet. After selling its headquarters building at 650 Townsend to Beacon Capital Partners, Zynga leased back 185,000 square feet of space.

Other leases include Open Table’s 57,194 square foot lease at Post Montgomery Tower; the company is renting the fifth through seventh floors for $90.56 per square foot. Customer service management company Medallia is also growing in the city with 8,178 square foot lease at 575 Market, and is renting the 18th floor for $80.25 per square foot. Out of the leases signed this quarter, DLA Piper is paying the most for its space at 555 Mission Street in the South Financial District. The multinational law firm took 67,244 square feet on the 20th, 22nd and 24th floors of the building for $99.27 per square foot.

The quarter was also an active one from a capital markets perspective. The Sobrato Organization purchased 808 Brannan Street for $1,000 per square foot, or $60 million in all, according to Larscheid’s report. The two-story, 55,000 rentable square foot Class B building is currently 100 percent occupied by Pinterest. Juul Labs, which currently leases Pier 70, purchased 123 Mission Street for $397 million, for its new headquarters, while Paramount Group acquired the KPMG building located at 55 Second Street for $1,054 per square foot, or $408 million.

The cost of real estate, according to the report, is “obliterating” companies’ operating and commercial real estate budgets, eating away a higher portion of revenue than ever. 

“As rental rates have grown unfettered, many tenant operating budgets just can’t keep pace,” said Larscheid. “For most professional service firms, law firms and FIRE tenants, usually occupancy costs take up 10 percent of their revenue, and now it is as high as 30 or 40 percent. I think we’re hitting a point where firms are either going to have to split their business operations or look at something like coworking options and adapting to a new normal that way.”

So far, companies have adjusted by decreasing their office footprints as well as decreasing the number of square feet allocated per employee. In addition, tenants, engaging in leasing talks with landlords and developers far earlier in order to secure space for future growth, or even to simply keep their existing office. 

“It’s uncharted territory; I’ve never seen the market office at full capacity,” said Larscheid, who has thirty years in the business. “I think it should be noted that most San Francisco tenants that do not have an option to renew run the real risk of having their space leased out from under them. There are pre-leasing commitments for developments that haven’t even been approved, let alone broken ground.”

For tenants hoping to stay — and grow — in San Francisco, Larscheid recommends that companies begin planning for a lease renewal at least 18 to 24 months before the end of their lease to lock in cost certainty for future business initiatives. Larscheid expects that the competitive nature of the office market will continue, as currently no market correction is in sight.

“Real estate cycles don’t die of old age, they die of some event that nobody can anticipate,” said Larscheid. “Currently, these market forces will cause disruption for many business entities who just can no longer afford to stay in San Francisco.”

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