Is Office Demand Coming Back?

The Real Estate Espresso Podcast

Is Office Demand Coming Back?

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Is Office Demand Coming Back?

Welcome to the Real Estate ~~Express’s~~ 📝Espresso Podcast, your morning shot of what’s new in the world of real estate investing. I’m your host, Victor Menasce.

On today’s show we’re talking about the office apocalypse, but first, I’d like to invite you to our upcoming Built to Scale Mastermind November 9 through 13th in Tulum, Mexico. This exclusive four-day event is for you to learn how to scale your business and your life. This is an opportunity to spend four high-quality days with the leadership of ~~Y3~~ 📝Y Street Capital and to take your investing business to the next level. To learn more, click on the link in the show notes. We’d love to have you at the Built to Scale Mastermind in Tulum, Mexico November 9 through 13.

On today’s show we’re talking about the office apocalypse and how it’s been felt across most major cities worldwide. The impact of the pandemic was to reduce the need for conventional office space. There are still people working from home who were in an office environment back in 2019. But slowly, demand for conventional office space is starting to normalize. ~~We’re markets.~~ 📝We’re seeing that in several markets.

Now on today’s show we’re going to look at San Francisco specifically. This city took a major hit in office vacancies. Several commercial real estate reports indicate that the peak office vacancy rate in San Francisco was 36.6% in the first ~~my~~ 📝quarter of 2024. That’s according to CBRE. Other reports have cited rates slightly above 37 percent. Based on the vacancy rate and the total inventory in the market, we can estimate that in fact ~~be~~ 📝to be about 36.6 million square feet of vacant space. About 10 million square feet of that vacant space was in the downtown alone.

We’re now starting to see a resurgence in demand. Now the numbers might seem small because the vacancy is still incredibly high. This year started on a shaky footing. The first quarter began with, of course, a very high vacancy rate, with some reports citing an overall vacancy rate increasing slightly from the end of 2024, so it was still getting worse in the first quarter of this year.

Leasing activity was strong, with one report noting ~~that~~ 📝it was the highest quarterly volume since the start of the pandemic era. But it wasn’t enough to make a dent in the overall vacancy because at the same time there was a lot of space being vacated as leases ran out.

The second quarter did see a notable shift. Several reports indicate the vacancy rate decreased. One report from CBRE states the vacancy rate dropped to 34.8% from 35.8% at the end of the first quarter. CBRE reported net absorption of 780,000 square feet. That is a notable turnaround and the first time the market has seen positive absorption in a long time.

The AI sector was the undisputed leader in leasing activity. Companies like Harvey.AI, ~~Databrix~~ 📝Databricks, and others were consistently responsible for a significant portion of the new leases. One report noted that AI companies accounted for 40.4% of all new leasing activity in the tech sector in the second quarter.

Now the companies are not just leasing space, they are leasing high-quality space. A majority of the leasing activity was concentrated in Class A and Trophy properties, which offer way better amenities and more modern layouts.

Coinbase, the crypto company, signed a new lease for 151,000 square feet at Mission Rock Building B. This is a relocation to a new, more modern development. It highlights the flight-to-quality trend where companies are opting for newer amenity-rich buildings.

While there were a lot of new leases, there were a few fairly significant givebacks. Google vacated 365,000 square feet, contributing to negative absorption to offset some of the gains. Another strong leasing activity was the City and the County of San Francisco. The city itself committed to 224,000 square feet in the Mid-Market area. That’s a significant boost for that sub-market. That major lease represents a consolidation of newly renovated space that will result in major operational savings as they vacate about 20 other buildings to consolidate into this one space.

Salesforce.com is a good example of a company that had previously embraced remote work and the hybrid model during the pandemic. The company announced a permanent policy allowing the majority of employees to work remotely or in a hybrid schedule. This drastically reduced the need for a large amount of dedicated office space they had planned to occupy. As a result of that shift, they made a strategic decision to significantly reduce their overall real estate footprint in San Francisco. They cancelled major lease commitments at the unbuilt Tower F, which represented about 325,000 square feet.

At that time, CEO Mark Benioff had stated that office mandates are never going to work. But the company has since reversed course on that policy. Effective October 2024, the company has established a new policy with different categories. Certain departments like sales, workplace services, data center engineering—anything reporting to the Chief Information Officer—are required to be in the office 4–5 days a week. Other departments like legal, product, and marketing are mandated to be in the office at least 3 days a week. And then some specific engineering roles have a less frequent requirement like 10 days a quarter.

Full-time remote work has become the exception rather than the norm. It’s only granted under very specific limited circumstances like, for example, working at a client site.

Google reduced their footprint by 365,000 square feet. Some of that may have been driven by layoffs. But the reductions at Google have been fairly small in the Bay Area. In 2024, the company reduced about 750 people, much of that concentrated in Mountain View. But most of the reductions this year have actually been quite small in numbers. The smaller footprint I think is attributed to more efficient use of space and some hybrid work.

But even Google is pushing employees to return to the office, with termination of employment being a consequence of non-compliance. Tech companies—new and mature—are all embracing the notion that people are more productive in the office environment than working from home. That would eventually result in the absorption of office space and the vacancy being concentrated in the oldest inventory in the market.

Vacancy is still above 30%, which is incredibly high. But there are signs of renewed demand for office, albeit in a smaller footprint.

As you think about that, have an awesome rest of your day. Go make some great things happen, and we’ll talk to you again tomorrow.

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