What is happening in the office space in large cities like San Francisco? What has happened in the last year? What is happening right now? Will we ever see any deals? Reuben Torenberg will share his insights, he is a vice president at CBRE, and specializes in representing tech companies and venture capital firms in acquiring and managing office space in the Bay Area.
Tell us a little bit about you.
I am a vice president at CBRE, I work at our San Francisco office. I’ve been in San Francisco for the last five years now. Seven years in brokerage. I represent technology companies, startups and venture capital firms in leasing and managing real estate, both locally here in San Francisco and across the globe. Our team also helps lead CBRS’s technology practice here in the Bay Area. We specialize in office space and are titled office brokers, but we certainly have experience in both industrial and retail.
I’ve been dying to speak with someone in the office space that is focused in large cities like San Francisco, to see what has happened with office over the last year, do you mind sharing with us what is going on in your world?
It has definitely been a change from anything we’ve experienced in our career. The market has been placed completely on pause since March of last year, and it’s due to the pandemic. As soon as it happened, as in many other large Metro cities, there was a mandate from the city that stated no one can occupy office space. Since then, all the technology companies locally have at first tried to defer their rent or get free rent with landlords. And unfortunately, they were not very successful because these landlords also have bills to pay, they have mortgages to pay, they have to keep up the operation of their building.
And since they’ve had to continue paying rent and rents for extremely high rates, in fact, they were the highest rates in almost 20 years, the average asking rate back in March was $88 per square foot per year. They’re these technology companies and their VC’s have said, Well, how do we stop burning this cash. And the way to do it, in their mind was to put their space in the sub market, try to generate interest, and get rid of their obligation. Since that point, just over 8.5 million square feet of sublease space has been placed on the market. They all place their space in the market, a few months go by, there’s no interest, there’s no demand because no one can occupy office space. And as the months went by, rates dropped from the mid to high 80s to mid to high 70s. Then a couple more months passed and rates dropped to the low 70s, then a few more months passed and rates have dropped into the 60s.
Now, for subleases, we are seeing rates at 30% lower than what they were back in March 2020. For class A space that’s really creative and the type of space that technology companies have wanted over the last five years, you’re seeing rates in the low 60s when back in March, they were in the high 80s. Now that really only affects the sublease market. Landlords on a direct basis have actually continued to keep their rates close to or if not at where they were pre COVID and the reason for that is because they aren’t yet feeling the pressure that all these technology companies are because they’re still receiving rent. Those technology companies are in leases for the next three to five years, they’re stuck at these rental rates. And until those leases start to expire and landlords start feeling the pain of vacancy, they don’t really have a need to drop their rates.
And also these tech companies, they are printing money, just like the government, basically. So I assume that there aren’t too many defaults, is that correct?
That is correct. There hasn’t been too many defaults, what some companies have tried to do is just cut their losses and seek a termination. Although landlords had been very hesitant to do so because of all the uncertainty going forward, if you were to terminate, and landlords had other tenants waiting in the wings, that’s one thing. And you can agree to a termination with a penalty of a couple months rent and feel confident that you’ll get the space leased again. But without any end in sight, it’s certainly much harder to have those conversations. Although some technology companies have gotten really aggressive and have proposed paying a year of rent, or half of their remaining obligation in exchange for the right to terminate. So we’ve seen that route a little bit. But I would say, at least 80% of these technology companies still have their space in the sublease market, or are hoping to come to an agreement with a growing technology company who can use the space once shelter in place is lifted, and rid themselves of remaining obligation without suffering too much pain.
And has that changed a little bit earlier this year? Or is still pretty much the same?
We’re starting to see a little bit of a change, which I’m sure is leading into your next question of what’s going on now. So far, in the new year, and especially after the news of the vaccine, we started to see technology companies plan for what things will look like in a post pandemic world and what their real estate presence will be here in San Francisco. Since January, we’ve certainly seen a huge uptick in the first step, which is sublease inquiries where they’ve asked their brokers to re-survey the market, find out what’s available, where are rates, where can deals be struck, and we’re starting to see tour activity seriously pick up. Now that is with the caveat that anyone who is proposing on space is likely proposing for a Q3 or Q4 start with the knowledge that they likely aren’t planning to or aren’t going to be occupying office space until then.
Do you see any deals happening right now from office being on sale? Do you think they will be coming up anytime this year?
The answer is yes, deals are happening in two forms. The first and this one has been more common, has been direct renewals. Those tenants who have leases expiring or have expired during the pandemic, or over the next six months, have been in negotiations with their direct landlords to renew their lease. And because they want to maintain an office presence in San Francisco and don’t want to have nothing. Those landlords who are having those conversations obviously don’t want to have vacant space. But what we’re seeing mostly is that they’re doing these short term renewals at rates that are a little bit lower than traditional direct rates, but offer both sides the flexibility in a situation that, in a year, either things look a lot different, and rates are way lower in advantage of the tenant, or things look way different, and rates are back to where they were for the landlord. So that’s one that we’re seeing quite a bit of action on in terms of renewals.
And the second is, as I’ve alluded to the sublease opportunities that are at 30%, reduced rates, we’re starting to see technology companies jump on those companies who have recently raised funding or are willing to be a little more opportunistic, about office space and who are bullish on the city of San Francisco going forward. Those deals are starting to happen. But even the ones that we do see happen, do not have an occupancy date before August one.
Is it safe to assume that landlords are not hurting right now? And nobody’s trying to sell their office building?
Yes, I would say they aren’t hurting as much as they likely will be if this continues in another year, just because the market has been so hot over the last five years that they’ve been able to get deals at the rates that they want for long term to lock in security for the building. And those who are going to sell their buildings right now are looking at a pretty difficult selling market. So what we’re really seeing mostly is landlords trying to hold on, and get past the uncertainty of the virus and see how efficacious the vaccine is before going back into into the market to sell their buildings.
And what is the sentiment regarding office in general in your world? I have my personal opinion, but I would love to hear what you think is going to happen to office space in large cities like San Francisco.
I certainly think that they will eventually bounce back. But the trend right now is leaning towards satellite offices in secondary metros like Austin, Salt Lake City, Denver, and even Miami, I’m sure you and everyone else has been hearing a lot about the Miami tech migration on Twitter and the like. Tech companies are seeing their employees either temporarily or permanently move to these secondary cities while working remote. And these companies want to put themselves in a position to retain their talent by giving them a place to work outside of their homes.
The reason I don’t think it’s permanent, is because the larger metros, particularly San Francisco and New York have been more strongly affected as it relates to the restrictions imposed by the pandemic. You can’t do many of the things that attract people to these big cities, whether it’s exploring the restaurant scene, enjoying nightlife, going to concerts, and more importantly, meeting new people, growing your network and enjoying the energy that these big cities offer. Now, once things are back to normal, are people going to flip flop back to these big cities, especially as rates continue to plummet, we’ll have to see what happens. It’s just an opinion, I don’t know for sure what is going to happen. I don’t have a crystal ball. But I’m certainly bullish on the future of San Francisco.
I do have a crystal ball, I am pretty sure that these people are coming back because I don’t think young professionals want to be in the suburbs, during their professional careers. They will definitely want to come back to large cities where they can enjoy all of these things that you listed. So that’s my prediction according to my purple crystal ball.
I certainly hope that you’re right. And I trust your opinion.
Is there anything else that you think is interesting for our audience to know or keep in mind, as real estate investors?
I’m very curious to see how the next year turns out and how opportunistic these technology companies choose to be, as it relates to picking up space at these low rates. I think it’s a little bit tough to compare this situation to past recessions, but cities especially large Metro cities, specifically San Francisco, in past recessions have seen this volatility, where rates were super high, both in the .com boom, or entering the .com boom and entering the recession of 2008. And they completely plummeted. They cut in half from 80 to 40, roughly, just using rough numbers. But at that time both of those recessions turned out with companies coming out of those recessions, that became huge. In 2008 a few great examples are Airbnb, Dropbox, Twitter, Lyft, Uber, etc. And those companies started gobbling up so much space in San Francisco at such low rates and for long terms. And as they continue to grow and grow out of those spaces, a lot of them ended up able to sublease those spaces at a profit. Because the market had gone up, there was more demand, these spaces had gone up in rate, and they were able to take advantage of the situation. I’m certainly very eager to see what companies come out of this, and how they’re able to also take advantage of the situation.