Demand for San Francisco Offices Plunges


The dot-com bust and a slowing national economy have sent San Francisco's lofty office rents plunging by more than one-third and have boosted the city's vacancy rate to the highest level since the recession years of the early 1990s, according to a new real estate market survey.

The months ahead promise more financial pain for landlords and great deals for tenants as a surge in new construction and cutbacks by some of the city's leading employers will put more empty space on the market.

"We have people who have been in the business 20 years saying, 'I have never seen this before,' " said broker Michael McCarthy at Colliers International. "What we don't have now is demand, and that's a very significant concern."

During the second quarter of 2001, the vacancy rate for downtown San Francisco jumped to 9.91% from less than 2% in the same period last year, according to Grubb & Ellis Co.

The average asking rent for the most desirable office space--Class A--fell 34.73% to $51.40 a square foot on an annual basis.

During the first half of 2001, San Francisco landlords leased 2 million square feet of space. But that was a fraction of the 6 million leased during the same period last year and not enough to offset the acres of offices available for sublease and newly built and vacant buildings. As a result, the city's pool of available space grew by 2.4 million square feet during the first six months of this year.

Ground zero for the market's implosion is in the South of Market area, where millions of square feet of former warehouses had been transformed into chic and high-priced real state for "new-economy" start-ups and high-technology tenants.

In this area, Class A rents tumbled by 44.76% and second-tier properties posted declines of nearly 60%. More than a quarter of the space is vacant, according to Grubb & Ellis.

The only bright spot in the report was that the pace of falling rents and occupancy rates has slowed.

"There is still more room to fall, but you got to believe that the [rents] won't decline as quickly," said Colin T. Yasukochi, market research director for Grubb & Ellis' San Francisco office.

Most of the tenants in the market are smaller players who can now afford to shop around for space in buildings that were once off limits.

"They were sort of shut out of the market when it was hot," Yasukochi said. "The landlords were not willing to cut floors up [for multiple tenants]. Now they are willing to do that."

Despite the market's trouble, San Francisco's second-quarter statistics would be the envy of office-building owners in most other cities.

Downtown Los Angeles, for example, posted a second-quarter vacancy rate of about 17%--nearly twice as high as San Francisco's, according to report by Cushman & Wakefield.

Meanwhile, San Francisco's average asking rent remains more than twice as high as downtown Los Angeles' $24 a square foot.

Still, San Francisco's performance this year is a shock for a city that saw rents in its most prestigious skyscrapers peak at above $110 a square foot. At the height of the dot-com frenzy, some landlords not only charged sky-high rents but demanded stock from promising high-tech start-up firms before they signed a lease.

The most optimistic of brokers expect the market to bottom out later this year, but some say it will be well into 2002 before there are signs of relief. Few expect a return to the mania of last year and the year before.

"Anybody who believes last year was reality will be hurt," McCarthy said.


Free Fall

The once red-hot San Francisco office market has taken a tumble in the aftermath of the dot-com bust and a slowing economy.


The vacancy rate is rising ...

2nd qtr. 2000: 1.73%

2nd qtr. 2001: 9.91%


... and rents are falling.

2nd qtr. 2000: $78.76 per square foot

2nd qtr. 2001: $51.40 per square foot

Source: Grubb & Ellis

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