Is San Francisco’s Sublease Sky Falling? We think it’s unlikely, here’s why.

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By: Amber Schiada, Vice President & Director of Research, JLL

Are we about to witness a sublease crisis in San Francisco’s office market?  We think it is unlikely in the near term.  Here’s why:

pexels-photo-29821Sublease space has increased, reaching 2.27MSF in the last week of March.  That’s up from an average of 1.5MSF throughout 2015. While any rise in sublease space is concerning and this amount of sublease space is approaching the levels we saw in San Francisco in 2009 (2.33MSF), we still have a long way to go to reach the astronomical level of sublease space – 9 MSF — that was dumped on the market in 2001.

If we look beyond this pure data, brokers report that the majority of large sublease spaces are seeing plenty of touring activity.  In fact, five of the top eight sublease spaces by size have pending deals in place.  That’s because we still have robust tenant demand, especially among large space users. JLL is tracking about 9.0MSF of current demand and there are around 20 tenants in the market for spaces over 100,000 sf, underscoring the need for large blocks of space. Only a handful of large contiguous blocks exist for occupancy today, and the sublease market is actually providing some supply relief in this segment.

Finally, even though tech subleases make up about half the available sublease space, these spaces are moving at an average of three months, versus six months for traditional spaces. One reason for this may be that the high cost to build out space in San Francisco today – our Project and Development Services teams report costs around $130-$140 per square foot for the average build-out — is causing some companies to think more about the bottom line when needing to expand their physical footprint.  In a cost-conscious environment, plug-and-play sublease space is filling a need for these tenants, as well as tenants who may not be able to see their growth trajectory beyond three to five years.

Our recent data show that San Francisco office landlords increased asking by $3.30 in the first quarter of 2016, reflecting some confidence that demand is still strong and likely to continue for the foreseeable future.

However, we’re watching the flow of sublease space extremely closely in San Francisco because we know that if a significant amount of space moves onto the market in a short amount of time, it will have an impact on the overall market.  Certainly, a drop-off in VC funding is one area of concern but let’s not forget that 2015 was a ‘banner year for VC funding’ …at least, until the fourth quarter.  Right now, sublease space is actually providing a safety valve for a market which was becoming very tight, especially in large block space.

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