San Francisco Office Market Shows Signs of Life

Technology companies’ rapid adaptation of remote work, along with an increase in crime and other quality-of-life concerns, hollowed out San Francisco’s business district. Vacancy rates soared to new highs, while building values plummeted.

Now San Francisco’s office market is seeing progress for the first time since the onset of the pandemic. Company searches for office space in the city are the highest they have been in years. Firms in the growing artificial-intelligence industry are leasing large blocks of space, signaling that the city’s appeal as a tech hub hasn’t evaporated.

After a long stretch when the city’s office buildings couldn’t attract buyers even at cut-rate prices, sales are slowly materializing. Investors have purchased or agreed to purchase five major office towers in recent months, already making 2023 the most active year for sales since 2019.

Office transactions are resuming largely because some sellers are at last surrendering, accepting prices that would have been laughable four years ago. A local investment group, for example, purchased 350 California Street for $61 million, or about a fifth of what the building was valued at before the pandemic. Other recent sales have gone for half or less of the office property’s prepandemic value.

As painful as those deals are to the sellers—and to other San Francisco office owners whose property values will reflect the recent fire sales—investors and landlords said periods of capitulation are the critical first steps toward recovery of real-estate markets that have been in free fall.

These first few sales are helping determine the value of San Francisco’s office stock. That knowledge tells landlords which price tags to put on their properties if they want to sell. It informs investors of how big a discount to expect.

The recent sales activity “is part of the adjustment that we’ve been waiting for," said Ted Egan, San Francisco’s chief economist. “The market-moving is healthy."

The new valuations are helping reset office rents, now that tenants and brokers know how far the new owners can cut rents and still make a profit. A venture of Swig Co. and SKS Partners, which acquired 350 California Street, have set asking rents in the range of $50 to $70 a square foot. Before the pandemic, asking rents for comparable space were around $90 a square foot, said Connor Kidd, Swig’s chief executive.

Others are taking advantage of deeply discounted sales prices to spruce up their new purchases. K. Cyrus Sanandaji, managing principal of Presidio Bay Ventures, recently acquired the office tower 60 Spear Street in the city’s financial district for about $41 million, or some 62% less than it sold for in 2014.

That low price will enable Presidio to add such amenities as a rooftop restaurant and bar and a fitness center to the building, Sanandaji said.

San Francisco office landlords charged some of the highest rents in the country for decades. Even before the pandemic, some businesses felt compelled to relocate to cheaper cities, from Austin, Texas, to Nashville, Tenn. Now rent levels have fallen to the point that some tenants who were priced out of the city can afford space.

“When prices come down, it makes San Francisco competitive again," said Nigel Hughes, senior director of the data firm CoStar Group.

San Francisco office brokers said that companies have search requests for 4.5 million square feet of office space, compared with 2.5 million square feet in January.

Overall this year, searching activity for San Francisco office space has increased by 40% from last year, according to the data firm VTS. The number of tenants looking for large blocks of space 50,000 square feet and above has more than doubled, VTS said.

Much of the demand is from the AI business. Six such companies, including Hive AI and Hayden AI, have leased a total of about 150,000 square feet, according to CoStar.

Two other AI companies are close to signing the largest office leases ever for the sector, according to brokers. Anthropic is close to subleasing the former Slack headquarters building, and the ChatGPT developer, OpenAI, is negotiating with Uber Technologies to sublease about 200,000 square feet of its space, these brokers said. Those two lease signings would help mop up some of the more than 12 million square feet of the city’s sublease office space available, the highest amount ever for San Francisco.

San Francisco’s office market isn’t in recovery mode yet. The city’s office vacancy rate stands at a record level of more than 25%. It is likely to climb higher as businesses keep shedding space under hybrid workplace strategies, according to Derek Daniels, regional research director for Colliers.

Office rents are likely to fall further. The new buyers of San Francisco office towers can afford to charge rents that undercut the rest of the market and still be profitable. Unable to compete with the lower rents, more owners will likely capitulate and join the growing list of sellers willing to take big losses.

Sales at distressed prices are poised to continue. North Park, an office complex formerly known as Embarcadero Center, is on the market with an asking price of around $90 million from the owner, Blackstone, and its lenders including ING Groep, said people familiar with the matter. Blackstone bought the property for $245 million in 2018.

“We effectively wrote this property off last year and are working collaboratively to exit this investment," a Blackstone spokeswoman said.

Higher mortgage rates, meanwhile, continue to pressure owners of even fully leased office buildings. An extended period of economic uncertainty will probably persuade many property owners to give up.

“Almost every week there’s another building that’s coming delinquent on its loan," said Hughes of CoStar.

Brokers said that plenty of investors are ready to buy in San Francisco at these steeply marked-down prices. Each of the recent fire-sale deals attracted more than 10 bidders, according to Kyle Kovac, executive vice president at the commercial real-estate services firm CBRE, who brokered the 350 California Street deal.

“There’s a lot of money that’s out there that is now ready to jump into San Francisco," he said.

Write to Peter Grant at peter.grant@wsj.com