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4/06/22
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Market Drivers
The San Francisco Office Market is still turning the corner with a slow, but steady recovery. In 2021 we reported 5.5 msf of leasing activity which was on track to pre-pandemic levels. This quarter we are seeing leasing activity of almost 1.3 msf, which is more than double the amount reported in Q1 of last year. Year-over-year there has been an improvement, though activity seems to have slowed when compared to Q4 2021, which recorded 2.1 msf of leasing activity.
Q4 2021 seemed to be a turning point for the market, but we aren’t seeing the uptick in activity that was expected. Total vacancy rates are still high at 20.2%, 100 basis points (bps) up from Q4 2021, while sublease vacancy rates remained steady at 4.4%. Kidder Mathews is seeing an uptick in tenant prospects, yet it seems they are not quite ready to make the jump to return to the office.
Much of the vacancy in the office market is still coming from class B and C buildings, currently reporting 22.5% and 20.6% respectively. The “flight to quality” trend continues, with class A office enjoying a lower 18.4% total vacancy rate.
Sublease vacancy has remained steady and only dipped by 10 bps since the last quarter. Direct leasing activity dropped significantly to only 704.8k sf compared to last quarter’s 1.7 msf. That said, subleasing activity rose to 562.9k sf as compared to last quarter’s 344.8k sf. The sublease market is approaching pre-pandemic levels, which indicates some level of demand. Our read is that prospective tenants may still be wary of long-term leases due to the latest Omicron surge but would still like to have office space in the city.
Economic Overview
In January of 2022 the unemployment rate rose slightly to only 3.4% in San Francisco, 10bps higher than last quarter. The Bay Area’s labor market remains strong.
Hybrid work models are here as Salesforce, Google, Meta, and many more notable companies have announced their plans to return to the office. Most companies are opting to “phase-in” hybrid work in the coming months until both employees and employers are ready to return to full time offices. Some companies may be thinking of a full-time hybrid model moving forward; however, they are still in the planning phase to straighten out the logistics of how much office space they will actually need.
Inflation remains on the rise-which is putting even more pressure on our supply chain. This is directly causing the cost of raw materials used in construction to increase which may delay delivery times and build outs.
Near-Term Outlook
Some landlords are starting to propose greater than 3% annual rent increases, which we expect to become a larger trend as the year progresses due to their inflation expectations.
Tenant prospect outreach has been increasing which is a positive sign for future market growth. Kidder Mathews is seeing many tenants in the market searching for space, although typically for smaller suites under 10,000 SF. Quarter-over-quarter we have tracked a 23% increase of tenants in the market that are looking for office space under 10,000 SF. The uptick in demand for smaller spaces is something we haven’t seen before as companies plan to return to the office. This could also be indicative of new company formation increasing as venture capital funding soared last year specifically in the Bay Area. According to data from CB Insights, the SF Bay Area reported 101% growth year-over-year in venture capital funding.
Due to inflation and the strain on the supply chain, delivery times may be delayed further.
Market Highlights
• Sub-10k sf tenant activity on the rise
• Companies still figuring out hybrid work models
• Flight to quality continues and some landlords are investing in their buildings to capture that demand
Source: CoStar, KM Research Group
This report was prepared by Kidder Mathews Director of Research Gary Baragona
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