Office Sublease Space Might Be Peaking In The Bay Area, But Don't Relax Yet

Office vacancies and sublease availability in San Francisco are sitting at all-time highs, according to reports from CBRE and JLL. There are signs the sublease scales are starting to slowly tip back in the other direction, but it isn’t necessarily an indication of improvement in the market.

“Most of that sublease space has gone back to the landlords,” said Colin Yasukochi, executive director of CBRE Tech Insights Center.

Concessions are on the rise as landlords offer larger tenant improvement allowances, more free rent and creative lease structures to lure tenants that are in a prime position to pursue deals.  

The office pain has been most acute in Downtown San Francisco.

“[Vacancy is] the highest it has ever been in history in San Francisco, surpassing the dot-com bust,” Yasukochi said. “That hasn’t been the case in other parts of the Bay Area though, as they have all seen improvement.”

The total amount of available sublease space in the Bay Area declined slightly in the first quarter of this year, from 17M SF to 16.8M SF, according to CBRE, but the total available space increased by 7.6M SF year-over-year to 59.6M SF, putting the metro at 20.1% total availability in Q1 2022. For San Francisco, that number is even higher: 28.6% total vacancy, a whopping 23.8% increase over the quarter before. 

Notable new leases that helped to cushion the wave of vacancies in the city included Sephora’s new sublease at 350 Mission St., which accounted for more than 286K SF, and CBS Viacom’s 70K SF sublease at 680 Folsom St.

But those deals were the exception, not the rule. CBRE notes that San Francisco’s net absorption in Q1 2022 was negative 1.1M SF, which marks the ninth consecutive quarter of occupancy losses. Nearly half of that (negative 496K SF) was in the North Financial District. Occupancy was set back by a wave of construction completions in the city in 2021, several of which were delayed at the onset of the coronavirus pandemic, though the city saw no new completions in Q1 2022.

Though San Francisco has struggled, it has been the opposite for Silicon Valley, which Yasukochi attributes to the nature of the work being done.

“Hiring has continued heavily in those areas. Many of their products supported remote work and everything else, whether that was productivity, Zoom, social media, cloud computing.”

Despite this, Yasukochi is uncertain about the strength of the office market long-term. Remote work can take a lot of forms, including a hybrid model where the whole workforce might be in simultaneously, which could prevent companies from suddenly reducing their office space.

“A lot of this is still in the experimental phase. We don’t know the shape of this,” JLL Director of Research Alexander Quinn said.

To try to shift the odds in their favor, landlords and building owners in San Francisco have decided to get creative, offering increased incentives in the way of free rent, larger tenant improvement allowances and more incremental lease structures.

The spike in free rent — landlords are increasingly offering six months, Quinn said — is having a dramatic impact on rental rates. Face rent is down about 15% across the Bay Area office market, he said.

Quinn also notes that many owners are starting to allow larger companies to phase in occupancies over time, offering incremental increases to leased square footage year-over-year, rather than banking on new tenants to come in and fill the available space. 

“Plug-and-play” deals in San Francisco are also becoming more popular. Quinn said the longer-term deals in these ready-made spaces are coming with increases in tenant improvement allowances, averaging $85 per SF for deals over six years, but as high as $150 per SF in some cases. 

Quinn said he is optimistic that the vacancies plaguing the city will turn around, attributing much of the Q1 struggles to the omicron variant.

“We have seen a lot of headcount growth among specific companies. Some were hired during the pandemic and needed to figure out if they needed to accommodate space for them. They couldn’t do that earlier this year because of omicron,” he said. “We are starting to see a thawing of that, and though we aren’t at pre-pandemic levels, we are starting to see it.”