The San Francisco industrial market has undergone notable shifts over the past year, driven by evolving tenant demand and economic challenges. This report offers an in-depth analysis of the key trends, metrics, and market drivers shaping the industrial sector in the second quarter of 2024.
Executive Summary
As of Q2 2024, the San Francisco industrial market is still experiencing many of the same trends observed over the past year. Leasing activity remains subdued, vacancy rates are rising, and rent growth has been moderate. However, the industrial market’s two primary sectors—flex and logistics—are diverging. The flex market has been significantly impacted by declining demand and an influx of new supply, while the logistics sector remains comparatively tight.
In recent years, the rapid growth of the life sciences industry fueled high demand for flex and R&D space, particularly from biotech companies. Developers responded by ramping up new construction, primarily in South San Francisco and other key areas along the Peninsula, as well as parts of the city itself. As a result, flex properties now account for over 30% of San Francisco’s industrial space, a sharp contrast to the 10%-12% typical in other markets.
Market Overview
The economic challenges of the last 18 months have dampened tenant demand across the market. Rising interest rates and turbulence in the banking sector have reduced venture capital investment in the biotech industry, while the slowing economy has curbed leasing activity in logistics spaces. Total industrial leasing in 2023 was the lowest since the Great Recession, and leasing volume continues to be sluggish in 2024. Several life sciences companies have placed large blocks of space on the sublease market, including Charles River Labs, which made half of its space at 225 Gateway Blvd. available in November.
Over the past year, net absorption in the industrial sector fell by 1.7 million square feet, with flex space alone accounting for a negative 200,000 square feet. Flex space construction is currently at record levels, with 24 projects totaling 3.9 million square feet set for delivery over the next three years. Much of this space is speculative, leading to a flex availability rate of 28.7% by Q2 2024. In contrast, no new logistics projects are under construction.
The overall industrial vacancy rate has risen to 12.1%, driven primarily by the flex segment, where vacancy has surged to 21.8%. Meanwhile, vacancy in logistics remains near its long-term average at 7.2%. Industrial rents in San Francisco, at $28.00 per square foot, are the highest in the U.S., though rent growth has slowed significantly, with a -0.5% decrease over the past year compared to a 3.1% increase nationally. The outlook for the coming year suggests continued high vacancy in flex space and minimal rent growth.
Key Metrics
Vacancy Rate
The slowdown in leasing activity, which began over a year ago, continues to influence the San Francisco industrial market in the third quarter of 2024. Total leasing volume in 2023 amounted to just 3.2 million square feet, marking the lowest level since the Great Recession. This dip in leasing has largely been driven by rising interest rates and broader economic uncertainty, leading to reduced demand for industrial spaces. The biotech sector, in particular, has seen a significant decline in demand for R&D space due to the drying up of venture capital funding.
As a result, the vacancy rate in the flex space sector has increased significantly, climbing by 6.2% over the past year to reach 21.8% in Q3 2024. Meanwhile, vacancy rates in logistics spaces have remained stable, holding close to the long-term average at 7.2%. Overall, the market-wide vacancy rate has edged up to 12.1%, reflecting these shifts in demand.
Rental Rates
Industrial rent levels in San Francisco remain the highest in the nation, driven by limited space and competition from other land uses. The constrained supply of large industrial buildings in key urban areas has resulted in available spaces leasing at premiums above the market average. For instance, in November, Keller Supply secured a lease for 38,800 square feet at 1575 Burke Avenue in San Francisco with a starting rent of $25.56 per square foot.
While demand for premium logistics space remains high, rents in the flex market have been more subdued. Flex properties have seen a 0.9% decline in asking rents over the past year due to rising availability, with some high-end R&D spaces in areas like South San Francisco marketing fully equipped lab space at competitive rates. Overall, rent growth in San Francisco lags behind national trends, with average rents increasing by only -0.5% in the past year compared to a national average of 3.1%.
Net Absorption
The San Francisco industrial market continues to face challenges with net absorption, particularly in the flex space segment. The slowdown in leasing activity and the significant volume of new construction have led to negative net absorption figures. Flex space, in particular, has seen a substantial increase in available space for sublease. For example, FibroGen recently placed 230,000 square feet of R&D space in Mission Bay on the sublease market, further contributing to the oversupply.
While some sublease spaces have been leased, such as Harpoon Therapeutics taking 35,000 square feet at 131 Oyster Point Blvd., the overall market absorption remains weak. Continued economic uncertainty is likely to put further pressure on absorption in the months ahead.
Under Construction
San Francisco is witnessing a historic level of industrial development, with approximately 3.9 million square feet of space currently under construction. The bulk of this new development is focused on speculative flex space, designed primarily for the life sciences and biotech industries. Much of the new construction is concentrated in South San Francisco and other Peninsula employment hubs, where high demand for R&D space has spurred development in recent years.
However, speculative projects dominate the construction pipeline, and a large portion—around 75%—remains available for lease. Major projects include Kilroy Realty’s Oyster Point development, which will deliver 860,000 square feet of life science and R&D space in 2024. Looking ahead, vacancy rates in newly completed flex buildings are expected to remain high, with over 50% of the space completed since 2022 still unoccupied.
Cap Rate
the industrial market continues to see cap rates influenced by the city’s high land and operating costs. The limited availability of industrial space, coupled with strong demand for logistics properties, has maintained pressure on cap rates. However, the outlook remains cautious for the flex segment, where rising vacancy rates and significant new supply are expected to constrain rent growth and put upward pressure on cap rates moving forward.
Market Drivers
San Francisco’s industrial market is heavily influenced by the tech sector, home to global leaders like Apple, Alphabet, and Meta. The city’s strong economic growth has historically supported high wages and some of the highest real estate rents and prices in the nation. However, the volatile nature of tech, with rapid growth followed by downturns, has led to cyclical fluctuations in the market.
The most recent boom peaked in the 2010s with the rise of mobile and cloud technologies, driving surging demand for real estate. But the COVID-19 pandemic in 2020 triggered a sharp decline, as tech companies embraced remote work and residents relocated to more affordable areas.
Since 2022, rising interest rates and tech sector layoffs have further pressured the market, particularly downtown, where economic challenges have been compounded by social issues. While employment has recovered to pre-pandemic levels, the shift to flexible work raises uncertainty about the local workforce’s impact on demand.
San Francisco’s reliance on the tech sector will continue to drive both growth and volatility in the industrial market, with future trends shaped by evolving economic conditions and workforce changes.
Concluding Thoughts
San Francisco’s industrial market remains deeply connected to the region’s tech-driven economy, resulting in both opportunities and challenges. While demand for logistics space remains stable, the flex segment faces increasing vacancies and pricing pressures due to oversupply and economic uncertainty. With significant speculative construction underway and continued volatility in the tech sector, the market is likely to see further adjustments in the near term.
As always, navigating these shifts requires careful planning and an adaptive strategy to capitalize on emerging opportunities.
In Case You Need Industrial Space
Westridge Technology Park. Life Sciences / Biotech Building In Miramar
Elk Grove Innovation Center.
