Big-office tenants return to San Francisco market

Demand for large chunks of office space in San Francisco has reached a post-pandemic high, according to research from commercial brokerage Avison Young.

AI is leading the way on the trend that puts demand for 50,000-plus-square-foot spaces at nearly 44 percent of active tenant requirements, according to Louis Thibault, senior market intelligence analyst at Avison Young. Leases on spaces that large made up more than 60 percent of the demand in 2019 but were at only about 30 percent in 2023.

Since 2023, 41 percent of San Francisco’s 50,000-plus space taken has come from AI firms and the industry represents nearly 57 percent of the 100,000-plus-square-foot leases signed during that time, according to Avison Young data.

OpenAI, Scale AI, and Adyen are some recent examples and Thibault said OpenAI in particular “showing its hand relatively early in the game” could have a ripple effect on smaller AI companies that may need more space down the line. Plus big tech has been upping its in-office demands and VC capital may lean towards in-office companies as well, adding to the pressure on these smaller companies to rent space. Around 350,000 square feet of offices has been taken by early-stage VC-backed firms in the city since 2023.

“This is promising for San Francisco, because if AI turns out to be the real deal, there are plenty of smaller firms that could galvanize the city’s CRE market,” Thibault said.

Leases under 20,000 square feet aren’t as popular as they once were — a little less than 40 percent of the market demand in 2024 compared with more than 50 percent in 2023. But these smaller offices, especially those that have premium view space and are already built out, are “extremely popular right now,” Thibault said, for tenants old and new.

“While many companies have decided to right-size, there are also many newer companies in the scene that have either grown from small startups or that have come from different markets to plant their flag in the city,” he said.

Despite AI and other tech companies making a big splash in the larger lease market, traditional FIRE (finance, insurance, real estate) industries make up a larger portion of the overall market than they did pre-pandemic, according to Avison Young data.

Tech was a whopping 57.4 percent of the market between 2018 and February 2020, but that number drops to 48.3 percent when looking at data from March 2020 until now. At the same time, the share of FIRE companies taking space has grown from 8.8 percent pre-pandemic in March 2020 to over 26 percent in the current market.

Before tech, these industries were the “backbone of the San Francisco” market, so their continued investment in the city makes sense, Thibault said. Plus, they may have more capital on hand, he said, even as the higher interest rate environment has slowed tech growth. The two groups are inextricably linked in the city, especially given that the San Francisco Bay Area has received about 57 percent of the nation’s VC funding since 2023.

“There’s a synergy with the tech companies, since that’s where the money is. These industries want to be in close proximity to each other,” he said.

Whether the target is FIRE or tech, in order to lure tenants, landlords have upped their concessions. Owners have had to cut back on up-front capital expenses such as tenant improvement allowances due to the scarcity of available capital, which has caused TIs to drop from $147 per square foot to $135 per square foot year-over-year, according to Avison Young data, even though custom buildouts from shell space and spec suites routinely cost between $200 to $250 per square foot. Without that carrot to dangle, more landlords have turned to free rent, which has risen from seven months to 10 months for a 10-year average deal, a 42.9 percent year-over-year increase.

“With high construction costs, landlords have chosen to increase abatement and absorb the expenses at a future date,” Thibault said. “These costs coupled with high vacancy rates have caused San Francisco’s development pipeline to grind to a screeching halt, with almost nonexistent construction in the city.”

The city has seen demand for large office leases go up and down over the last four years, and while Thibault said it’s difficult to predict with certainty whether or not the current trend towards larger leases are sustainable, the increasing number of tenants in the market (from around 3 million square feet of requirements at the end of 2022 to about 6.5 million square feet now), several interest rate drops that might spur tech growth again, and tech companies stricter in-office policies all give him cause for optimism.

“There are increasingly positive signs pointing to this being more than a blip,” he said.