Real Estate Investor

Office space is dear and expensive

Is it time to head to Oakland or pray for a recession?
Office space in San Francisco’s Financial District is hard to come by these days.. Photo: eric hunt

Stuck in the middle of a report on the performance of San Francisco’s office real estate in the fourth-quarter of 2014 is this tidbit: 2014 sales volume was 64 percent higher than at the peak of the dot-com boom in 2000. The report by Colliers International also notes that vacancy rates are at 7.5 percent and have decreased four years in a row, declining by 51 percent from their peak of 15.2 percent in 2010.

A different real estate services firm, CBRE, reported local office vacancy rates of 6.6 percent for the quarter, but either way the message is clear: Owners of office properties in San Francisco are reaping the benefits of the booming economy. That means that office tenants, just like residential and retail tenants, are enduring the brunt of that boom in the form of higher rents, difficulty in finding new space, and even pressure to relocate so the landlords can get new tenants and lock them into long-term leases now while rents are high and alternatives are scarce. CBRE reports that asking rates grew by 14.2 percent to $63.24 per square foot in the fourth quarter of 2014.

CBRE notes the obvious: It’s a tech-driven market right now. “There were 17 [office rental] deals over 100,000 square feet for a total of 3.6 million square feet, 87 percent of which was leased by technology tenants” in the quarter, CBRE reported.

Colliers took that idea a bit further. “The city is now the undisputed urban epicenter of the world’s knowledge-based economy,” said hyperbole-immune Alan D. Collenette, the San Francisco-based executive regional managing director at Colliers International.

That appears set to continue, at least until the tech sector has another crash. “The technology industry continues to drive job growth and has reached its greatest share of total office employment this year, outgrowing the finance, legal, and professional service sectors,” reports JLL Research. “Financial service sector jobs are slowly declining in San Francisco, reporting a 1.6 percent job loss year-over-year. Besides financial services, all other industries reported positive job growth over the past year. Of occupations with the most job openings currently, tech represents at least 10 percent and continues to grow.”

For businesses that need space, many have faced double-digit rental increases over the past few years. Those that were forced to look for different space have been met with a very tight market run by landlords who can bargain hard. Some of those tenants are being forced to relocate to Oakland or the suburbs — which isn’t the end of the world, after all, but it does involve the cost and disruption of a move and it can be an undesirable relocation to companies with clients and staff who are accustomed to or prefer a San Francisco location.

When city voters passed Prop M in the 1980s, they voted to limit the total amount of office space that could be built in the city in a given year. Done ostensibly to prevent overbuilding of office towers, it has had the effect of making the rich richer by artificially creating scarcity and pushing up rents for the owners who already have space on the market.

Are there other things government can do to help commercial office tenants big and small? The San Francisco Rent Board notes prominently on its website that “There is no commercial rent control in San Francisco.” It’s an idea that is occasionally kicked around, but it has market-warping effects arguably as bad as Prop M’s, one of which is serving as a disincentive to develop new office space and thereby keeping inventory constrained.

Yes, there are millions of square feet under construction (all of that space doesn’t come onto the market at the same time, of course), but JLL Research notes that nearly 60 percent of it is preleased. So it will not suddenly glut the market with space and force lease rates to plummet. It might free up some space from other office towers as growing companies move into bigger space, and that should serve as a limited pressure valve on rent costs. But the pressure valve would be even better for tenants if there were twice or thrice as much space coming onto the market.

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John Zipperer is the former new media editor of the CCIM Institute and senior editor of Apartment Finance Today and Affordable Housing Finance. E-mail: [email protected].