By Eli Ceryak, Senior Vice President
San Francisco continues to be a painfully competitive market to secure office space, the skyline is dominated by construction cranes and tech companies have a seemingly insatiable thirst for space and workers in the city. But despite this boom, we’ve seen a jump in the amount of sublease space available since the beginning of the year. Given the roaring economy, why is there more sublease space? And how will it affect the market?
Let’s start with the data: specifically, how much sublease space is available, and how does that compare with recent history? Below, we compared statistics from three recent time periods: 1) today; 2) the beginning of this year; and 3) October 2010, when the San Francisco market bottomed out before the current boom;
|Date||Total Sublease Space||Total Direct Space||Total Available||Vacancy Rate|
In 2010, when San Francisco’s recovery started, the sublease space represented 15.5% of total vacancy (meaning 15.5% of the available space was sublease; 84.5% was available directly through landlords); at the end of 2014 it was similar at 16.4% of total vacancy, and currently it’s increased to 22.16% of total vacancy. So there’s undeniably been a surge in available sublease space over the past 6 months, particularly as it relates to total vacancy. Since 2010, San Francisco’s total vacancy rate on about 85 million square feet of space has plunged to 5.7% from 15.3%. And the amount of sublease space decreased by half from 1.7 million square feet in October 2010 to 880,000 square feet at the beginning of the year, before the recent uptick to 1.1 million square feet.
Who is putting space on the market for sublease? And why?
The larger blocks include 150,000+ sf of space that Salesforce has made available as they move people to newer space at 50 Fremont and 350 Mission, as well as 50,000 square feet that Square is subleasing as they rein in expenses prior to a potential IPO. Other large subleases are the result of mergers, with Bingham McCutchen putting 98,000sf on the market after merging with Morgan Lewis, and Conversant putting 32,000sf on the market after being acquired by Epsilon. So a significant amount of the sublease space is a result of the normal business cycle, such as mergers & acquisitions, companies unloading excess space as they move to a new & larger location, etc. What we haven’t seen – yet – is a substantial amount of early-stage technology companies or “unicorns” putting large blocks of space on the sublease market. And that would be one of the biggest indicators of cracks in the current technology boom.
The turnover rate for subleases is also exceptionally high, with most sublease space sitting on the market for just 120 days before being leased. And because subleases are particularly attractive for growing technology companies – who like a shorter-term real estate commitment as they grow, without having to make a large capital investment into tenant improvements – we anticipate the available sublease space will get absorbed quickly over the remainder of the year. In fact, most of the Salesforce space is already taken or in leases, and many of the other large blocks are in subleases or reviewing multiple offers. And the big story with Salesforce isn’t that they made 150,000sf of sublease space available. It’s that the sublease space signals that the biggest consumer of office space in San Francisco, with more than 2 million square feet of new space leased over the past few years, isn’t going to be an active buyer in this market for the foreseeable future.
One challenge with sublease space, particularly if there’s a flood of it, is that the companies subleasing space are generally trying to recover a sunk cost and are motivated to get a deal done as quickly as possible, even if it means doing a “below-market” deal. So while landlords might be more patient and wait for the right tenant and a higher rent number, and don’t want to do a cheap deal that resets the market rate for their building, sublandlords will take more of a fire sale approach which can lead to a significant market correction if it happens en masse.
Perhaps the biggest potential exposure to more sublease space is the number of large technology companies moving into new buildings over the next year, including LinkedIn, Salesforce, Twitter, DropBox and Splunk. The potential for sublease space to dramatically affect the market really lies in whether these companies need all of the space they have leased with visions of big growth. If they make large blocks available in their new buildings, the effect will be far more significant than the recent, and likely short-lived, uptick we’re currently seeing.
In sum, the increase in sublease has provided a small dose of relief in a highly competitive market, but it will likely be short-lived barring aggressive moves by the city’s largest technology companies.
For additional insight, you can view our latest market report snapshots by clicking here.
Eli has 13 years’ experience as a commercial real estate broker. Mr. Ceryak has been with DTZ (formerly Cassidy Turley) since 2004. He has advised clients in a variety of indsutries, including technology, digital media, professional service firms and non-profits. His clients appreciate his creative problem solving ability and long-term view of the market. Mr. Ceryak specializes in office leasing for the San Francisco and East Bay office markets.