Right-Sizing Tech Sector Contributes to San Francisco Office Market Slowdown According to Q4 2016 Savills Studley Report

Tenants leased less than 6.6 msf in during 2016, the weakest annual total since 2009

“Despite a flurry of leases to end the year, 2016 was the weakest year for transaction activity since 2009. Tenants continue to focus their attention on quality built sublet space. Anemic demand and a deep pool of sublet space has finally brought rental rate growth to a halt.” – Colin Scanlon, Research Manager

Report highlights include:

Tenants leased less than 6.6 million square feet in San Francisco during 2016, the weakest annual total since 2009. Rightsizing has once again come to the tech sector, overtaking the rapid expansion phase of this cycle which had prevailed for several years.

More businesses have kept their headcount flat, while a few have had to shut down operations entirely. Layoffs are being announced, not just at smaller startups, but at some larger firms as well. Twitter’s 9.0% headcount reduction and shutdown of Vine dominated headlines, but Cisco, Intel and Yahoo also made big cuts. Some companies remain in expansion mode but they are no longer the dominant driver.

Landlords are increasingly looking at prospective tenants’ credit and are requiring larger security deposits for less established firms.

The sublease market dominated leasing in 2016, and the second half in particular. Overall, subleasing accounted for roughly 35% of yearly leasing, and over 50% of activity in the second half. Counterintuitively, this is not due to a discount on sublease space, rather the ability to acquire pre-built facilities for shorter terms than landlords are willing to offer. As a result, shorter term turnkey subleases are being priced at direct rates.

Tenants are wary of coming out of pocket as much as $140 to build out space, so the appeal of built space is understandable. Landlords have been forced to up their tenant improvement allowances, sometimes to more than $85.00/sf to compete with either the renewal option or a sublet play.

The availability of sublet space is clearly hampering the efforts of landlords trying to lease newly constructed space. During the hypertrophied growth phase, which prevailed as recently as late 2015, tenants were grabbing new product almost as soon as plans were unveiled. In the last five quarters, movement on this space has been anemic. Currently there is 4.1 million square feet of new office product under construction—nearly triple the historical average—and only 34% has been preleased.

Key statistics:

ANEMIC YEAR OF LEASING
Several significant leases boosted quarterly activity. Nevertheless, tenants have only leased 5.3 msf in 2016, falling well short of the long-term annual average of 8.0 msf.

VACANCY UP FROM A YEAR AGO
Following two consecutive quarters with an increase in vacancy, San Francisco’s overall vacant availability rate fell by 30 basis points to 8.7%. The Class A availability rate dropped below 10.0%, to 9.8%, a 60 basis point quarter-on-quarter decrease. Even so, the overall and Class rate have increased by 70 basis points and 130 basis points respectively from year-end 2015.

RENTS FLAT
Overall asking rent inched down by 0.6% to $64.80, but rose by 1.4% year-on-year. The average Class A rent jumped by 1.2% quarter-on-quarter to $67.53 and rose by 2.4% year-on-year.

SALES UP FROM A YEAR AGO
Sales during 2016 increased 17.2% over 2015, totaling $5.2 billion in 2016 compared to $4.5 billion in 2015.

To view the full report, please click here.

West Coast Commercial Real Estate News