AI Fuels Bay Area Office Hopes, But This Cycle Looks Nothing Like The Last

The Bay Area’s office market may finally be on the rebound, but the deals look very different from the last cycle. Instead of the blisteringly fast growth of the prepandemic era, the Bay Area office market is moving forward with caution as tenants rethink how they use space.

Long-term leases are giving way to shorter, more flexible deals, and the most competitive buildings are delivering turnkey, tech-enabled workplaces that emphasize collaboration and experience over square footage.

Preliminary net positive absorption of about 450K SF last quarter pushed vacancy down to 35.4%, a 30-basis-point dip from Q2. Sublease availability also fell by roughly 300K SF, and leasing activity in the third quarter was around 2M SF. Annual leasing activity is approaching prepandemic averages, according to JLL.

"San Francisco leases used to be tens of thousands of square feet. Average-wise, now it is probably sub-10K SF," Stephanie Ting of The Swig Co. said at Bisnow’s Bay Area Office Market Outlook on Sept. 30.

Artificial intelligence growth is a driving force in many of the changes in the market. Nearly 1M SF has been leased by 83 AI firms so far this year, with related players like venture capital and law firms also expanding. Tenant requirements have climbed to 9M SF, up 3M SF since January, according to JLL.

"Every day an AI company gets formed, and two days later they're joined with five others. So if you start a company, are you really going to take that long-term lease?" WeWork's Haris Totakhail said at the event, held at the Grand Hyatt San Francisco.

As a result, lenders for office spaces are cautiously reentering the market. They are showing a muted appetite for office investments with a focus on high-quality assets and an increased emphasis on yield and attractive loan spreads.

"Everyone wants yield," PGIM Real Estate Executive Director Jace Berges said. "I want deals that generate attractive spreads for our investors. I'm tired of doing multifamily deals at 110 basis points. Go find me the 200-plus-spread loan executions."

Investors show a preference for assets with strong fundamentals, balancing risk mitigation while still seeking opportunities. Many are waiting for market stabilization.

"Institutional investors love some element of predictability and data. If we can't say with any type of certainty when rent growth is going to start happening again, it's hard to have intelligent conversations at investment committee," Rockwood Capital Group Managing Director Matthew Friedman said.

"From a borrower standpoint, it's still a tale of two cities," Ting said. "We have great assets, but when we've been looking at new acquisitions, there's more appetite from lenders when you're going in at a low basis."

But across the Bay Area, not all submarkets are equal.

"Silicon Valley is still happening," TRI Commercial Executive Vice President Edward Del Baccaro said. "Apple just finalized its purchase of a 700K SF building in Sunnyvale for $365M. San Jose has an 18% vacancy. Oakland is insisting on going backwards. It's 30% vacant and experiencing negative absorption."

There are emerging pockets of opportunity, particularly around mass transit.

"Where we are seeing real traction is accessibility to mass transit," Totakhail said. "People want intentional space, a reason to go to an office, and they want to make that commute easy. Anything near Caltrain in Silicon Valley or near [Bay Area Rapid Transit] in San Francisco has been fantastic."

Landlords are adopting leasing strategies to attract and keep tenants, often having to get creative. Totakhail described interim approaches to deal with the difficulty of subdividing large floor plates with only two exits, like offering tenants the option to share spaces.

"The other strategy that doesn't bother the lender is you buy out a lease," Totakhail said. "So a tenant says, 'I can't move for a year.' OK, well, I'll take over your lease over here off the books, and meanwhile, you pay me a higher contract rent over here because you need to expand or whatever the case."

Asset management is also key. Getting to know tenants leads to higher retention, as does repositioning buildings with amenities like fitness centers, bars and private clubs.

"The goal should be to make your tenants' lives easier and be a good customer service provider," Totakhail said.

Success comes not just from a focus on the tenant but also from being proactive with lenders. Word gets out in the market.

"Leasing brokers find out very quickly if you have a problem loan situation or a maturing loan that's not fixed," Bertges said. "They will drive a tenant to another building much faster before they come to you."

Meanwhile, return-to-office activity is inching up, with BART exits during peak morning hours up roughly 10% year-over-year, according to JLL.

The Bay Area office market is recalibrating, with tenants rethinking what they need from space and landlords adjusting strategies to meet that shift. As they step up to the challenge, both tenants and investors are responding.

"We’re seeing a lot of enthusiasm on the leasing side, and the institutional capital will follow," Friedman said.