Bargain Office Rents on the Rise in San Francisco

More office tenants looking to lease in Downtown San Francisco have bargains on the brain, according to a third-quarter Colliers report. After more than a year of hearing about the “flight to quality,” it seems there’s still some allure in an old-fashioned low-priced deal.

Colliers noted a 14 percent quarterly decrease in effective annualized rents, from nearly $70 in the second quarter to just over $60 per square foot in the third quarter. A lack of “premium” transactions, which had dominated the previous quarters, and a rise in subleases, which averaged only $44 per square foot, were credited for the downward shift.

Derek Daniels, Colliers’ regional director of research, said he started noticing the bargain-hunting trend in the second quarter but it became even more noticeable when compiling the data for the third quarter report. Many tenants are still shelling out top-of-market rents for amenity-filled buildings with views, turnkey space and desirable locations near transit, restaurants and shops, he said. But an increasing number are cost-motivated and looking to take short-term, less expensive deals while they determine what they’re looking for in a more permanent place.

“There’s always going to be an appetite from tenants who are less cost-conscious and willing to sign on a long-term basis and will pay, and those rents are still holding up,” he said. “I think the big story is that more of the cheaper deals are out there these days.”

It’s a trend that could benefit tenants and owners during the current uncertain economic climate, he added.

“There’s enough quality space at flexible terms for tenants to sublease on a shorter-term basis,” he said. “Conversely, landlords are willing to do a lower cost transaction with the potential to re-assess when the market turns around.”

The vacancy rate continued to climb and the absorption rate was down again in the quarter, with the North and South Financial District leading the way in negative net absorption. The latter reported nearly 700,000 square feet of negative net absorption, compared with 530,000 square feet north of Market.

Jackson Square was a bright spot with positive net absorption in the quarter, according to the report. The North Waterfront a few blocks away has also been popular, Daniels said.

“Every office building and every company is competing with the couch to get their people back in the office,” he said. “People want to go where it’s safe, where they have a place to eat lunch and go out after work. And I think you get all that in the North Waterfront and Jackson Square.”

According to Colliers, Snap’s sign-on for more than 30,000 square feet in Levi’s Plaza was the biggest direct lease of the quarter and exemplified both the trend of companies preferring the North Waterfront area — Snapchat’s parent company formerly had its SF office in SoMa — as well as looking beyond trophy space to a Class B low-rise building.

Two AI companies took even more space, but only as a sublease — Hayden.AI signed for more than 40,000 square feet near South Park and Adept AI will sublease 35,000 square feet in Potrero Hill near the Design District, a neighborhood being billed as “Area AI.” Daniels said AI companies and other startups could be looking for temporary spaces now as they await future VC funding.

Daniels said tenants are wary of buildings that might have distressed ownership and will be more likely to seek a new lease after they change hands, drawn as much by stable ownership as the attractive rents those new owners will be able to offer given the lower cost basis.

Now that a few big office sales — such as 350 California Street , 550 California Street and 60 Spear Street — have gone through, he expects more to follow. And while vacancy is likely to continue to rise in the short term, the health of the market appears to be slowly but surely improving.

“We finally saw some closely watched sales close. We’re starting to see these lower-cost lease transactions signed and we’re seeing an uptick in tenant touring activity,” he said. “This is all part of the process of moving our market through this cycle.”