San Francisco has been a boom-and-bust market since the Gold Rush. The current intense scrutiny of the yield curve, combined with the stock market’s recent erratic behavior, has sent warnings of the next looming recession. Just how will this affect the office market? Fortunately for the Bay Area, not much. Today, several key factors insulate San Francisco from a severe downturn, unlike past cycles. Among them are Proposition M and a concentration of venture capital, highly skilled talent and some of the world’s largest companies.
Since 1986, Proposition M has limited the amount of office development the city will authorize in any given year. The program aims to guard against typical boom-and-bust cycles. The San Francisco office market only includes 85 million square feet, as opposed to Manhattan or Houston, for example, which comprise 400 million and 240 million square feet, respectively. Manhattan currently has 12.4 million square feet of office space under construction, while San Francisco has 3 million square feet in the pipeline. The entitlement limit under Prop M has been reached, meaning no additional new projects can be approved until October when another 950,000 square feet will be allocated for the next year.
Blake Peterson, Transwestern
At first glance, these metrics may seem proportional. However, consider that three out of the top 10 largest companies by market cap are headquartered in the Bay Area. Add to that the fact that nearly a third of all U.S. venture capital deals that have closed through June 2019 have been for Bay Area-based companies (1,048 of 3,074 total). When you do, it becomes clearer why San Francisco has the highest office rents in the country and continued low vacancy. While the artificial constraint on highly in-demand office product is exactly why many in San Francisco oppose Prop M, it appears to be accomplishing exactly what it is designed to do: protect building owners from the overdevelopment that has plagued other markets after a downturn.
Those who remember the dot-com bust of 1999 to 2000 and the Great Recession of 2008 to 2009 may be understandably fearful of the next significant market dip. However, while no U.S. office market would be unaffected by a recession, including San Francisco, minimal new office product thanks to Prop M means the region is arguably better positioned than other major office markets.
That’s not all. Another significant difference is the strength of the Bay Area’s technology sector. Aspects of nearly everyone’s work, news, transportation, entertainment, banking and even food rely on tech-sector companies based here. That will not fundamentally change in the next cycle. Google, Facebook, Apple and Salesforce, to name just a few, have deeper roots and more diversified assets than the largely unsecured internet ventures of the ‘90s. These tech giants are unlikely to be uprooted by a recession, and their presence strengthens the region’s draw as a hub of innovation and a highly skilled labor force. These are conditions for an even greater concentration of venture capital, ensuring continued new business and new office occupiers. Eight of the 10 largest leases in the past 10 years in San Francisco have been tech tenants, with Facebook, Dropbox and Salesforce grabbing the top three spots — two of which commenced just this year.
Let’s not forget about the investors. Nationally, San Francisco is the 12th-most populous city, but it ranked third in commercial real estate sales volume for the first half of 2019. With the announcement of a potential Transamerica Pyramid sale for the first time ever, the sale of Levi’s Plaza for more than $800 million and Boston Property’s purchase of Hines’ minority share of Salesforce Tower, San Francisco’s capital markets activity is outpacing the national average. Even the most skeptical interpretation must be tempered by the clear demonstration of buyer confidence.
Despite market optimism, a thoughtful strategy is vital in the face of an impending recession. Office tenants hoping to stave off a lease renewal for lower prices in a year or two might be disappointed. Naturally, not every great idea will make it through a downturn. Savvy property owners should carefully review leases for securitization and creditworthiness. Expect to see investors and entrepreneurs trying to capitalize on record prices in the near term, while startups continue to compete for limited space with ample previously secured funding. San Francisco may experience a floor in the market, but it will be a high floor. This is good news for a market that has rebounded more quickly than most time and again.
— By Blake Peterson, senior vice president, Transwestern. This article first appeared in the September 2019 issue of Western Real Estate Business magazine.