February 22, 2024

Roman Adler, executive managing editor, Newmark
For years, Cameron Love, a senior vice president with real estate firm Hughes Marino, found success in an office market that was notorious for being the country’s most expensive and — with a 4% vacancy rate pre-pandemic — was so incredibly tight that, by some standards, it bordered on unhealthy.
But the pandemic and remote work have made the market unhealthy for the opposite reason. Close to a quarter of the city’s office space sits vacant, among the worst in the country.
“From a demand perspective, we have the lowest overall appetite to take office space in the history of this market,” Love says. “San Francisco is in a new, hybrid reality.”

Some fear the office market will never be the the same. Which begs the question: Where does San Francisco’s downtown go from here, and what do we do with all that space?
“It seems like every time we take one step forward, we then take two steps back,” said real estate veteran Scott Harper, a senior vice president at Colliers.
Expiring leases
In the past two years, Covid-19 surges have delayed progress toward San Francisco’s recovery by preventing office workers from safely returning to downtown skyscrapers, but it’s become clear that a permanent remote workforce is a huge obstacle to the city’s economic recovery.
“San Francisco has been particularly hit hard because we’ve got 65% of office tenants in the technology sector, and those companies have for the most part done really well adapting to hybrid work faster than other industries,” said Love. “So little of the downtown working core lives a convenient distance from the office. It’s seemingly going to take a long time for the allure of the office to outweigh the loss of productivity caused by commuting in San Francisco.”
Though weekly office attendance has increased since January, just under 40% of the city’s office workers entered the physical office in mid-September, according to data gleaned from employee badge swipes. The city has projected that its office-based workforce will be remote 33% of the time on a permanent basis. The loss of in-person workers is expected to reduce the city’s business tax revenue by $64.6 million in 2022-2023 fiscal year.
That leaves much of the city’s downtown — in which close to 75% of the real estate is dedicated to office space — ailing.
Office vacancy is hovering at 22.4% and availability, which includes space that is occupied or under construction but could still be available, is nearing 30%. These measurements vary depending on the firms tracking office data, but they are generally expected to increase as many companies that have embraced remote work continue to “right size” their real estate to cut costs, particularly as leases expire naturally.
“We are entering a period of higher-than-normal lease turnover than we saw in 2020 and 2021, where we naturally have more leases expiring,” said Elizabeth Hart, a vice chairman at Newmark who has worked in the city’s real estate market for nearly two decades. “There’s no magic as to why that occurred, but it is true that there are more companies that are going to be making real estate decisions in the next 24 to 36 months than during the previous two years, especially because there were many companies that kicked the can down the road and took Band-Aid options to get through the pandemic.”
Based on the number of expiring leases as well as the amount of sublease and vacant space currently on the market, San Francisco Chief Economist Ted Egan described earlier this summer what has been dubbed the “Armageddon” scenario, in which the city’s office vacancy could double in some areas by 2024. Citing data from real estate firm JLL, Egan said that the city’s downtown is at risk of seeing vacancy reach 35% to 50% in certain areas, assuming that current market conditions continue.
According to this scenario — which market insiders caution is “unlikely,” as it is predicated on the assumption that no existing leases are renewed or new leases are signed— vacancy in the north and south Financial District would spike to 41.1% and 34.2%, respectively, by the end of 2024.
But it highlights a major concern: Upward of 2 million square feet currently on the sublease market will expire through the end of 2023 and more may hit the market, the firm says.
Data provided by Colliers shows that the north and south Financial District have the largest share of subleases, with 123 and 89 current listings, respectively, totaling a combined 3.7 million square feet. Derek Daniels, a Colliers research director in San Francisco, said about one-quarter of all subleases in the Financial District have remaining lease terms of less than two years and will “potentially become direct vacancy in the next 24 months.”
The above chart from Colliers shows vacancy rate and net absorption trends for San Francisco office space.
He added that vacancy in the area is expected to remain at “near historic highs until a more significant return-to-office trend emerges.”
The city’s overall sublease availability has remained at around 8 million square feet for the past year after peaking at nearly 10 million square feet in early 2021. Roughly half of all subleases removed from the market since May are the result of deals signing or tenants reoccupying their spaces, and about one-fourth have been removed as a result of subleases converting to direct, vacant space, according to Colliers.
Historical data shows that there is significantly more office space on the sublease market now than there was during the dot-com crash of the early 2000s.
Rents hold steady
Scott Harper, the senior vice president at Colliers, is the first to admit that the current market is the worst he’s seen in his 32-year-career. But while vacancy is up and absorption — or the amount of space that is being leased, or “absorbed,” by tenants — is negative, he said the market has remained relatively healthy from the standpoint of rental rates.
“You are still seeing landlords being able to capture really good rents for quality space,” said Harper, adding that landlords have become generous in giving concessions on tenant improvement costs and rent-free periods, but are holding out on lowering rents for quality spaces.
That leads to optimism from a landlord’s perspective, Harper said. He said many buildings in the city’s downtown are owned by large institutions, which are less likely to lower rents in order to maintain building valuations.
About 15.5% of the city’s total vacant space is direct space, meaning that there are a lot of offices that are currently empty but “are still being paid on,” said Alexander Quinn, director of research for Northern California for real estate services firm JLL. He added that landlords are not yet “compromised on making their debt payments.”
“For them, it makes sense to hold on ‘face rent,’ especially, and concede on things like free rent, on tenant improvements and on flexibility of terms,” he said.
When that will change depends on capital and debt balances, said Quinn. Landlords that have owned their buildings for a while and have not refinanced recently are generally among the cohort that can afford to cut rent.
“Obviously, the rental rate is going to be directly impacting future building value,” said Love, the tenant broker. “It impacts all the future renewals that landlords are negotiating on over the next two to three years, so the longer they can keep the rent high, they’re happy to bury other incentives in the deal.”
When more sublease space turns into direct vacancy as leases expire, “landlords will hurt a little more,” he said.
Flight to quality
Data provided by JLL paints a picture of a growing divide when it comes to the city’s office rents. And not all buildings are struggling equally.
Asking rents on average have dropped by about 15%, from $93 per square to $79 per square foot, since the last quarter of 2019 through the second quarter of 2022. Net effective rents — actual lease terms for signed deals — show a starker decline, by close to 27%, during that same time frame.
In the city’s most desirable real estate, however, a reversal of that trend is unfolding.
According to JLL, net effective rents for the city’s top 20 buildings, which represent about 13.3 million square feet of the San Francisco’s total office space, have increased by nearly 15%.
The above chart from Colliers show how Class A and trophy buildings with views and other high-end amenities are outpacing rents at Class B and C buildings.
At the top of San Francisco’s perhaps most iconic office skyscraper, the Transamerica Pyramid, sources say not one but multiple lease deals were closed at record asking rents this summer. According to sources, several unnamed, non-tech tenants agreed to pay north of $100 per square foot.
What’s unusual about this: Commercial rents across different classes of space have historically dropped in tandem with one another.
“We didn’t see as much of a bifurcation during the two previous recessions,” Quinn said. “Generally trophy buildings tend to hold up better, but they still saw rents drop. We haven’t seen that in this case. What we’ve seen so far is that the buildings that are of highest prominence have seen their rents go up, whereas rents have dropped in general, for the overall market.”
An overall “flight to quality” is typical during recessions, as office tenants are presented with opportunities to upgrade their spaces.
“In San Francisco, flight to quality not only means a slightly nicer building, but views,” said Tom McDonell, national leasing director for Shorenstein Properties, a top San Francisco landlord. “If you have nice views of the water, either east, north or south, those owners are still doing just fine.”
What is new during the current downturn is that tenants are not only paying less for more, but some are willing to pay “more for more,” said Roman Adler, an executive managing director at Newmark who represents landlords.
“Certainly the trophy segment of the market has performed remarkably well throughout Covid and rents in a lot of trophy buildings are now 20% and up from where they were pre-Covid,” Adler said.
At 101 California, a 48-story, 1.2 million-square-foot cylindrical tower owned by Texas developer Hines that landed the city’s largest new lease deal of 2021 when Chime took six floors in the building’s podium along with a private roof-top terrace, just over 200,000 square feet of office space was available in August.
Rents for most floors inside of the building have not budged from pre-pandemic rates, continuing to sit in the mid-$80s per square foot, according to market sources. The building’s upper floors are renting out for as much as $130-$135 per square foot.
Paul Paradis, senior managing director of Hines, knows why they are commanding top dollar.
“What’s happening is that tenants who are healthy and continue to need office space are focusing on newer buildings that are able to offer a good [environmental, social and governance] profile, a good indoor-outdoor experience, for obvious reasons, and exciting amenities and newness that will attract people back into work.”
Autodesk Inc. leased 117,000 square feet in a premium downtown San Francisco skyscraper in the summer of 2019 and spent the better part of two years customizing its space to the liking of its local employees.
The result: A carefully curated office with San Francisco themes, packed with a fully equipped gym, employee lounge and music room. The construction and engineering software company lowered capacity by 30% as a Covid-19 safeguard to justify opening a brand new space at a time when many Bay Area companies were cutting back on real estate.
But the doors to Autodesk’s new digs at 300 Mission St. shut permanently in January, just eight months after the space was first opened. That is because a solid majority of the company’s employees — 55%, according to Autodesk’s own calculations — balked at the idea of returning to in-person work, in spite of the alluring perks awaiting them.
Rather than force a return, Autodesk — a nearly four-decade-old company concerned with growing its Bay Area workforce — decided to listen, said Jenny Lum, the company’s director of global needs. The decision to shutter 300 Mission was “heartfelt” given the time and money invested, she said, but it is what made the most sense based on the feedback. The company took a $180 million charge related to terminating the Mission Street lease and others worldwide.
“We don’t think mandating employees, at least not at this point in time, is the highest priority for us,” Lum said, adding that the focus is on employee satisfaction and productivity.
In August, Autodesk made yet another head-turning move by ending its 30-year residency in Marin County. The company is now relocating its San Rafael headquarters to existing 284,000-square-foot office it occupies at One Market in San Francisco.
More than 500 employees have been reassigned to the new headquarters across the bay, but most won’t be coming in daily.
Prior to the pandemic, the company’s offices consisted of roughly 60% workstations and 40% collaboration areas. Now Autodesk is creating spaces with an “80% collaboration and social zone and a 20% focus zone,” per Lum. Between 20% and 30% of employees assigned to that office frequent Autodesk’s One Market office on a regular basis, numbers that double when the company hosts events targeted at increasing foot traffic.
Mobile tools have been added to the One Market office to allow employees to reserve workstations and conference rooms and locate their colleagues throughout the space. Lum said Autodesk has found inspiration in airport seating systems and lounges.
“You’ll see a lot of options and choices,” she said. “We know that when you’re at home, sometimes you’ll be at your desk, and sometimes you’re on your sofa. We want to offer the office as your second home, but at a premium, because our technology is not going to fail you.”
In the 17 years that Tony Zucker has represented tenants in San Francisco’s historically tight office market, he’s never seen a landlord offer to furnish an office for a tenant.
He’s also never seen a San Francisco owner grant a one-, two- or three-year term on a direct lease.
“Landlords would never agree to lease direct space for that short of a term, for brand new space,” said Zucker, of Dunhill Partners West.
Yet he cites a growing list of examples, including newly built space inside of an iconic downtown San Francisco office tower at 580 California St. available at a per-square-foot asking rate in the mid-$50s, with lease terms from one to three years.
“When you see the rents of direct space in that $45 to $60 per foot range, you’re seeing creative space that’s being marketed to compete with some of the other space that’s on the market — and that’s tech sublease space,” said Zucker, adding that he has seen asking rents for sublease spaces drop below $40 per square foot. “Direct space will sit and will be getting stale, unless rents drop drastically.”
Compared to previous recessions, asking rents have not yet fallen at a pace that reflects the state of the current market. However, leasing incentives increasingly offered by the city’s office landlords — from free rent to flexible terms on direct space — are an effort to compete with the city’s glut of sublease space and a striking departure from a pre-pandemic market in which demand for offices was so strong that its building owners generally set the tone in negotiations.
In September, a Financial District sublease for a creative, fully-furnished 12,000-square-foot space at 575 Market St. was available for $39 per square foot for a one-year term. In order to compete with such sublease offerings — which are generally “plug and play,” meaning fully furnished and ready to be occupied floors with terms under five years at below market rates — some San Francisco landlords are now sweetening the pot for direct deals, said Zucker.
Bonuses and incentives such as free rent, flexible terms and furnished spaces, have become firm signs that the market has flipped in favor of office tenants, bringing bargaining power for aspects of lease negotiations such as space build-outs.
In the end, it’s “all about cash flow,” Zucker said.
Brokers are also being courted in an attempt by landlords to drive business to their buildings.
“The brokerage fees have been increased by 50%,” said Zucker. “Typically, they were $2 per square foot — now you’re seeing $3 per square foot. You’re sometimes seeing $4 on some of these subleases.”
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