Our client is a full-service marketing firm founded by four marketing professionals that rose from the depths of the dotcom bust in San Francisco.
The Perfect Storm
San Francisco’s proactive approach in the 2010s to luring companies away from Silicon Valley established the City as the new epicenter for the tech economy. Over the past decade tech firms and coworking space providers gradually expanded into the City which more than doubled rents creating one of the country’s most expensive office markets. As a result, many traditional businesses and institutions were squeezed out of the City’s most desirable buildings and submarkets.
Then, on March 17, 2020, San Francisco issued a stay-at-home order. According to CoStar, daily asking rents on that date in the Financial District submarket were $74.59/RSF and vacancy was very tight at 6.5%. Two years later, San Francisco had the highest sublease availability rate in the country. On St. Patrick’s Day 2022, market uncertainty caused by the pandemic had tripled vacancy in the Financial District to a staggering 19.8% and had driven down asking rents to $59.20/RSF.
In the slow recovery from the pandemic San Francisco, with a large population of work-from-anywhere friendly companies, sat at the bottom of major metros nationwide in return-to-office rates. The energy that attracted tech firm employees to working and living in the City became the very thing that employees of work-from-anywhere companies now want to avoid.
When our client’s Civic Center submarket lease expired amid the pandemic they temporarily shifted to a work-from-home model while also securing a small coworking office for the principals rather than renew an office lease that they weren’t using. Because they were on a month-to-month lease and had clearly defined business and real estate objectives they were well prepared when the time came to return to the office.
One of their most important requirements was for the office to be located near public transportation which in San Francisco means along BART, Muni bus, light rail Metro trains, streetcar and iconic cable cars lines. To find the best combination of value and fit we searched for turnkey spaces with little to no tenant improvement work required. And, the building had to be dog friendly.
Solution & Process
The good news for tenants is that the pandemic has created plenty of options. In fact, you could easily find over 100 spaces that met their rough size, layout, and location criteria. We needed to refine our search to a manageable list of space alternatives.
Class of Office Building. We settled on Class B Office buildings which offer “character” without the abundant amenities that a class A building have. They tend to have average finishes, adequate systems and overall good condition.
Term. Pre-COVID there was a direct correlation between the lease term you were willing to commit to and the quantity and quality of options you would have. But that all changed with the pandemic. Some Landlords that previously demanded five- or seven-year lease terms were now insisting on shorter terms. Some didn’t but that needed to be vetted. Our client was steadfast in their desire for a longer lease term to minimize the future disruption to their business.
Budget. Rather than focusing on rent per square foot, we determined up front what the budget was for occupancy costs including but not limited to operating expenses “pass-through”, base rent escalations, parking, utilities, janitorial, relocation, insurance, furniture, and other office fees. Focusing only on the alternatives that didn’t exceed their budget helped refine our search to a manageable list of alternatives. A building with the lowest base rent doesn’t always guarantee the lowest cost of occupancy.
Layout. No two spaces with the same square footage are the same. A rectangular space is much more efficient and will support more people than layouts with round or angled corners. We required some open space for collaboration, two medium offices, a small conference room and a kitchenette. We focused only on alternatives with efficient layouts that supported our requirements.
Amenities. Fiber internet, walking distance to transportation, quality bathrooms and even the number of electrical outlets were differentiators between similar space alternatives. These were not all deal breakers, but we communicated the desire for these amenities up front and were more quickly able to refine our search to a manageable list of alternatives.
Plan B. We thoroughly researched, toured, and engaged our options to give us a Plan B in case we were unable to work out an agreement with our top alternative. There is no negotiation leverage if you aren’t willing to walk.
The Shift in Negotiating Leverage
For the first time in a decade, tenants that were previously priced out of the highest quality spaces in San Francisco have gained negotiating leverage created by two years of pandemic. Office space with modern amenities in transit friendly locations can act as a catalyst for return-to-office initiatives as well as a competitive advantage for recruiting new talent.
As tenant representatives we work exclusively with tenants. Never landlords. We ended up negotiating a five-year direct lease for our client that was 42.9% below the 2020 starting rent for the same space. The landlord offered a large palette of concessions to make the lease even more enticing including tenant improvements, free rent, an OPEX cap, and a one-time exemption on a property tax pass-through in the event the building is sold to an outside buyer.
Now, a 42.9% drop in negotiated rent from pre-pandemic may be an outlier but it signals a shift in negotiating leverage from landlords to tenants.
Despite the pandemic, talent remains the fuel for viability and growth. While some tech firms with work-from-anywhere policies struggle with the uncertainty around their need for office space, businesses that want their employees to work from a central location are taking advantage of the staggering vacancy rate and return to the most desirable buildings and locations in San Francisco.