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San Francisco Office Market Still Struggling to Gain Traction

11/04/22

San Francisco Office Market - 3rd Quarter 2022 Review

This report provided by real estate services form Kidder Mathews

Market Drivers

After another consecutive quarter of negative net absorption, the San Francisco Office market continues the trend of “flight to quality”. With many employees still cautious and/ or reluctant to brave public transit or traffic (and the resulting financial and time costs), tenants must make difficult decisions in terms of their leases. Whether that’s finding premier Class A office space to incentivize staff to return to the office, “right-sizing” by subleasing some of their existing space to accommodate this new normal, or looking for shorter term leases to stay nimble, current and prospective tenants need to think ahead more than ever before. This uncertainty led to negative net absorption of 1.4 msf. Quarter-over-quarter the total net absorption grew from negative 849.8k sf, as San Francisco is still very much in recovery. Fortunately, year-to-date leasing activity is sitting at 4.61 msf, which already has surpassed 2020’s leasing activity of 3.73 msf.

Quarter to date leasing activity totals 736k sf, roughly a 65% decrease from this time last year (2.13 msf). Direct vacancy rose slightly quarter-over-quarter to 17.1%, but sublease vacancy increased by 60 basis points (bps) to 5%. While this only slightly raised San Francisco’s vacancy rate to 22.1%, most of the vacancies are in Class B and C buildings, which are reporting a direct vacancy rate of 18.2% and 18.7% respectively. The direct vacancy rate for Class A is only 16.1%, supporting the continuing trend of flight to quality. Throughout the market, Class A buildings are reporting an average direct asking lease rate of $68.46 per square foot full service and Class B buildings are reporting $54.53 per square foot full service.

There is 1.16 msf of office space currently under construction. The largest project is Mission Rock building B, consisting of 314k sf slated for delivery in Q4 2022. Due to continuing supply chain issues and rising inflation, construction costs have increased, delaying projects even further.

Economic Review

This July, San Francisco’s unemployment rate dropped to 2.1%, only 10 bps lower than what was reported in April. Despite recession concerns, the labor market remains incredibly strong.

Throughout 2022, inflation has been on the rise leading to several interest rate hikes. Most recently, the Federal Reserve approved its third consecutive 75 bps interest rate increase to combat inflation. The rise in inflation continues to strain the supply chain causing the cost of raw materials used in construction to increase, further delaying delivery times and tenant improvement projects.

Near-Term Outlook

San Francisco remains in recovery two and a half years after the start of the pandemic, but continues to show signs of growth throughout 2022. Kastle Systems, a company that tracks occupancy for buildings, reported in mid-September that the San Francisco metro has a weekly occupancy rate of 40.7%, up 2.3% from the previous week. In early June, Kastle reported only 34% for the San Francisco metro. While leasing activity is not at the heights of the pre-COVID era, San Francisco is on track to surpass or at least maintain a similar level of activity as 2021. Throughout 2022 San Francisco has seen some of the largest lease transactions the city has had since March 2020, including Wells Fargo’s renewal of 622.4k sf at 333 Market St. On the other hand, in July, Salesforce put roughly 350k sf of office space on the market at 50 Fremont (a building the company owns) for lease, so the near-term outlook remains mixed.





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