Got Leverage?
With the exception of premium view space, which is leasing at rates above pre-pandemic highs, many office owners in San Francisco are heading into a prolonged period when competition for tenants will be intense. There are several reasons, but let’s start with a few stats:
Total San Francisco Office Market: 85M sf
Currently Available: 23%, or ~19.5M sf
2020 Net Absorption: (10.6%) or (~9M sf)
2021 Net Absorption: (5.1%) or (~4.3M sf)
Q1 2022 Net Absorption: (1.8%) or (~1.5M sf)
Expiring Leases 2022, 2023 and 2024: 11.8% or 10M sf
Assume 70% expiry extension rate: Add 3M sf, or 3.5% to vacancy
Assume 60% expiry extension rate: Add 4M sf, or 4.7% to vacancy
Assume 50% expiry extension rate: Add 5M sf, or 5.9% to vacancy
Prolonged vacancy of 20% or higher will put considerable downward pressure on rental rates and result in greater concessions as landlords compete to fill vacancies. I believe vacancy will remain >20% for at least 3 more years.
Here's why: Firstly, the trend in net new occupiers coming to San Francisco is not positive. In fact, despite record payrolls, the workers aren't here. They either live in the region but don't work in an office, or they live in a different part of the country or world. Given the strong employee bias against being forced back to the office and the significant economic benefits of leaving San Francisco for a lower cost of living, it's hard to forecast a reversal in this trend. Secondly, as a byproduct of job migration outside the region and of remote and virtual-first workplace strategies, San Francisco office demand relating to expiring leases is closer to the 50% level. Lastly, we’re heading into a potential recession; or, at best, a period of economic headwind that is already resulting in reduced hiring.
The data tells a story. Market participants often endeavor to spin it, one way or the other, to protect or enhance their position. I think the facts speak for themselves. Of course, the future is unknown. But it's clear that mitigating the mounting supply of vacant space will require wholesale changes to the trends presently characterizing demand, changes that aren't easy to effectuate. For these reasons, we are seeing a rapid shift in the landlord/tenant leverage dynamic. We anticipate material gains in tenant leverage to accelerate over the coming months.