San Francisco landlords gird for slowdown as startup frenzy ebbs

Bloomberg

Office landlords are bracing for a cooling of San Francisco’s red-hot market as weaker startup valuations and lower venture-capital funding temper years of runaway growth in the technology-industry hub.
The city’s office-vacancy rate jumped in the second quarter by the most since the last recession, while the amount of space available for sublease almost doubled, according to a report to be released this week by brokerage Cushman & Wakefield Inc. New lease deals have tumbled so far this year.
With demand seen cooling further, office owners who benefited from years of heated leasing by the likes of Uber Technologies Inc., Airbnb Inc. and Twitter Inc. are now rushing to seal deals and capture rents near record highs. They’re seeking to sign longer leases with creditworthy companies before prices slide, renewing agreements well ahead of their expiration and offering concessions, including free rent and cash for space improvements, according to J.D. Lumpkin, a managing director at Cushman & Wakefield in San Francisco.
“We may not be in a free fall, but it’s a sign of things to come,” Lumpkin said. “Those who are smart know it’s time to get aggressive and lock in credit tenants that you want for the next five, seven, 10 years in new leases and do whatever it takes.”
The moves represent a turn for a commercial real estate market that until recently had the nation’s lowest vacancy rate, driven by early stage tech firms scooping up space and Silicon Valley giants expanding to accommodate workers seeking an urban lifestyle. Now, the flood of money to startups is slowing and investors expect acquisitions of smaller companies whose valuations are falling, potentially leading to job cuts and office consolidation.

Greater Flexibility
“There’s no question the market has cooled,” said David Dowdney, senior vice president of the western region at Atlanta-based Columbia Property Trust Inc., which owns three buildings in San Francisco. “Twelve months ago, you probably could have a very poor-looking space and it probably could lease anyway.”
His company is becoming more flexible when negotiating leases, such as being open to letting workers bring their dogs to work and providing bike storage and access to gym and party space. About 25 percent of Columbia’s tenants are in the tech industry, including electronic-signature company DocuSign Inc.
San Francisco’s office-vacancy rate rose to 7.3 percent in the second quarter from 5.7 percent in the previous three months, Cushman & Wakefield data show.
It was the first increase since 2013, and the biggest since the start of 2009. The average asking rent, which can lag in a changing market, rose 1.3 percent to $69.30 a square foot.
New leasing declined 33 percent in the first half of 2016 from a year earlier. Available sublease space — which can be an indicator of companies scaling back after growing too fast — jumped to almost 1.5 million square feet in the second quarter from 822,000 square feet in the prior three months.
“The market has turned and it’s not going to spike again,” Lumpkin said. “It’s going to flatten. Generally, landlords are speaking with tenants earlier in anticipation of a further market correction.”

Low Vacancies
Still, the city’s office-vacancy rate remains well below the national average of 13.5 percent, and its first-quarter rate of 5.7 percent was the lowest in the country. Many bigger, well-established companies are still clamoring for space.
“From what we’ve experienced in the last 30 to 60 days, there’s a new wave of activity from large San Francisco-based companies as well as Silicon Valley companies that are looking at the new developments and larger blocks of space,” said Chris Roeder, international director at Jones Lang LaSalle Inc. in San Francisco. “A lot of them are in expansion mode.”