'A New Era': San Francisco's Office Prices May Have Hit Bottom

Positive momentum from local and out-of-state investors in San Francisco’s office investment market over at least nine months has helped reset pricing and inspired newfound hope in the beleaguered property sector.

But a glut of unoccupied office space means the local office market is not quite out of the woods.

Transaction activity began to thaw in late 2023 and gained momentum in Q1 2024, JLL wrote in a Q1 San Francisco office market report. Five buildings in Downtown San Francisco are on the market, and two buildings are scheduled to close in the next two months.

There have been a few deeply discounted office-building transactions in recent weeks, primarily for lower classes of space, including 995 Market St. which sold for about $72 per SF at auction. But in general, Class-A office space in San Francisco commands an average of $270 per SF, according to CBRE Research.

Notable examples of properties trading around the $270 a SF range include 410 Townsend St., 300 California St. and 350 California St. At 410 Townsend St., out-of-state investors New York Life Real Estate Investors and Bridgeton purchased the 78K SF asset in mid-April for $280 per SF, or $22M. 

For about $240 per SF, locally based investor Redco Development and GCI General Contractors are reportedly under contract to buy 300 California St., totaling $28M from New York-based LeFrak. Last summer, a joint venture of The Swig Co. and SKS Partners purchased 350 California St. for about $61M, or about $200 a SF for the 300K SF building.

The buyers of 410 Townsend St. said the transaction symbolizes a new era in San Francisco’s office market.  

“It's our opinion that this is the start of the recovery for the San Francisco real estate market,” Albert Pura, senior director of transactions for NYLREI, said in a press release issued by CBRE.

Connor Kidd, CEO of The Swig Co., said Class-A office values in the Financial District bottomed in 2023 and are probably up 20% to 30% year-to-date. 

Recent office building investment sales have helped reset San Francisco office property prices and expectations among buyers, according to Scott Swisher, managing director and head of western originations for Acore Capital, a San Francisco-based CRE lender. 

“I've talked to a lot of prominent sales brokers over the last few months and they feel confident that the office market hit its bottom in terms of values late last year, as commodity buildings with lower occupancy seemed to hit a floor around the low $200 per SF range, with limited bids," said Swisher. 

In recent months, there’s been a flight to quality, both from a leasing and a value perspective, Swisher said. The pricing floor for Class-A assets seems to have moved up to a range closer to $300 per SF.

Local investors are also more likely to be comfortable making a longer-term investment because they are apt to know best when absorption will return to the San Francisco office market, Swisher said. 

“To be perfectly honest, anyone buying real estate in San Francisco right now is not looking at a cap rate,” Kidd said. “They’re saying, at $250 a foot, I am 70% below replacement cost, and in some cases your cap rate might be zero,” Kidd said. “You're barely covering your expenses because you're not that well leased.” 

As absorption and leasing improve in San Francisco, patient building owners could see anywhere between 14% and 18% levered internal rate of return over the next five to 10 years, Kidd said. 

Kidd said he expects a flight to quality will fuel additional leasing activity among AI tenants, tech firms, banks and traditional financial services companies.

On the debt side, Swisher said more interested investors are reaching out to his shop with inquiries about San Francisco office buildings. “While there’s still limited data available for office sales, I think a lot of the sales are happening unlevered, and the buyers are closing all cash. And they'll look to leverage that building maybe later when leasing demand improves and they've shored up the rent roll bit.”

Swisher said that leverage is available to buyers, but still at unattractive rates. If the Fed decides to ease inflation by lowering interest rates, leverage could be more attractive to borrowers in 2025.

While some experts are more upbeat about the future of San Francisco office prices, others believe values have more room to fall. Property values in West Coast markets with a high concentration of tech jobs and long commute times are expected to drop another 25% from year-end 2023 levels, according to an April 8 report written by Kiran Raichura, deputy chief economist of London-based Capital Economics. 

Ryan Miller, West Coast analyst for Green Street, said that values for average-quality office product in San Francisco are down 70% from their 2019 peak. Meanwhile, values for Class-A, institutional-quality assets dropped 50% from the same period.

San Francisco still faces political and economic headwinds that are keeping office values depressed, Miller said. A wave of tech layoffs caused “cyclical challenges,” while the desire to work from home, particularly among tech workers who have faced some of the biggest layoffs, continues to keep vacancies high. 

These factors will result in further occupancy losses through year-end 2024, Miller said. 

Starting in 2025, Green Street expects occupancy levels to begin clawing back, “but we are not calling this a V-shaped recovery,” Miller said. “It will be a little bit more drawn out. We think that there will be a higher level of structural vacancy going forward.”