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How has the pandemic changed the commercial real estate market?

The Bay Area has been largely built on booms and busts, from the Gold Rush to the Dot-com Bubble and the Great Recession. For decades, tech companies fueled the office real-estate boom in the Bay Area. Many of these companies are now choosing to invest elsewhere due to high real estate prices, taxes, and regulatory hurdles. Now, as downtowns continue to hollow out and San Francisco’s office vacancy rate stands at 32% as of the second quarter of 2023, the region is facing a long road to recovery.

First, let’s identify the problem. How do we compare to other regions?

As we explored in the jobs section of our analysis, the pandemic and resulting work-from-home policies — more prominent in the region’s vast tech sector — deeply affected the way many companies approached hiring and the cost of doing business. Within the region, San Francisco saw the largest increase in office vacancies among major markets, going from a 4% vacancy rate in Q4 2019 to 32% by Q2 2023. This 28 percentage point increase is nearly double as high as the next highest increase, a 10 percentage point increase in the Tri-Valley. Net absorption in the region is also remains negative —meaning that there is more space is coming onto to the market (via new construction, subleasing and lease expirations) than new leasing activity.

Such a dramatic increase in San Francisco’s vacancy underscores a downturn in what was once a red hot office market. Places like Austin have also experienced an increase in office vacancy, however there are fundamental differences in what’s driving high vacancy rates in these two places. For San Francisco, increased vacancy is part of a broader decline in office demand reflected in higher remote and hybrid work arrangements, lower employment and job postings (see section on jobs), lower migration into the city (both temporarily via low commuting and permanently via low immigration), and lower business activity (see section on economic activity). For Austin, excessive building led to its increased vacancy rate. Yet, it’s one of the fastest growing office markets in the country, experiencing positive net absorption every quarter since the beginning of 2021. 

Why have the office markets in the Peninsula and Silicon Valley been more resilient than San Francisco’s?

Within the region, there has been greater leasing activity in the Peninsula and Silicon Valley, boasting much lower office vacancy rates of 18% in Mountain View/Los Altos, 20% in Palo Alto, and 18% in San Mateo, despite the fact that asking rents in the Peninsula are higher than any other submarket in the region. One hypothesis points to the different in maturity of these two markets – Silicon Valley and the Peninsula are home to older deeply rooted technology companies that have also invested (and continue to invest) huge sums of money on their corporate campuses. San Francisco’s tech boom, by contrast, has been driven by venture capital-backed startups and younger public companies that pivoted more easily and quickly to remote work. 

There is also a higher demand for research and development (R&D) spaces in the South Bay. Life sciences and biotechnology firms often require more space and are less impacted by remote work trends – which has led to a faster recovery in leasing activity for these spaces. The Peninsula’s R&D lease rates grew by 7.2% in the fourth quarter of 2022 to a new high watermark of $7.30 per square foot. At the same time, office lease rates fell by 1.7%, marking the third consecutive quarter of negative growth. Silicon Valley’s R&D lease rates grew by 2.1% in the second quarter of 2022, while office lease rates showed more modest growth, increasing by 0.2%. Of course, vacancy and occupancy trends do not indicate the extent to which employees are coming into the office. The San Jose metro area, which includes most of the South Bay, still has a fairly low office attendance rate of 38%, according to key fob data from Kastle Systems, 4% lower than San Francisco’s rate.

Has venture capital investment been affected?

For decades now, the Bay Area has been the epicenter of venture capital investment. The investors themselves are concentrated here, and much of their investment capital flowed to Bay Area-based startups. That proximity allowed for easy exchange of information between companies and investors, and it provided a network effect that made Silicon Valley a magnet for entrepreneurs from across the globe. Those entrepreneurs started companies that are now some of the region’s largest private employers in the tech industry. Even amid a downturn in hiring and leasing activity, the Bay Area remains unrivaled in its amount of venture capital (VC) funding, especially early stage funding, a measure of investment activity into start-up companies. The San Jose metro area received $1,457 of Seed and Series A funding per capita in the second quarter of 2023, and San Francisco received $1,313 – a total of $8.8 billion. Boston, a growing player in the life sciences and biotech industries, received 40% of what the Bay Area received.

What’s next?

The region’s downtown areas cannot rely on bringing back the same office workers that once commuted to its central business district to fortify a slow real estate market or struggling leisure and hospitality industry. Even beyond 2023, San Francisco’s office vacancy rate may continue to rise, as thousands of leases are slated to expire within the next two to five years. To get a better sense of how employers are thinking about office space and return to work strategies, the Bay Area Council has been collecting monthly survey data from roughly 200 employers throughout the region (in partnership with the Metropolitan Transportation Commission and EMC Research) to inform transit agencies and policymakers. As of March 2023, 68% of employers said they are already operating under their “new normal” in terms of bringing employees back to the workplace. When asked about frequency with which employees come to the office, employers said that 49% of their workforce comes in 1-3 days a week, and that 21% don’t come in at all.

We recently started asking employers if they’ve reduced or consolidated office space in the region, or if they have plans to in the next few years. Of the 160 employers that responded in March 2023, 22% say they’ve already reduced or consolidated their total office space in the Bay Area, and another 23% say they plan to reduce or consolidate their office space in the region over the next few years. This indicates a significant loss in property taxes – with some figures projecting a nearly $200 million loss each year in the City of San Francisco. Moving forward, cities are likely to adopt creative strategies to increase vitality and economic activity downtown, which may include an increased focus on R&D and life sciences, new residential construction, reformed zoning codes, or reinvigorated nightlife and events.

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