COMMENTARY: San Francisco’s Real Estate Nightmare: Office Vacancies and Urban Flight

Devan Bhumralkar, Stanford University

In early 2023, the office vacancy rate in San Francisco climbed to a record 34.6%. The compounded effects of the remote work movement, massive layoffs in the tech industry, and the general economic downturn have left the city’s once-thriving financial district seemingly empty. Although one of the worst examples, San Francisco is not unique: High office vacancies have been the story nationwide, with cities like New York and Chicago seeing vacancy rates of 16% and 19%, respectively. 

More alarming about the situation in San Francisco is the coinciding trend of “urban flight”—the city’s population reached its lowest level since 2012 this year. Real estate markets in the city have begun to cool, yet as net absorption for both office space and luxury housing declines amidst the backdrop of a shortage in affordable housing, dislocation in real estate markets could be detrimental to San Francisco’s residents and investors alike.

The downturn in net absorption for office assets in San Francisco began in early 2020, likely brought about by COVID-19 lockdowns and the switch to remote work. This figure reached its lowest point in Q3 of 2020 at a level of -7,000,000 square feet and is yet to reach positive levels. In contrast to 2020 and 2021, in which vacancies were largely attributed to lease abandonment, non-renewals, and unleased new construction, office space brought to market in 2023 can largely be traced to subleasing by major tech companies looking to downsize their office footprints in San Francisco.

This feature of the high vacancy rate should be the most concerning to investors. The tech industry accounts for over 18% of San Francisco’s private sector employment and over 32% of its private sector payroll. Over the course of the past two decades, San Francisco’s economy, which is now 72% driven by office-based industries, has become reliant on the tech industry. As tech giants like Salesforce and Meta have announced layoffs of tens of thousands of employees, millions of square feet in office space have come to market in San Francisco, the bulk of which has not been absorbed.

Economic turmoil is by no means isolated within the tech industry, and with rising interest rates and increased fears of an impending recession, real estate deal velocity has slowed. Moreover, the availability of leveraged loans started to dry up in 2022 as the result of market volatility and uncertainty, a process that is sure to continue in the midst of recent bank failures. The result of this dislocation is an accumulation of private equity dry powder and an increased role for private direct lenders. But high vacancy rates and distressing trends in the tech industry have turned these private investors away from San Francisco, leaving the city’s real estate market with a deeply uncertain future.

Naturally, the effects of these shocks extend beyond the market for office space, as residential markets have begun to cool as well. San Francisco County experienced a 6.7% decline in median home price between 2020 and 2021, the largest of any Bay Area county. In addition, the city saw a 66% rise in listings with a price decrease, one of the best indicators of a decline in the demand for housing. Because these downtrends predate the tech layoffs and bank failures of late, early market cooldown was likely the result of rising interest rates and uncertainty, meaning that the compounded effects of the city’s economic downturn are yet to hit residential markets. As companies abandon their offices and cut employment in San Francisco, residential real estate prices could tumble even further. 

But in a city that has struggled with housing affordability for decades, it may be tempting to view the cooldown in home prices as a welcome byproduct. After all, rising prices in the city have been cited as a key issue driving the housing crisis in the area. Notwithstanding, and perhaps counterintuitively, cooling real estate markets do nothing to address the affordable housing crisis and may disproportionately harm lower-income groups. To contextualize recent trends, the aforementioned 6.7% decline brought the median sale price in San Francisco to $1,422,500. Compared to the statewide median of $722,000 and the national median of $436,800, San Francisco still remains one of the most costly places to live. The economic toll of high-income businesses and individuals leaving San Francisco is likely to have the worst effects on low-income households. As was the case in many Rust Belt cities during the period of deindustrialization, those who can afford to leave the city will do so the earliest in times of economic distress, leaving those who cannot behind. Public goods and social services, funded by the most wealthy but crucial to the least, will deteriorate as the tax base erodes and economic activity slows in the city. The results of urban flight, driven by a collapse in the office markets, could be devastating for San Francisco residents.

San Francisco is, as of now, not beyond saving. The city still boasts a gross domestic product of over $200 billion, and unemployment has contracted even below pre-pandemic levels to 2.9% in February 2023. Despite massive layoffs, many tech firms based in the area still employ more workers now than they did before the pandemic. Nonetheless, it is crucial to see the signs early, and an office vacancy rate of over 30% is a clear red flag. The city has recourse in this transitional period, but with investor confidence souring, it is imperative that decisive action is taken to curb these alarming trends so that San Francisco can avoid the fate of cities like Detroit.

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