In the past six years San Francisco’s tech-fuelled economy has pushed rents to all-time highs, sparked a massive building boom, and made the Bay Area one of the most dynamic and expensive regions in the world.
Tech companies have accounted for virtually all of this expansion over the past several years, and justifiably most of the media coverage on the San Francisco economy has focused on how technology companies have affected the real estate market and the region. There’s a worthwhile conversation to be had about whether the San Francisco economy is too exposed to tech; not unlike the Rust Belt was to manufacturing, or Russia and the Middle East are to oil.
A commonly overlooked reality is the fact that the San Francisco economy is pretty diverse. Companies like Salesforce, Twitter, Uber and Airbnb have fuelled massive amounts of job creation and absorption of office space. However, if one looks at who’s occupying the 75+ million square feet of office space that is leased in San Francisco, tech companies occupy less than half of the space. So how are more traditional companies navigating a commercial real estate landscape that has been completely transformed by the booming tech companies?
Corporate Behemoths Provide Stability
In addition to the aforementioned tech stalwarts, the largest employers in San Francisco include companies like Levi’s, The Gap, PG&E, Williams Sonoma, Wells Fargo and Charles Schwab. While these companies employ large numbers of people and lease or own significant amounts of real estate, they tend to not be active players in the real estate market, and in some cases have leased or owned the same buildings for decades.
They provide an underlying base of stability for the market, but for the past decade generally haven’t been consumers of space in S.F. Occasionally, companies like Schwab have cut back on large blocks of space — although in the most recent case for Schwab that space at 215 Fremont was immediately absorbed by a 300,000sf expansion by Fitbit.
While the overall trend with these types of companies is stability, recently some large users have re-evaluated how they use their space in San Francisco. McKesson, headquartered in San Francisco since the 1960s and with roots dating back to New York in the 1830s, is currently pursuing a sale of its headquarters building at 1 Post in the financial district. This sale would keep their corporate headquarters in San Francisco, but downsize their footprint in the building, while cashing out of a long-held real estate asset that has appreciated considerably in the last few years.
Union Bank is evaluating a similar strategy at their 400 California building in the heart of the financial district. A historic bank building overshadowed by a hulking 1960’s concrete high-rise, the structure would require a significant renovation in order to be marketable office space.
Union Bank and McKesson offer examples of long-time San Francisco companies re-evaluating their real estate needs in a changing market. However, the overall theme with similar large traditional employers in San Francisco is hunkering down in their current location and not making significant waves in the real estate market.
Who’s Active in the Market Other than Tech Companies?
The companies that are considering significant expansions in San Francisco are still, almost universally, technology companies. Of the 20 largest companies currently looking for space, 15 of them are tech companies, and all are looking for 50,000 square feet or larger. Based on typical occupancy standards, this is space for a minimum of 300 people for each of those requirements.
If we look at companies that are looking for 10,000-40,000sf — or, generally speaking, space for about 50 to 250 employees — there are a lot more non-tech companies in the market. These include financial services firms, law firms and consumer products firms, with FIRE (finance, insurance, real estate) and professional services firms comprising most of the demand. In this size range, there are still slightly more tech companies in the market than non-tech companies, but the numbers are closer to 50%/50%.
Looking at who has signed office leases in San Francisco over the past 6 months highlights the disparity between tech and non-tech. Of 197 companies that signed leases, 86 are tech companies (44%) and 111 are non-tech companies (56%) — fairly balanced, with non-tech companies slightly outnumbering tech.
However, of the 4 million square feet leased by those 197 companies, tech companies leased 3.16 million square feet (77.5% of the total space) and the 111 non-tech companies leased 918,000 square feet (22.5%). The average tech deal was 36,750sf and the average non-tech deal was 8,270sf — in other words, the average tech company is signing a lease that is 4x the size of the average non-tech company.
“These stats drive home the point that in a market where space is expensive and scarce, the large tech companies are making it very hard for the more traditional businesses to compete.
David Vs. Goliath
In the San Francisco Bay Area, tech companies are Goliath and non-tech companies are David. How does David compete?
For most of the non-tech companies, San Francisco’s expensive rents and high cost of living are huge challenges. However, there are changes happening in San Francisco’s extremely competitive commercial real estate market that help make this scenario more favourable to those non-tech businesses.
First, landlords are concerned about being overexposed to tech tenants. Landlords have reaped the rewards of tech companies causing rents to double over the past 6 years, but they also want to make sure they’re making a deal with a tenant that will be paying rent for the next 6 years. That makes established businesses increasingly attractive as tenants.
In many cases, we’ve seen landlords willing to offer more attractive terms to a more traditional, stronger credit business — perhaps a slightly cheaper rent, free rent or more generous tenant improvement allowance.
Tenant improvements are one of the biggest areas where established businesses have leverage with landlords. Despite a recent increase in vacancy, rents in San Francisco haven’t changed much — essentially they have stabilised after years of massive increases. Many landlords recognise that rents are very favourable to them, but also that the market has slowed down and tenants have more options, including move-in ready subleases.
In order to compete, it’s increasingly common for landlords to agree to a full turnkey renovation or to build a space out speculatively, as opposed to the typical model of a tenant improvement allowance where tenants are funding a significant portion of the build-out costs. As such there are more abundant opportunities to move into newly renovated and refreshed space without tenants having to make an investment of their own capital.
We’ve also found that the challenges of doing business in an economic boomtown can provide some leverage for tenants in negotiations with landlords. Many companies that have been in San Francisco for years and are dealing with burdens like snarled traffic and the disruption of major construction projects feel their rents should be going down, not up. For those tenants, making a compelling case to their landlord that a high rent is going to be the catalyst that forces them to downsize to a smaller space or move out of the city can help get concessions in a lease negotiation.
In short, the cost of doing business in San Francisco is as challenging as ever, particularly for companies that aren’t in the tech space.
Companies that understand the changing nature of the commercial real estate market, and what makes them desirable as a tenant, can position themselves to take advantage of increased motivation by many landlords.
Guest Blogger Eli Ceryak is a Senior Vice President and commercial broker for Cushman & Wakefield San Francisco. He represents a broad and eclectic client base, ranging from startup growth-stage tech companies to established Fortune 500 firms. Eli earned his undergraduate degree from Harvard University and received his Masters of Business Administration from the Walter A. Haas School of Business at University of California Berkeley.
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