Heading towards the end of 2023, the San Francisco multifamily market is showing signs of a cyclical slowdown in demand after the steady improvement of the past two years. Net absorption was only marginally positive in the third quarter, and the vacancy rate, which had moved lower every quarter since the pandemic, was flat. Weak demand has also impacted the rate and location of construction activity, with the focus shifting from San Francisco to the Peninsula. There are now more units underway in San Mateo County than there are in San Francisco.
At the end of 2023, the apartment vacancy rate in San Francisco stands at 6.7%. Annual net absorption, at 1,400 units, is about half the annual average that the market has seen during its recovery over the past three years. With very low levels of new deliveries, the muted absorption numbers suggest a cyclical weakness in demand. Renter interest has softened as a result of weaker economic conditions, such as continuing tech layoffs and high interest rates. Among the submarkets with the highest vacancy rates are those that saw the greatest exodus of tech workers during the pandemic and those with the worst street-level social problems. These neighborhoods include parts of Downtown San Francisco, Haight-Ashbury/Castro/Noe Valley, and Civic Center/Tenderloin.
The volume of new apartment completions in San Francisco has slowed. However, the pace of new construction has picked up recently, and approximately 2,000 units are projected to be completed in calendar year 2024. Over the longer term, San Francisco is generally more insulated from supply risk than most markets in the country. Stringent zoning, costly affordable housing requirements, NIMBY objections, and a lack of available land make the development process in San Francisco more arduous than in most U.S. cities. As a result, supply growth over the past 40 years falls below most major U.S. markets on a percentage basis, despite strong demand for more housing.
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Activity indicators for downtown San Francisco, such as Kastle Data Systems’ Back To Work Barometer, and transit ridership data from BART, show that the return to office, which had been steadily increasing in previous years, plateaued in 2023, suggesting that hybrid working has become entrenched as we head into 2024. While most of the current narrative is negative, there are bright spots. Leasing brokers report an increase in the amount of space sought by tenants in the market. Specifically, AI companies are active, with large sublease deals being signed in 2023 by OpenAI and Anthropic.
Heading into 2024, leasing conditions remain subdued. In the year ahead, tenants will continue to evaluate their space needs as they decide whether to renew leases that were signed prior to the pandemic. This may lead to further space reductions. Office utilization in downtown San Francisco, as measured by Kastle Data Systems key card activity, has increased slightly since last year but has been generally flat in recent quarters. The overall vacancy rate for the San Francisco Market increased to 21.7% in the fourth quarter and is forecast to rise further. Annual net absorption was negative by -9.6 million SF and, with 12.2 million SF of sublease space available, the availability rate has increased to 26.1%.
Office construction activity in San Francisco remains subdued, with developers reluctant to commence projects while demand for existing spaces remains weak. Currently, there are about 2.4 million SF underway. About 940,000 SF of new office space completed during the past 12 months. Major completions include Building B at Mission Rock in Mission Bay, a 311,000-SF life science building that is available for lease.
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With 2024 fast approaching, the San Francisco industrial market is seeing a continuation of the trends that have characterized 2023, with low levels of leasing, vacancy rising, and moderate rent growth. However, the two main industrial market segments are on different tracks. The flex market has been weakened by falling demand and historically high levels of new supply, while the logistics segment has remained generally stable.
The slowdown in leasing activity that began a year ago is still shaping activity heading towards 2024. Flex vacancy increased by 7.1% in the past year and stands at 17.8% in the fourth quarter. By comparison, logistics space vacancy remains close to its long-term average at 5.2%. Overall market vacancy ticked up to its current rate of 9.2%. Continued economic uncertainty and deliveries of speculative flex space in the months ahead are projected to cause vacancy to rise further in the coming quarters. Of the 4.8 million SF currently under construction, 3.7 million SF is available for lease
New construction activity in the flex segment is at an all-time high, with 26 projects comprising around 5 million SF of new flex space underway and set to deliver over the next three years. These projects are all flex buildings that are predominantly aimed at providing R&D space for the life science/biotech industry. This sector has seen high levels of growth and occupier demand in recent years. However, in the past 18 months, tenants have reigned in their expansion plans after interest rate hikes curbed funding for biotech businesses. In contrast, there are no logistics buildings under construction.
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San Francisco’s performance lags behind most other metros across the nation. Retail vacancy in San Francisco was one of the lowest in the nation in 2019, but it is now one of the nation’s highest. The City of San Francisco itself is characterized by general retailing along popular urban strips in heavily populated neighborhoods, such as Chestnut Street in the Marina District, Valencia Street in The Mission, and Hayes Street in Hayes Valley. In contrast to the current situation in downtown and Union Square, these retail zones are generally active and vibrant, with a healthy influx of new stores and restaurants.
Market vacancy stands at 5.9%. The market’s largest mall, Stonestown Galleria, has seen major changes in recent years. The owners have replaced Macy’s and Nordstrom with Target, Whole Foods, and Sports Basement, and it is currently planning to redevelop the mall as a mixed-use urban village, with the addition of 3,000 homes. San Francisco’s smaller retail centers and urban main street shopping districts have generally performed well in recent years, benefitting from the shift in working patterns that has led to people spending more time shopping closer to home in their local neighborhoods.
The construction pipeline consists of a small number of mixed-use redevelopment projects and a single Safeway store, with a total volume of 220,000 SF underway. Over the longer term, the stock of shopping center space is falling as other uses become relatively more valuable. Redevelopment of brownfield sites is an additional source of new retail space; however, these projects tend to focus on other uses, such as apartments and offices, with a smaller component of ancillary retail. For example, the Gateway at Millbrae Station is a large mixed-use project that includes residences, affordable housing, offices, and a hotel, together with 44,000 SF of street-level retail. The apartment buildings have recently completed, and the retail space is in lease-up.
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