Tenants Increasingly Choosing to Pre-Lease Unentitled Developments to Secure San Francisco Office Space

Calvera Partners, Bay Area, Multifamily Transformation Fund,

By Bekka Wiedenmeyer

The struggle for tenants seeking space in San Francisco continues as Q1 is now at a close, with companies making dramatic moves to leverage their demand in a market that simply can’t keep up the supply. While numbers for companies seeking blocks 20,000 square feet and more remained steady in Q1, the ratio of companies looking for leases of 100,000 square feet and more to the amount of large block spaces available continues to weigh heavily in favor of limited leasing supply. Q1 office market research reports released by commercial real estate advisory firms JLL and Newmark Knight Frank show that in an increasingly constrained market, tenants are making unconventional moves to secure large blocks of space by pre-leasing properties even before they have received Proposition M allocations from the city.

“Preleasing an unentitled development is shocking, not just in San Francisco but in any real estate market,” said Ada Wong, senior research analyst at JLL. “The Salesforce/Hines deal was the first time it has ever happened in San Francisco.

Demand continues to rise across the board. According to JLL’s Q1 2019 San Francisco Office Leasing Report, demand for leases 20,000 square feet and more remained strong with 24 transactions totalling 2,118,951 square feet, with YTD net absorption forecasted to rise 694,993 square feet. Tom Doupe, vice president of office leasing at JLL, said the most dramatic increase in activity can be seen in the 30,000 square feet and more margin. Activity in the 100,000 square feet and more margin has been strong, as well, despite the lack of available space. Newmark Knight Frank’s Q1 2019 San Francisco Office Market Research revealed five tenants had successfully signed leases greater than 100,000 square feet, including Asana, Slack and Google.

“We’ve seen back-to-back record years for the number of deals greater than 100,000 RSF and Q1’s activity in this size range gives us hope that we’ll see a three-peat,” Doupe said.

Wong suggested there may be a decrease in the number of transactions going into the next quarter in the 100,000 square feet and more margin, partially because there is not enough space to fulfill the demand. That isn’t stopping tenants from pursuing large blocks of space, however, and one such way they are looking to secure those spaces is through pre-leasing speculative projects that have yet to receive Proposition M allocations from the city, which caps new office space approvals at 875,000 square feet a year.

“The lack of supply in the 100,000 RSF and above has caused tenants in the market to get creative, even go as far as pre-leasing unentitled developments in the city,” Doupe said.

Notable companies playing the waiting game are Salesforce in Q4 2018 and most recently Pinterest in Q1 2019, which has secured 490,000 square feet of space at 88 Bluxome St. In fact, according to numbers released by the San Francisco Planning Department, pending large allocation projects (50,000 square feet or more space) account for 8,906,165 gross square feet in the pipeline, and space for allocation by the city currently hovers at 2,892,466 gross square feet. In addition, 590,355 gross square feet of projects are in the pre-application stage. While Proposition M allocations are on the near horizon, it’s unknown who will receive those entitlements, according to Andrea Arata, director of research at Newmark Knight Frank’s San Francisco office.

“Right now the city is about to distribute a bunch of Proposition M allocations, but we don’t know where those are going,” Arata said. “There’s lots of rumors but no one’s sure who’s going to get what and where.”

Doupe said even as available space in San Francisco continues to shrink, companies also face the challenge of a highly competitive market where some landlords are holding out large blocks of space to lease to businesses that can take out the whole block. While many businesses look to expand their footprint under one existing roof by leasing entire floors, a lot of companies don’t have the bandwidth.

“For instance, if a landlord has a 50,000 square foot block of contiguous space or larger, they will likely hold out for a tenant who will take the entire balance of the space even though there is a tenant who wants to lease 30,000 RSF of it,” Doupe said. “No doubt vacancy is low and opportunities are slim, but in a lot of ways this trend creates an artificial scarcity for tenants in that 20,000 – 30,000 RSF size range.

That hasn’t waned tenant interest in San Francisco, however. Though a few companies have looked to places such as Oakland or South Bay to expand, the primary goal for many is to be in San Francisco.

“There are several companies that say they need to have a presence in San Francisco,” Doupe said.

While the experts forecast rising demand and rent prices, and as always an ever diminishing amount of available space, Wong said the one thing on everyone’s minds is who will receive the Proposition M allocations. Determining which spaces are entitled by the city will also determine which developments will be able to break ground and eventually house the company whose bold moves are going to pay off.

“With the existing available supply so constrained, everyone is focused on future developments and when they are going to break ground,” Wong said. “Companies are expanding so rapidly in San Francisco that it’s sort of a game focused around delivery. Tenants are eager to secure space and they’re eager to expand their presence in San Francisco, but the existing supply of big blocks is so constrained. As a result, tenants looking for large blocks are keeping their eye on upcoming developments.”

West Coast Commercial Real Estate News