San Francisco Office Subleasing Climbs But Bubble Talk is Premature

Swift Real Estate Partners Swift Real Estate Partners Fund II San Francisco Bay Area


By Neil Gonzales

Bay Area real estate has sustained a hot streak for a while now, so it is tempting to cry bubble at any sign that the market is headed toward a boom-and-bust scenario akin to the dot-com era at around the turn of the century.

The latest “sign” is a bump in the amount of office space available for sublease in San Francisco. But industry experts say the uptick actually reinforces the projection of a strong market continuing for the foreseeable future.

“This sublease trend could soften the market in a positive way, allowing for more stable long-term growth instead of the traditional boom-bust cycle,” said Amber Schiada, the research director for real estate services firm JLL’s Northern California and Rocky Mountain regions. “It’s probably a good thing that the market cares so much and is acting with caution despite high returns currently. The good news is that this time around the market seems obsessed with detecting and reacting to an emerging bubble.”

Sublease availability in San Francisco has been climbing the past 18 months as companies—much of them in the technology arena—have placed unneeded space out for rent. Sublease space in the city has reached 1.6 million square feet, an increase of 3 percent from early May, according to JLL.

In contrast, sublease space during the dot-com bubble quickly reached 8.5 million square feet at its peak, Schiada said, and “We’re not even close to that.”

Also, sublease vacancy represented just 1.4 percent of the overall office inventory, or about 20 percent of total vacancy in the first quarter of this year, according to JLL. In the third quarter of 2001, as a comparison, sublease vacancy made up nearly half of the total.

Among the larger spaces to have gone on sublease over the past several months are law firm Bingham McCutchen’s 98,000 square feet at 3 Embarcadero Center; cloud-computing giant Salesforce’s 96,000 square feet at 1 California St. and 71,000 square feet at 123 Mission St.; and mobile-payments company Square’s 49,000 square feet at 1455 Market St., according to JLL.

“The majority of the subleases are tech,” Schiada said, “but they are moving quickly.”

On average, she said, the subleases are on the market for 94 days as opposed to at least six months in the past. This indicates that tech firms, in particular, are expanding, trading or looking for other space.

Salesforce is a prime example of a company subleasing space because of expansion. The firm is subleasing “all the hodgepodge space it has,” Schiada said, as it prepares to move into its new headquarters at Salesforce Tower under way at Mission and Fremont streets.

Other companies are subleasing because they are banking space in case of future growth while wanting to draw rent from it in the meantime, she said.

In most cases, experts say, the current subleasing is tied to expansion and space banking. But other reasons for subleasing are consolidation, downsizing and relocation.

Financial services firm Charles Schwab, which last year announced plans to relocate a number of its San Francisco-based jobs out of state over time, is looking to sublease more than 300,000 square feet at 215 Fremont St. as it consolidates at another site in the city.

“Other companies are not expanding as quickly as anticipated or are shedding a bit of payroll,” real estate services firm Savills Studley said in its 2015 first quarter report for the San Francisco office market.

Savills Studley cited marketing-analytics company Rocket Fuel as an example of a company subleasing space while going through financial challenges. Rocket Fuel put about 49,000 square feet at 1455 Market for sublease after announcing losses of $21 million in the fourth quarter of last year and projecting more of the same in the first quarter of 2015.

If more companies start to downsize, move out of San Francisco or fail completely, Schiada said, “that would be a red flag for the market’s health. But we’re not seeing that play out.”

As a whole, today’s tech firms—a key driver behind the Bay Area’s surging economy—have solid business models and good balance sheets so a repeat of the dot-com collapse is unlikely, said Markus Shayeb, San Francisco-based senior vice president of tenant advisory for real estate services firm Transwestern.

Still, Shayeb predicts subleasing will continue to pick up over the next 18 months partly because of all the square footage expected to come on line for tech companies during that span.

These companies have preleased 3.2 million square feet currently under construction—not including Salesforce Tower, he said. That amount of space equates to about 25,000 jobs.

But Shayeb wonders how these companies will be able to fill that many positions by the end of 2016 when last year about 7,000 tech workers were hired in San Francisco, he said. Companies are also having a hard time hiring because of a tight talent pool.

“Growth expectations went overboard, so there’s going to be an adjustment,” he said. “Bigger chunks of [sublease] space will be coming onto the market.”

But that should not be the cause for concern as tenant demand remains rabid, investment capital is still flowing and innovation continues to evolve—factors indicating sustained market growth, he said.

“I wouldn’t push the alarm button,” Shayeb said. “It will be a soft landing than what we had” in the dot-com era.

That means skyrocketing rents easing up, he said, and other tech companies should then be able to afford to establish a presence in San Francisco.

“Increased space availability and less upward pressure on rents can provide some relief to the market right now,” Schiada added. “With nothing major hitting the market in terms of direct available space … the market could probably handle current sublease availability levels before becoming much of an issue.”

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