Starboard Commercial Real Estate

Hans Hansson | October 21, 2008

Recent headlines that the San Francisco Bay Area office market is ready for steep increases in their office vacancy rate are at best premature. CB Richard Ellis announced that San Francisco saw 650,000 square feet of new sublease space in the third quarter of this year alone. Although this sounds bad this is not 2001 dot.com bust waiting to happen.

In 1989 right after our earthquake, vacancy rates hit 23%. This was a combination of overbuilding that started in the early 1980's combined with a major tax change that negatively impacted the commercial real estate market. The earthquake itself was simply the event that pushed the office market over the edge.

In 2001 right after the dot.com bust vacancy rates again went over 20%. Again, this market was fueled by mass conversions of non-office space to "tech" offices; as well as, an extreme rapid growth of new office tenants in a short time never seen in an office market cycle.

Today we have a vacancy rate of 7%. This vacancy rate has held steady for most of this year. Sublease space is not included in office vacancy quotes because tenants pay rent. Traditionally San Francisco, in "normal" office market periods, will absorb between 600,000 and 800,000 square feet of office space a year. This year net absorption has been flat.

Most of the sublease spaces that are coming on line tend to come from large financial institutions that typically office in large full floor office spaces. In San Francisco the average tenant is a 10-15-person firm that needs 3,200 square feet. Most of these sublease spaces have two years or more on their remaining lease terms. Therefore companies that have larger offices that need to sublease their space will have to look at dividing spaces in order to meet the market. This will prove expensive and probably impractical. They could try to lower prices but again they will find little interest in their spaces from tenants that actually need to move because their spaces are simply too large.

This will lead to an interesting market. You will continue to see a low vacancy rate and minimum choices of direct space to meet the real market demand from smaller tenants; and, you will also see large blocks of space available for sublease that will sit vacant until their leases actually come up.

Landlords will be hoping that by the time these large blocks of space actually come back to them the financial market conditions will improve. If not then vacancy rates could in fact go up significantly.

Tenants should be careful not to overplay their negotiations in getting the best deal they can. Yes, if you are a large block tenant you have a lot of buying power today. But if you are a tenant with less than 6,000 square feet you will still find limited choices and landlords holding pricing pretty close to their asking rates.
Posted 10 years, 11 months ago on October 21, 2008
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