Bay Area Midsized Tenants Eye Suburbs As They Brace For Market Correction

As the Bay Area's small to midsized office tenants have contended with the region's rising costs in recent years, a number have drifted away from San Francisco, sometimes toward Sacramento or even out of state.

Now, with upheaval rearranging office markets, many such companies are putting off making large decisions altogether, Hughes Marino Senior Vice President Cale Miller said.

"I think there's going to be a fairly large market correction over the next six to 18 months, and all of our clients are for the most part putting off decision-making as much as possible, because they think the market is going to take a little while to correct, which we think, too," Miller said.

In S.F., for instance, a wait-and-see approach by midsized tenants started to manifest in Q1 this year. The city saw 25 new leases for between 10K and 75K SF signed in the opening quarter, compared to 43 such leases that time last year, according to Cushman & Wakefield Senior Director of Bay Area Research Robert Sammons.

With asking rents across the Bay Area still at or near all-time highs, and a return to the office not desperately needed, some companies are opting to wait for rents to fall more meaningfully before signing new leases, according to Miller, who works with large, publicly traded companies, early stage startups and companies in between. 

Such a fall has yet to occur in S.F., which finished May with an overall average asking rent of $84.65 per SF (up about 2.74% year-to-date), and likely won't occur until owners know where to reset them to later in the year, Sammons said. When rates do adjust, leasing activity will likely vary by submarket and market type, Sammons and Miller said.

Less stymied by reliance on mass transit, Bay Area suburban offices might pick up some steam as part of a trend experts see happening in other markets across the country. Concerned about sanitation, companies and their employees wanting back into the office may prefer a quick local drive to work, rather than taking crowded public transit into city centers.

“In the Bay Area, certainly, I think you may see this need or desire to have satellite offices in the suburbs, close to the employment base," Sammons said.

Compared to San Francisco proper, the Peninsula and Silicon Valley have seen more active leasing, possibly because those markets have low-rise and mid-rise product and parking.

Within those areas, submarkets like Redwood City and Mountain View are less likely to see rents fall in the way midsized tenants are waiting for, according to Miller. He said markets with similarly strong absorption at high rents in recent years already have much of their inventories already spoken for well into the decade. 

Based on past recessions, Miller said he expects a flight to quality to characterize office site selection for small to midsized tenants going forward. 

"They will look at shorter-term, fully furnished, fully fitted-out, low [capital expenditure] opportunities as being highly desirable," he said. 

All the while, Miller said he predicts the market correction he and midsized tenants are looking for will be about 20% this year and another 10% to 20% in 2021 and fueled in good part by sublease space becoming available.

By late March, S.F. metro area sublease space had jumped 28% year-to-date, Hughes Marino told Bisnow at the time, and that jump appears to be still present in the market and then some. As of this month, sublease space in the central business district specifically has now jumped about 56% year-to-date, according to data provided by Miller. 

“That space that’s going to come online is the relief valve that everyone has been talking about the market needing for quite some time," he said.