San Francisco Workplace Market Turns into Nightmare, in Two Straightforward Steps. Step 1: Hogging Workplace House; Step 2: Working from Dwelling

Step 3: The economy… but that step hasn’t happened yet.

By Wolf Richter for WOLF STREET.

San Francisco was the hottest office market in the US in 2019, when the office vacancy rate was just 7.1%, as tech and social media companies and all kinds of startups piled on top of each other, renting office space they didn’t need and couldn’t use , to prepare for a future that would not come.

Now, Q1, 2023: The vacancy rate is 32.7%. According to Savills, almost a third of San Francisco’s office space was for rent, an all-time high. And all trends are going in the wrong direction. In the worst year of the dot-com bust, 2003, the vacancy rate reached 18%.

First quarter vacancy rates ranged from 28% in the South of Market Area (SOMA) to 55.4% in the Yerba Buena area.

Of the 86.6 million square feet (msf) of total office space, over 28 msf is vacant and on the market. This includes a record leasable area of ​​8.9 msf, up from 7.7 msf a year ago.

This type of aggregation of sublet space is gross. At that moment, companies like Meta realize they’ll never move into the spaces they rented years ago for a future that didn’t come, and then try to find a tenant for the remaining years of the lease to help out you bear the transport costs. They tend to undercut landlords who try to rent their own vacant space directly, as the goal of subletting is not profit but lowering operating costs.

Meta said in January that it plans to list its 435,000 sf office at 181 Fremont Street for subleases.

Salesforce, the city’s largest tech employer, put another 125,000 sf on the sublease market in March, this time in the Salesforce Tower, owned by Boston Properties. This brings Salesforce’s total sublease space to over 1 million sf.

I mean what were these people thinking when they rented this space? These big tech companies that think they’re going to grow forever have big real estate divisions run by highly paid executives with titles like VP of Global Real Estate whose job is building campuses and leasing offices, and they’ve done that, and that is what they end up with.

The first major defaults – because of the interest. PIMCO’s Columbia Property Trust defaulted on two downtown office towers: 201 California Street and 650 California Street. In the latter, Twitter rented the 30th floor and simply stopped paying rent after Musk acquired it, according to a lawsuit filed by Columbia in December. In theory, Twitter is on the hook for the lease until January 31, 2025.

One problem behind the default is the adjustable rate mortgage bond. Columbia completed the adjustable rate mortgage in December 2021. I mean, what were these people thinking? That was the time when inflation was spiking and the Fed was choking on QE and warning of rate hikes and these idiots who might have been holed up in the pivot trader camp threw out the Fed and got a 3% floating rate note and up By early 2023, it had doubled to 6%. OK, game over – this is where the talks begin.

The company said it was in talks with the lenders to restructure the mortgage. Lenders definitely don’t want the towers. Defaulting on the mortgage of office towers in this market is like putting a gun to your head. And they will talk.

But this time it’s not the economy yet, this shoe has yet to fall. This time the main drivers are two factors:

1. Confiscation of office space in the years leading up to 2019 to prepare for a future that would not come. As everyone ate up office space they didn’t need, an office shortage ensued, fueling the office shortage even further. Human brains are funny when it comes to hogging, as we learned during Spring 2020’s Empty Shelves episode.

2. Home office since the pandemic. Many San Francisco employers have embraced it fully, while others are desperate to hybridize some workers back into the office for a few days a week. But they realize they don’t need all the space they’ve hogged over the last few years.

Leasing activity fizzled out in the first quarter. Only 900,000 sf was leased compared to 1.5 msf in Q1 2022 and 2.5 msf in Q1 2019.

The largest transaction was Gap’s sale-leaseback of its Athletica headquarters. It sold the 162,000 sf building at 1 Harrison Street to Sobrato Organization for $80 million and leased it back for a year. So that didn’t take any office space off the market.

The third largest transaction was an extension by Bank of the West. This has not taken any office space off the market either.

The fourth-biggest deal was Reddit’s downscaling move: It’s moving out of its 78,000-square-foot Market St. office it subleased from Block and moving into a 47,000-square-foot space at 303 Second St. This move will create even more vacancy space on the market.

Average asking rents continued to fall. For Class A space, they dropped to $74.59 per square foot per year. This is about 16% down from the peak in 2019.

Price would normally solve demand problems by causing prices to fall until demand occurs. But with heavily leveraged commercial properties, landlords aren’t able to lower rents past a certain point because even if they could fill the building, landlords couldn’t pay the mortgage with lowered rents, and contract language could put them in default. And so they fall behind.

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