In January, office rents in San Francisco eclipsed those of New York to become the most expensive in the country.
Two months later, there are signs the San Francisco may not maintain its dubious position for long. The biggest indicator? There’s suddenly 1.7 million square feet of sublease space available in San Francisco, up more than 60 percent from 1.1 million in November, according to CBRE Group, a commercial real estate services and investment firm.
That kind of jump in four month’s time suggests ripple effects from a funding slowdown that stretch beyond a small but growing number of layoffs.
If the trend isn’t giving local landlords flashbacks of the late ‘90s, it may soon. The Bay Area’s real estate market enjoyed an historically active 2015, with San Francisco accounting for the world’s highest rent growth at 14 percent, according to brokerage Cushman & Wakefield. (Oakland saw the third biggest jump in rent nationally, said the brokerage.)
The last time San Francisco surpassed New York in price per square footage, says CBRE, it was 2000, the same year that the tech market famously peaked then abruptly imploded.
Of course, today’s volatility in the public tech sector pales in comparison to tech market nosedive that followed the dot com boom of 16 years ago. The slowdown in venture investing isn’t as sudden or severe, either, making it “too early to tell” if the economy has turned in a meaningful way, says Colin Yasukochi, director of research and analysis at CBRE.
Still, says Yasukochi, “There are definitely signs of change. It’s mostly a question of how severe they are, and how they evolve.”
Bay Area brokers, landlords and tenants appear to be in a kind of discovery stage at the moment. On the one hand, despite the dramatic increase in subleased space that’s become available, new tenants aren’t seeing a huge discount, which is usually an indication of a weak market.
“It depends on how long the lease is – one, two or five years or more – in terms of cost,” says Yasukochi. “But if you compare a good quality sublease space to a good, quality space direct from its owner, you’re seeing maybe a 10 percent markdown.”
It’s when discounts rise to 30 and 40 percent that a market is officially in trouble, says Yasukochi.
Yasukochi says another clue that the market is holding its own centers on commercial real estate development, which has been booming in recent years and continues for now.
“I haven’t seen developers stop their projects yet,” says Yasukochi, who began tracking the real estate industry in 2000. “Most of the buildings that are under construction right now are fairly well under way, and the one office building in downtown San Francisco that’s just starting construction right now appears to be going ahead with its plans.”
According to Colliers International data, four properties completed construction in San Francisco in the fourth quarter alone, opening up 1.2 million square feet of new space to the market. Notably, all the newly completed construction was pre-leased, with tenants scheduled to take occupancy during the first half of this year.
In fact, Yasukochi says that “we’re not really seeing landlords trying to increase rents and otherwise tighten terms for tenants,” which is a clear sign of nervousness.
That may be starting to change, though. So suggests Evan Combs, a San Francisco-based advisor at Cresa, a corporate real estate advisory firm that helps tech startups, among other companies, land the right space, and which began to observe the increase in subleased property in the third quarter of last year.
Combs says that while “we haven’t seen landlords shifting their pricing plans yet,” he and his colleagues have registered more “landlords now trying to tie up their vacancies. If they can lock someone in for five to seven years,” they’re going to do it.
CBRE’s Yasukochi also notes that the real estate market typically lags the broader investment market by half a year, suggesting we’ll know much more by early summer.
“When the stock market peaked in April 2000, the real estate market reacted six months later,” he says. “The same thing happened [following the financial crisis of] 2008. Whether this market peaked in July when the Nasdaq hit 5200 or it effectively peaked in the fall or later,” possibly when mutual fund investors began publicly marking down their private company holdings, is an open question, he notes, adding: “I’ve got to imagine that any new [building] starts this year will be scrutinized much more.”
Plainly, so will the amount of space that tech companies need to make it through what could be a painful year, given a mostly shut IPO market and investors who are thinking harder about each check they write.
Such reassessments aren’t such a terrible thing, given the runaway perks that startups had begun to offer their employees. There’s less pressure to build an office slide when everyone else is cuting back on spending.
The growing amount of subleased inventory is good for nascent tech companies, too. While startups “still request those personal touches – they all want the communal kitchen and the game room,” Combs says – startups and their backers have also grown “more opportunistic.”
Though subleases aren’t coming at a huge discount (yet), startups are still benefiting from entering into space that other tech companies previously occupied. As Combs notes, “The infrastructure is in place. These offices require less build out.
“That [equates to] cash flow preservation” at a time when startups need it the most.
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