San Francisco’s industrial real estate market continues to suffer from an aging supply and virtually no modern development. Q4 2022 saw overall negative absorption and low leasing volume. The area is losing tenants as they move to more affordable surrounding regions.
Despite the subdued activity, average rents increased significantly across the year, and vacancies remain near record lows. Landlords can expect regular rent increases amidst constrained supply and high demand.
General Area Overview & Demographics
San Francisco is the fourth largest city in California, with a population of 894,584 as of 2023.
The median age is 38, and the median household income is $119,136. San Francisco has the highest per capita income and the sixth-highest aggregate income in the US.
San Francisco’s warm Mediterranean climate is characterized by temperate summers and cool winters. Temperatures hover between 50 and 80 degrees F most months of the year, and snow is rare. The city is known for its fog and agreeable climate.
San Francisco is a global city with a highly diversified economy and significant activity in technology, medical research, and software sectors. The city is a central hub for startup and venture capitalist activity and also has a world-renowned artistic and cultural scene.
Summary of San Francisco Industrial Real Estate Performance in Q4 2022
The San Francisco industrial real estate market had a sluggish quarter, posting 95,953 square feet of negative absorption. Despite the negative absorption, vacancy rates fell 20 basis points to 4.5% in Q4 2022. Vacancy rates have dropped nearly 40 basis points YOY as tenants face heavy competition with high demand and supply constraints.
Submarkets with the highest absorptions were Potera East and India Basin, with 75,331 and 3,693 square feet of positive absorption, respectively. The quarterly negative absorption brings overall YTD absorption to 95,953 negative square feet.
What are industrial rents like in San Francisco?
Average industrial asking rates increased to $24.97 per square foot in Q4 2022, representing a 27% YOY rental increase, despite the negative absorption. This makes San Francisco one of the most expensive cities to lease commercial real estate.
Constraints on warehouse and flex space, in addition to high demand, have allowed existing landlords to negotiate higher rents, especially on new constructions. Industrial space conversions have also influenced scarcity and increased rents.
Average warehouse/distribution rental rates were $25.82, while average manufacturing rental rates were $27.77. The submarkets with the highest average asking rates were Showplace Square, Dogpatch, Potrero East, and Potrero West at $30.00, $28.20, $25.39, and $25.00 per square foot, respectively.
Purchase & Leasing Activity
Leasing activity has slowed considerably in San Francisco as development is virtually non-existent. A significant amount of existing space is obsolete or in need of functional updates, and modern space with high-quality amenities is rare. These shortcomings are pushing tenants out of San Francisco proper into surrounding neighborhoods in the Bay Area.
Notable Industrial Real Estate Deals in San Francisco
Despite the negative absorption and lower leasing velocities, the San Francisco industrial real estate market posted some noteworthy lease and purchase transactions in Q4 2022, including:
- RoadOne’s 232,881 square foot lease at 8350 Pardee Dr.;
- Performance Food Group’s 266,825 square foot lease renewal at 7501 and 7597 Las Positas Rd.;
- Moxion Power’s 200,000 square foot lease at 1411 Harbour Way;
- The Cary Company’s 148,440 square foot least at 6150 Las Positas Rb.;
- BioMed Realty’s $80 million purchase of 84,000 square feet at 513 Eccles Ave; and,
- BentalGreeOak’s $120 million purchase of 574,847 square feet at 38811 Cherry St.
As supply constraints upset the supply-demand balance in San Francisco, tenants will start moving to surrounding neighborhoods and regions.
New Industrial Real Estate Development in San Francisco
The San Francisco industrial market had no significant deliveries this quarter, continuing the trend of low construction activity. The average age of industrial space in the US is 43 years, and only about 7% of San Francisco’s industrial real estate stock was built after 2000.
Although demand for modern facilities is high, arduous zoning laws and building regulations have caused developers to abandon plans. Construction regulations make building in the Bay Area difficult as developers have to deal with a lengthy entitlement process.
Given these harsh market conditions, there are no construction deliveries planned for the near future.
Market Forecast for San Francisco Industrial Real Estate Market in 2023
As the San Francisco industrial market moves into 2023, it will face problems from supply-demand imbalances and aging infrastructure. Many facilities require electrical updates to meet modern tenants’ power needs, and the high costs and regulations for construction in the Bay Area make developers hesitant to pay for capital improvements.
The main factor keeping businesses in San Francisco is the proximity to the Bay Area and its consumers with higher-than-average household incomes. Given that no new industrial construction is in the development pipeline, tenants will face high competition for traditional leases for limited space.
Takeaways for Industrial Real Estate Investors
Experts don’t expect the poor conditions in the San Francisco industrial market to go away anytime soon.
Investors should be wary of delays in permitting and infrastructure updates, as developers have abandoned projects due to long entitlement processes. In the meantime, high demand for limited space in the heart of the Bay Area will drive rental increases and limited lease concessions.
Like always, do your research, stay vigilant, and happy investing.