Features

SAN FRANCISCO — With millions of square feet in new office construction and few tenants in sight, San Francisco is facing a commercial real estate glut rivaling the excess development of the late 1980s. 

More than 3 million square feet of prime office space is under construction and scheduled for delivery within 12 to 18 months, according to brokers. Another 3 million square feet is approved for building in San Francisco but pending groundbreaking. 

That new space, combined with falling rents, high vacancies and a huge amount of sublease space, is spelling trouble for a market that fairly recently posted record rents and single-digit vacancies. 

“This is the highest vacancy in two decades, and millions of square feet of sublease space is hanging over the market and depressing rents,” said Margaret Duskin, a senior director at Cushman & Wakefield, a global real estate firm. “We’re all concerned at the lack of demand in office product.” 

Many of the new buildings coming online were planned during the dot-com boom and will apparently open up amid slumping demand for space. Developers, for their part, say they are continuing to build during the slower climate because city entitlements carry strict construction timetables. 

“We are going forward because the entitlements are structured in such a way that we have to go forward,” said Rob Paratte of Wilson Equity Office, which is building the 1.1 million-square-foot Foundry Square office complex. “Our view is that things will be very difficult, but it’s not going to get appreciably worse.” 

Foundry Square was intended to serve thousands of new tech workers. Technology giant Sun Microsystems preleased about 500,000 square feet, but brokers said that as much as half of that space will be dumped on the sublease market as soon as the buildings open. 

Developers of a number of other high-profile projects who were counting on the dot-com economy to provide tenants are also proceeding despite an uncertain future. 

The projects include a 155,000-square-foot building across from Pacific Bell Park, a 260,000-square-foot building on Potrero Hill and a 660,000-square-foot building in the south Financial District. 

The Financial District building was preleased by JP Morgan Chase, but that firm said it will put the space on the sublease market.  

Brokers said it illustrates the current dilemma facing companies that preleased space at high rents in a hot market. 

“The JP Morgan lease deal was done in a bold environment,” said Dan Cressman, managing director at real estate services firm Grubb & Ellis, which recently predicted a 25 percent vacancy rate in San Francisco by the middle of next year. “It was dot-com growth that fueled the increase in rental rate.” 

As of Oct. 1, the average Class A office rent in San Francisco was $43 per square foot, a stunning decrease from the record high of $80 last year. Average Class B rents have fallen to $30 per square foot from a record $68 last year. 

The last time the city endured such a glut was the late ’80s, a period that followed an intense political debate over downtown development. The excess office space produced by that boom took several years to fill. 

Experts said the spike in construction this time happened much more quickly, with normal business assumptions temporarily suspended. 

“Nobody looked at operating expenses,” said Paratte, referring to the headlong rush to find office space. “People focused on tying up space. Now it’s back to basics.” 

On the other hand, Cressman said the current market means it is a great time to be a tenant. 

“Ten years ago, the (downturn) occurred a lot more slowly,” he said. “We’re taking a big hit, but I think a lot of the empty space will be absorbed over time. You can view it as the sky is falling, or you can see the net of it all as greater opportunities for tenants.”