The Bay Area economy remains strong, direct vacancy is tight, and tenants are paying record high rents:
- Class A office rents are in the mid-$80s per square foot with the highest rents exceeding triple digits.
- Office rents are rising at two times the national average.
- The direct vacancy rate ranks lowest among major markets and is holding steady at ~7%
- The outlook for job growth in San Francisco remains positive.
On the other hand, there are indicators that an office market bubble could be on the horizon.
- According to Costar, sublease availability in San Francisco has ballooned by 50% since 2018.
- San Francisco firms Stripe, Charles Schwab, Bechtel Group, McKesson, and Core-Mark have relocated headquarters and jobs to cities where the cost of doing business is much lower.
- Many tenants are paying rents or are looking at renewals that surpass dot.com prices and that didn’t end well for anyone – tenants or landlords.
- Possibly more alarming is the current amount of sublease space on the market which exceeds recession level at nearly 5 million square feet.
Reading the Tea Leaves
From a tenant’s perspective it’s important to understand what is causing these conflicting market conditions in order to leverage your advantages as a tenant in the current office market.
Nearly every rapidly scaling tech company has a business plan that relies on headcount growth, which is why tech tenants like Dropbox, Micron Technology and Splunk are “banking” space in advance of hiring and are offering to sublet portions that are going unused for now.
These unicorns are wisely looking to monetize their leased but unused space until they grow and are therefore creating large amounts of sublease space on the market. This monetization of banked space is not likely a leading indicator of an office market bubble. In fact, it presents below market opportunities and leverage for tenants willing to move into a sublease.
So, given the below market rents for sublease space, why isn’t your broker enthusiastic about sublease space options?
More than 90% of the commercial real estate brokers in San Francisco represent both landlords and tenants. This creates a built-in conflict of interest that few tenants understand and even fewer brokers discuss. No one would hire a lawyer who works for the other side. Yet, the equivalent happens every day when tenants work with commercial real estate brokers and firms that also represent landlords.
It is in the best interest of brokers that represent landlords to keep perceived asking rates as high as possible and vacancy rates as low as possible. But, large amounts of below market sublease space softens the market. Otherwise, landlords and listing brokers would openly publish asking and actual rents on every direct and sublease space they list.
A bigger reason your broker isn’t enthusiastic about sublease space options is brokers are sometimes paid a lower fee on subleases. And, a sublease transaction is often more complicated and difficult to negotiate than a direct space lease. So, more work and less commission make sublease options a lower priority for most commercial real estate brokers.
Leverage Your Advantages
In order to gain leverage on your office transaction you need to first eliminate conflict of interest. If your broker or anyone in their office has listings in the market, they have a conflict of interest. Make sure you are working with a tenant representative firm and not listing brokers.
Next, explore all your options with your tenant representative. There are very real differences and trade-offs associated with each of your options – shared, co-working, sublease, direct, etc…
If you decide to explore subleases be certain they fit your timeline and flexibility. Companies that are uncertain about long-term growth plans may desire shorter lease terms. In this case, sublease may be an option that would otherwise not be available in the direct lease market. You’ll definitely be able to find sublease space at below market rates but your trade-offs will include limited flexibility on tenant improvements, renewal options and financial liability.