AI growth won’t be enough to save SF office sector, report finds

AI companies have leased 1 million square feet of San Francisco office space since 2020. But with about 30 percent of existing leases due to expire by the end of 2025, AI alone will not be enough to save the city’s office market, according to a new report from Savills and CompStak. 

Many commercial agents have pointed to growth in AI as a sign of hope as office vacancies reached new highs last year, hitting 32.2 million square feet. But 2024 and 2025 will be a peak time for lease expirations in San Francisco, and in gateway markets overall, according to the report, meaning that the lease rollover could add up to more than those AI gains. 

In San Francisco, 32 percent of leases set to expire by the end of 2025 were signed in 2019 and 2018, during the previous market peak, according to CompStak data.

While an expiring lease doesn’t necessarily mean that companies will abandon the city altogether, the trend since the pandemic has been towards smaller footprints, with shorter lease terms and lower price points. 

FitBit’s lease of about 500,000 square feet between 215 and 199 Fremont Street in Rincon Hill is one of the first major tech leases to expire later this year, according to CompStak’s Director of Real Estate Intelligence Alison Baumann. Google’s 400,000-square-foot lease at 345 Spear Street near the Embarcadero is up in 2025, as is PayPal’s 100,000-square-foot lease at 123 Townsend Street, near Oracle Park.

Like many of the upcoming expiring leases, these tenancies were signed pre-pandemic at higher than current market rates. According to CompStak, SF tech tenants with leases expiring from 2024 to 2025 are paying on average about a quarter more than the average starting rent for transactions signed in the last 12 months.

“Tech has been a solid driver of rent growth in pre-pandemic years, which is why it’s a concern that their leases are expiring and why a lot of people were excited about AI filling the gap,” Baumann said.

In addition, there has been a downward trend in the city on both transaction size and lease term lengths, with drops of 42.6 percent and 15.7 percent, respectively, from 2019 to 2023. 

Savills and CompStak expect that continued distress in the office market will lead to discounted sales, which will then greatly reduce rental rates in those buildings. Ideally, that lower rent could help to refill offices.

“That’s the current hope and thinking but the demand still has to be there,” Baumann said.

It would bolster the city several ways if it could boost its traction with Finance, Insurance and Real Estate companies, as these companies are signing leases in other markets and are more likely to require in-office commitments from their employees. The FIRE sector is “bolstering the NYC office market and behind many triple-dollar leases and larger transactions,” Baumann said. 

In San Francisco, as tech pulled back in 2022, FIRE companies made up more than 37 percent of all leasing activity. But that fell in 2023 to about 20 percent, just below the sector’s 2019 lease share. 

AI impact

The report is clear that the rapid growth of AI companies and their billions in investor funding is a positive for the market and the city’s employment numbers. It notes that seven AI tenancies over 15,000 square feet have been signed in the city since the pandemic, with six out of those seven being subleases from other tech companies. As of the fourth quarter of 2023, nearly 9 million of the city’s vacant 32.2 million square feet was sublease space, and of that, nearly 80 percent is from tech tenants. 

The OpenAI lease of nearly 500,000 square feet in Uber’s headquarters in Mission Bay is by far the biggest lease signed in the city in the last four years. Before that deal was finalized last fall, the biggest lease was Anthropic’s sublease of 230,000 square feet at Slack’s former headquarters in the South Financial District. Salesforce owns Slack and moved the company to its namesake tower last year. It is also a major investor in Anthropic, founded by former employees of OpenAI. 

AI companies have seen investment swell in the last few years, to the tune of $13 billion in VC funding since the pandemic just for AI companies leasing in San Francisco, according to the report. Artificial intelligence and machine learning, which could mean anything from autonomous vehicles to predictive analytics, made up 25 of the top 100 VC deals in 2023. Software as a Service followed with 15 deals and Health Tech had 12 deals.

The investment means that even as headlines focus on layoffs in tech, the city has actually gained 13.5 percent more tech jobs than it had in February 2020, according to the report, far outpacing the growth in the tech sector in other markets. 

Population is also on the way back up. After plummeting from about 875,000 pre-pandemic to about 840,000 in early 2021, the 12-month average population in the city was back up to around 860,000 at the end of last year, according to Placer.ai data.

Baumann said she was surprised to see how robust the tech employment figures have remained for San Francisco, given the continued negative narrative about the city. 

“We know that just because people’s place of employment is located in San Francisco, where they are actually physically working or living day to day may be further afield,” she said. “But this employment data signifies that San Francisco is still a major tech hub, which is why AI companies have chosen to locate there.”

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