Why Are Prices in San Francisco’s Office Markets So High?

San Francisco’s office market isn’t in a bubble, analysts say, but a tech boom is driving up lease rates and lowering vacancies.
Credit: Flickr CC user Scott Carr

If you think office space rents are outrageously high in San Francisco and other office markets along the California coast, you’re right. San Francisco could potentially eclipse Manhattan this year as the most expensive office market in the U.S. The average price per square foot jumped more than 14 percent year-over-year in the last three months of the year, reaching $61.71 per square foot per year. That’s the highest it’s been since the days of the dot com bubble, according to Cushman & Wakefield.

But the question is: why?

The U.S. Office Market Still Struggles to Recover

Theoretically, lease prices for office space shouldn’t be that high in any markets. Nationally, the office market has been slow to recover. That’s because in the lead up to the Great Recession, a building boom created a glut of office space. After the crash, companies shed square footage as they laid off employees. Companies have also embarked on space-saving initiatives by shrinking cubicle space and adopting open floor plans. All this has left up to a quarter of the office space vacant in many major cities.

Although the economy has been adding roughly 250,000 jobs per month, the national office vacancy rate hasn’t moved all that much. Cushman & Wakefield, in one of the more optimistic surveys, says that the national office vacancy rate was around 14.5 percent at the end of the year. The average rent was $26.89, less than half the average rate in San Francisco. REIS, however, pegged the national vacancy rate at the end of 2014 at closer to 17 percent. This double-digit vacancy means that companies can usually find a fairly good deal in many major cities.

Tech Firms Are Driving Up Lease Prices in San Francisco, Other Cities

San Francisco and other cities on the West Coast are an exception. In San Francisco, the overall vacancy rate dropped to around 7 percent last year. That’s primarily because the city has become the new epicenter for tech-based firms. Facebook, Google, Yahoo, and Microsoft, among scores of other established and start-up companies, are gobbling up space. According to an analysis by CBRE, technology firms have accounted for one quarter of the office jobs in the U.S., but these companies accounted for close to 75 percent of all the leasing activity in San Francisco. The city is also seeing big growth in education and healthcare.

San Francisco is not the only city that has seen prices escalate. In Seattle and Manhattan, technology companies have swallowed up space, shrinking the overall supply of office space and driving up prices. In Santa Monica, a hub for tech firms close to Los Angeles, lease prices have gone up, too. Some companies, most notably Google and Yahoo, have moved into the Playa Vista neighborhood of Los Angeles, believing that Santa Monica has been built out and the city has thrown up too many barriers to development. When space is available there, however, tech firms want it badly.

High-Priced Office Markets Are Likely to Stay High

From the point of view of a tenant, the prospects for finding affordable leases in these high-priced markets doesn’t look good. For one thing, the tech boom doesn’t show any signs of slowing. New office space inventory also tends to take longer to build, often more than two years compared to a potential six-month build out for warehouse space. Additionally, developers aren’t building many new office towers on speculation. Investors and banks want to see strong preleasing activity before pulling the trigger on a loan. In its market studies, for example, Cushman & Wakefield also noted that new office buildings that are coming online are already almost entirely pre-leased. Subleasing activity — a sign that the market is weakening and might lead to lower prices — is also well below the historic norms in the hottest tech markets.

Companies Have Alternatives Close to High-Priced Office Markets

This all means that lease prices will likely get higher for the foreseeable future, not lower, in cities with booming tech industries. That being said, companies have plenty of options in California. Although lease prices are astronomically high in tech-based centers, generally speaking, it is still a good time to enter into a long-term lease in an office building. In cities and neighborhoods within just a few miles of where prices are exploding, companies can find much more favorable terms.

Oakland’s downtown, for example, is less than 11 miles from downtown San Francisco. Yet its average gross asking rent was half the cost at $29.04 per square foot annually at year’s end, even after office rents jumped by 12 percent for the year. In the Alameda submarket, the asking prices were below the national average at $24.48 per square foot at the end of the year. Roughly 23 percent of the 3.4 million square feet of office space in Alameda was vacant.

Companies Should Look At Nearby Office Markets

As we have seen by these studies, office space can be had at affordable rates, even when close to high-priced markets. Several office markets around the San Francisco Bay area have good public transportation options and city amenities. They may not have a San Francisco zip code, but they can be good options for companies under the right circumstances.

As we have previously written, a company should remain flexible and keep an open mind when considering property and buildings. In the case of leasing office space, the tenant should not leap into a long-term deal in a high-priced area without exploring less expensive options in the communities nearby. As always, a company should consult with a commercial real estate consultant who is familiar with all of the available options in an area.

If you are looking for office space, you don’t have to go it alone. You can get a thorough analysis of the market with all the available options from a consultant whose community values align with your own. Contact DCG Real Estate today to learn more.