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Spencer Levy
The city of San Francisco, along with the greater Bay Area, has a long legacy of boom and bust cycles. The region blends the old and the new, established and emerging talent, tradition and innovation. It's arguably the world's most fertile ground for tech development, and today the growth of AI could help launch the next boom. Yet it's also experiencing challenges in regaining its footing following pandemic induced setbacks. On this episode, we return to our Shaping Tomorrow's Cities series with a trip to a so-called mixed major, San Francisco.
Jim Wunderman
This place is unique and offers incredible opportunities for entrepreneurs and for capital to find its way. The levels just don't exist anywhere else.
Spencer Levy
That's Jim Wunderman, President and CEO of the Bay Area Council, the region's major employer sponsored public policy group. The council represents more than 300 members across business sectors, as well as major universities and government enterprises such as ports and airports. In a career of more than 40 years, Jim has worked in the public and private sectors, including positions on the staffs of two of San Francisco's mayors in the late 1990s.
Joe Wallace
We do have challenges, but one challenge that we fortunately don't have is we have resources. We have resources, we have people who are committed, who love this community, are committed to it.
Spencer Levy
And that's Joe Wallace, President of CBRE’s Advisory Business in Northern California. Joe's group covers brokerage, debt, and structured finance, capital markets and more, helping clients define their real estate strategies with a focus on San Francisco and the region. Coming up, we explore a place that's both a classic American metropolis and the heart of a city that's always on the edge of tomorrow. I'm Spencer Levy, and that's right now on The Weekly Take.
Spencer Levy
Welcome to The Weekly Take. And this week we are talking about one of my truly favorite cities in the whole world, San Francisco, with two of the leaders of that market. Starting with Jim Wunderman, CEO of the Bay Area Council. Jim, thanks for coming out.
Jim Wunderman
Great to be here, Spencer.
Spencer Levy
And then my old friend, Joe Wallace, the President of CBRE’s Northern California division. Joe, thanks so much.
Joe Wallace
Always great to see you, Spencer.
Spencer Levy
Well, I wish I spent more time in San Francisco because I meant what I said at the opener. It is truly one of the most dynamic, great cities in the world. But I would say that today it's getting a little bit of negative press. And that's what we're going to talk about today, which is what San Francisco is, what it will do again, though, some of its challenges and what it is facing right now. But to begin, Jim, can you just define for us the Bay Area. How do you define the geography?
Jim Wunderman
So the Bay Area, which we helped create the definition, it technically is the nine counties that surround the bay. So if your county actually touches on San Francisco Bay, you're part of the Bay Area. That was in 1945. It could be argued, and we've argued, that the Bay Area has actually grown, because the commute shed around the Bay Area has grown quite a bit and people come and go from longer distances. So you could say there's over 20 counties that are part of what we sometimes now call the Greater Bay Area. But there's no official designation for that in the government. So, two major focal points of the Bay Area are San Francisco and Silicon Valley. Those are the two major economic centers. Then there's the East Bay, which has UC Berkeley and a tremendous amount of business that's built around it and that region. And then you've got the bay in between. So we've got this region whose economy is built around the bay. There's also the wine country, which is a major tourist destination, and the Bay Area Council was created to have a regional business association that could help guide the development of the region and make sure that it works together as one large economic unit.
Spencer Levy
Jim, how do you see where is San Francisco today, and where it's going?
Jim Wunderman
Well, I think today it's in recovery mode from the pandemic. Leading up to the pandemic, you couldn't get an office, you could barely fit on the train or the bus or the road to get here. The place was just in terrific demand, and office valuations, home valuations skyrocketed, all of that. And then the pandemic hit and decisions were made that probably went beyond other regions in the country to protect the citizenry from this incredible health disturbance. We stayed in a pandemic for longer than other regions, so long after most other regions in the country had decided that face masks, for example, were no longer necessary, people were still wearing them here. And the restrictions on activities here, like, for example, going to an NBA basketball game in a brand new arena, Chase Center, couldn't do that. So we actively slowed down our economy and we gave our workers a chance to really think about what it's like not to work in an office. And we gave our corporate leaders a chance to really think about their strategy in terms of this region. And the result was what we have today, which is we've got building valuations down three, four times less, sometimes more than that, than what they were worth at their peak. And we've got a vacancy factor of somewhere around 35%, which is historic. When it's that big, it's hard to get the momentum going again to get folks back in. People are hesitant to make decisions. I think we might be turning the corner in the AI revolution, which is taking place within walking distance of where I sit on the waterfront in San Francisco, is a huge driver. So that provides a big opportunity for us. Millions of square feet have been leased in San Francisco fairly recently, and almost all from the AI companies which have massive valuations. On the upside of that, there's views that the potential of this AI revolution could be something on the order of the Internet itself or social media, or even maybe more. That's pretty darn exciting. So even though we've got some challenges here, it's still happening here, and I think it will happen here. It's just going to take a little bit of time.
Spencer Levy
Joe, how do you see it?
Joe Wallace
I remember clearly on January 1st of 2020, the vacancy rate in San Francisco was 3.9%. And on our real estate data, we had three spaces available that were over 100,000 feet, and I think we had 30 or 40 clients in the market for more than 100,000 feet. By 2023, that had reversed. We had three tenants in the market for over 100,000 feet, and we had 30 or 40 options for them to go to. And San Francisco has always been a very volatile place, I think because San Francisco has such big mindshare globally. It's a city that people all know a little bit about or have gone to or want to travel to. But San Francisco itself is not a very big market. San Francisco is 20% of the size of Manhattan, as an example. And so what happened, as Jim pointed out, is we gave people a long time to think about, you know, whether they wanted to come back to work and in what way they wanted to do it. And then, in fairness, the few other things piled on there. There was some new taxes that were passed in San Francisco that… there are companies, I think, clients of ours who would have liked to stay in San Francisco, felt like the new tax landscape made it impossible for them to do that. So we kind of made it even worse than it would have been. We got to just under 40% vacancy now. But this quarter, fourth quarter, which we're just wrapping up, will be the first quarter that we don't increase our vacancy in San Francisco since the first quarter of 2020. So I do think it's changing. And then to Jim's point on AI, our great research leader, Colin Yasukochi, published a piece about the impact of it on AI in San Francisco. As challenging as it is in San Francisco, AI has been a bright spot. I think the Collins stats was in the last four years, there have been 180 AI leases signed in San Francisco. And if you look at the amount of space occupied by AI companies in San Francisco now, it's between 15 and 20% of the occupied space in San Francisco. AI is a super bright spot in the future of the city, and we're already starting to see that take effect.
Spencer Levy
So let me make a New York observation, and then this translated to San Francisco. So I was with one of our great friends, Mary Ann Tighe, who was on this show, and she said that by 2026, New York City is going to have a shortage of office space. And then I met with the CEO of a major developer in New York City, and they're building spec office in New York right now, notwithstanding the fact that there's 45 million square feet of space that probably won't be used as office anymore. How do you see those dynamics in San Francisco? Do we have a shortage of Class A space today?
Jim Wunderman
Well, I'll start. As a born and raised New Yorker with irritation, since I left in 1980 convinced that New York could only fail worse in the future and there could never be a recovery. So I came to San Francisco and I think maybe brought some problems here. So I was a deputy mayor back in the early 90s. I had worked for Mayor Feinstein in the 80s. I'd seen some changes taking place then, when there was some corporate flight from San Francisco. And then in the 90s, the economy was really quite dead after the Loma Prieta earthquake in 1989. Mayor Jordan and myself, we used to lament, what are we going to do? How do we attract companies? There's no cranes, there's no interest here. And within two years of that conversation, we had the .com boom and you couldn't get space in San Francisco, nor could you get a restaurant reservation or drive down the street. I mean, it changed overnight. Now, there was less built commercial space at that time, so a lot of folks then went about building space. And then we had the .com bust, as we got into the 2000s. And then everybody left, and everything was deserted. And the reason we lost over 400,000 jobs almost overnight. And then they came back over the next few years and the mortgage crisis and they left, things slowed down. And then we had a ten year period of just unbridled growth from around 2010 to 2020. And during that period of time, a lot got built. We increased our commercial space opportunity quite a bit during that time. I think it's about 85 million feet, Joe. Somewhere in there?
Joe Wallace
Right about there, yeah.
Jim Wunderman
There's a lot of space that got built that really never met its opportunity because things started to take the dive just as buildings were completed. But I expect that we'll see it all fill up again, and that we're going to start to see companies put out edicts that are saying, yeah, actually employees have to come back to work in the office. We're seeing more of that. AT&T just made that announcement. Salesforce did something like that. Microsoft and others. Google are beginning to talk about their employees coming back. You can feel it starting to happen, and that's going to make a really big difference. I think there's a bit of a herd mentality, and as companies do that, more companies will feel comfortable doing that, and then more employees will feel better about coming back and worse about not being in the office when other people are there having opportunities for visibility and promotions. So I think this thing has a chance to turn fairly quickly, maybe more so than most people think. San Francisco has had this history for a reason, because of the nature of the ups and downs of the key business that's driven the economy here in the last generation or more, which is technology. And so I see things rising again. And I think that there will be construction of new office in the future and talks of residential conversion will wane. I think this is a great headquarters city. I'm very bullish on the future. This place is unique and offers incredible opportunity for entrepreneurs and for capital to find its way to levels that just don't exist anywhere else.
Joe Wallace
Just take it back to the real estate piece of it for a second. We did have development, but what people don't realize is how constrained development has always been in San Francisco. There were caps on how much new space could be added that go back to the 1980s. The reason rents shot up and we got down to 3% vacancy and 2%, you know, it's because there wasn't enough supply to keep up with this explosion of demand. So if you look at our inventory right now, we have a pretty old inventory. Like we didn't bring as much online as you would have thought. And as a result, we have a bigger challenge with obsolescence here. Our research team spends, as you know, they've looked at the vacancy rate in the upper half of the Class A inventory versus the lower half, and the Bs and the B minuses, and down at the Cs. It's a tale of two cities. I do think Mary Ann is right. We're going to run out of good quality space in relatively short order. And then the question is, what happens to the obsolete stock? Very difficult for it to do these conversions. Like everybody knows that there's a big payoff if you can figure it out. Very few people have been able to figure out how to do it at scale in San Francisco. Probably just a fluke of the stock that we have. But there's a lot of people who are really smart who are working on it. I think at the building values that we're looking at, we're going to see more scraping of commercial assets and rebuilding. I'm encouraged by places like Vancouver and places that have figured out how to build a significant quantity of really great housing stock, fairly short order, to help feed the vibrancy of the culture.
Jim Wunderman
I would just say second tier Class A space looks a lot better when there's no first tier. And Class B buildings look a lot better when there's no Class-A buildings. So has the world decided that Class B and B minus and C are just un-occupiable in the future? I would wager no. Once the rush is on, at one point I can remember after the .com bust, you had a lot of these buildings that were empty, particularly south of market, some here north of market, particularly south of market. We were showing one of these buildings for the Bay Area Council for our space and I said, who would want to work here? And within a couple of years everybody wanted to work there. That became the hot area. And while residential conversions are difficult in this kind of a market, improving existing commercial spaces is, if you have the money to do it, is easier. And a lot of it got done. So there are some really cool buildings that don't look so cool from the outside that are out there, right? And that happened because there was tremendous demand and companies were willing to be very, very creative about what the opportunities would be. I don't know where they're going to want to be in the future. So while we're lamenting what's happened in kind of the business, financial district core, check out Mission Bay, where Visa just moved its headquarters. And go in that area, and let's have somebody visit from someplace else and walk that area and tell me that San Francisco is all rotten, right? Because this is a vibrant, dynamic, new area. Or Jackson Square, a few blocks from where we are here. Which has suddenly become one of the hot places in the city. Or Hayes Valley, where people are working even though there's no place to work there, but they're starting these companies in existing residential buildings and living and working in these spaces. I think we're going to see more of these kind of alternative spaces pop up, but also eventually there's going to be a return to the areas which are best transit served and where the best opportunities are for larger footprints for people to lease buildings. Just a lot of opportunity if you want to come into San Francisco right now. You can make a pretty good deal.
Spencer Levy
Well Jim, you opened the door to something I wanted to discuss in more detail, which is these submarkets. Joe, walk me through just a few of these submarkets that you think are doing better, will come back first, and where the opportunities are drying up because people are taking them already.
Joe Wallace
We just hit a couple of really dynamic submarkets and Jim mentioned it as well. What's happening down in Mission Bay is just stunning. The retail is just on it. It's beautiful. The public parks that have been built, the entertainment venues – our baseball stadium kind of leads you into that area. And then our basketball arena is right in the middle of it. It's a whole new part of the city that was created out of ingenuity and out of need. The challenge is not… I mean, there are challenges with economics and replacement costs, but it's a high enough value place that if we can deliver something that's really good, there's the means to make it work financially, generally. We do have some embedded challenges and labor costs and materials cost different things, but it's an extremely well off place. The GDP per capita is exceptionally high. The companies here are doing exceptionally well. We have 460,000 tech workers in the Bay Area. It's 12% of our employment. There's no other place that it's more than 10%. Even Seattle is below 10% and it's considered a tech town. This is an enormous base and tech jobs are exceptionally good jobs. The average salary of a tech worker in the Bay Area is almost double the salary of a tech worker in New York metro area, which is not a cheap place to live. So, I mean, we do have challenges, but one challenge that we fortunately don't have is we have resources. We have resources and we have people who are committed, who love this community or are committed to it. And I think that's going to be part of this turnaround. That's part of what's bringing places like Jackson Square back and helping people envision what Mission Bay can do and what that can be like. And that magic will happen in other parts of the city, as well, if the city lets it. It's very hard to build here. The private sector can envision these things as much as it wants, but it takes a committed city government to help turn that into a reality. And then they're the beneficiaries of the municipal finance that comes out of that and the additional jobs.
Spencer Levy
So in our Shaping Tomorrow's Cities report, the term we gave to San Francisco was a quote, “mixed major”. Putting it in the category with Boston. In the category with Seattle. And so how do you see San Francisco in the, I guess, the North American economy?
Jim Wunderman
Well, I think there are similarities. Any great economy in this era is going to have tech be at the center. And so I think there's been tremendous competition among places to try to be that. And it comes at a price, because it drives prices up. You look at Austin and suddenly they start to inherit the problems. And be careful what you ask for. You might get it. And so I think that we are part of a fabric around the country and around the world of places which have figured out how to compete in this space of science, technology, innovation. But we have managed to compete better than everybody else. There were times when I wondered, we used to debate this, you know, are we past our time? Everybody wants to compete with us. They come from around the world. China. How many visits did we have from the Chinese to find out what the secret sauce of Silicon Valley is, as if we could just give them the recipe? And yet, ultimately, the jury came back and it decided on San Francisco every single time. And there was always a new iteration because there was a new bent to whatever the technology was at that point in history. There was computer hardware and then there was computer software. And then there was this Internet thing that people didn't believe in. And then the advent of what, the social media, something called the social media, right? And each one of these things had its detractors, and said, you can't build an economy around that. It's a fad. So now they're saying that about AI. It's just a passing fad. It doesn't create enough jobs, etc.. And they've been wrong every single time. Maybe this time they'll be right. But I don't suspect that. And as Joe was saying, this is a place where it may be harder to be here. It's more expensive. It demands more from you, but you get more from it. And the people who make it here make it big. And people around the world see that, and then they come here because that's naturally what they want. And you can find the talent pool and you can find the capital and you can find that secret sauce that the Chinese wanted from us that makes it all kind of come together. I do wish we had more of a diverse economy in the region. I think we have lost our way when it comes to industry, you know, industrial core. And we have chased industry away for a long time. And so I'm out there encouraging that we should start looking at the waterfront as a place where people could live and where we could build new industries. And I'm particularly focused on maritime because we've got this amazing deep water ports and we've got a Navy that needs to build ships. And I'm the chair of the ferry system, and we're building the nation's first zero emission battery electric ferries. We've already contracted to build six of them. This could be a place where sort of industry and technology merge. Offshore wind farms and the ability to service them created here on shipyards that have been closed, or relatively closed, for 30, 40 years. We could see a comeback. But we have to push for it. Great cities and regions of the world have re-invented their waterfronts. And we're doing that in little pieces here in San Francisco. There's some really cool projects happening. But for the next iteration of our economy, I would like to see us try to bring back a little bit of balance and see if we can have some blue collar jobs come back into the mix and see if we can build houses for middle class people and have our service workers live closer to where they're providing the service. I think that would make the Bay Area much healthier.
Spencer Levy
One place I wanted to go here, and maybe I'm picking up on the wrong thread here, but you said secret sauce. We talked about tech. We talked about jobs. We talked about industry. I want to talk about the restaurants. I want to talk about the Grateful Dead, Journey, and Jefferson Airplane for a second. And you say, well, what does that have to do with any of this stuff? And well, the answer is everything. And the reason is is that creativity creates creativity across the board. And so the secret sauce is taking that creativity that has flourished in tech and into some of these consumer oriented industries, restaurants and music, and bringing it to everything else. That's my opinion. Joe, what do you think?
Joe Wallace
It's a great city for all of those reasons. You think of it as a tech down, but there's this core of the arts in San Francisco that's been here for a long time, and they're doing innovative things, the museums. But I'll give you one quick anecdote. I moved here from Washington, D.C., and about, gosh, I've been here eight years. And we were at a going away party and one of our friends in D.C. grew up here and spent some time here, went to college here, and then wound up on the East Coast. And I asked him, you know, how is it different in San Francisco? He said, Joe, here's how it's different. In Washington, D.C., where we were when we had this conversation at this cocktail party, you go up and over there and talk to somebody and you're going to ask him, you know, what do you do? And they're going to say, I'm a lobbyist. I sell insurance. You know, I'm a dentist. That's the way they answer the question. He said you're in a cocktail party in San Francisco. You say, so what do you do? And it's like, I'm a kayaker. I like to ski. You know, I boat. You know, I've got a sailboat that I keep down at the Marina. They answer that question in a fundamentally different way. And this is not a knock against all my friends in Washington, D.C., but there is something about the people who are here. They're here because this place gives you these opportunities to live your life. It can be expensive, and it certainly is, but it gives you an opportunity to live your life in a really compelling way. And it's not just about the work opportunities. It's about everything else. And the last thing that I think is vital to it: it's an exceptionally diverse area. I haven't been here for that long, but I definitely see that. I think one of the reasons why this was a place that companies could come and they could attract the best talent from all over the world is that there is an appreciation for diversity here. Diverse cultures and people from different places. And in that sense, San Francisco really is a world class city.
Jim Wunderman
I totally agree with what you said and what Joe said. It's a different kind of quality of life that's here, and opportunity for people to enjoy a place differently. There's just a lot of opportunity to really enjoy life here. And on the diversity question, yeah, it's not so much that the place is diverse, but it believes in diversity. People talk about it and they honor it. And we have the advantage of being a Pacific Rim headquarters in the century of the Pacific. We’re the point of entry for China, for Japan, for Vietnam, for Singapore, India. A huge Indian-American population, now. Many of those folks are heads of companies here. They’re all part of the fabric, and that's a really big advantage that we have.
Spencer Levy
So gentlemen, the wrap up question is this: Let's assume we have you back on the show three years from now and we're looking back. What's the conversation going to be like three years from now about San Francisco? And if there's any one factor that can help get us there and any one factor that can hold us back, I'd love to know what you think about that. So starting with you, Joe.
Joe Wallace
I'm an optimist. As they say in golf, all the trouble is short on this hole. We’ve got to get it over some water, but the fairway is pretty green out there for us. I think there's been a change in San Francisco. I think that there's been a change among the people of San Francisco. And the people are expecting different things from their leaders. As somebody who works in the business community and interacting with our clients and reading and learning what I can, it feels like it's different. I think there's an appreciation for the fact that the great cities get to be great through cooperation around shared initiatives and goals. And I think we're going to define what those are. I think we're moving out of an age of public-private opposition, and we're moving into an age where there will be more cooperation. I don't think San Francisco is ever going to let the business community run amok. You guys do whatever you want. It's never going to be that. It's always these sacred things in San Francisco that will always be that way. But I do think we're moving into an age of cooperation. We're going to go through a period where we have very shared goals, and those shared goals are going to take us back into that green fairway and what's going to get us past some of the trouble that we see in the short run.
Jim Wunderman
We managed to stop ourselves from making some mistakes that I think some other places made, and we probably made some, too. Like Joe says, we're not going to roll out the red carpet to everybody under any conditions, but we're going to do better and we're going to fix some of those San Francisco taxes. We made a movement toward that in November. We actually had a revenue negative tax measure put on the ballot supported by the mayor and all five mayoral candidates which passed, the voters. Now wasn't a huge rollback, but it helped certain companies who are focused on San Francisco not be penalized for being in San Francisco. And I think we're going to see some more of that. I think we're going to see some greater willingness to allow housing. So people are saying, at least now, they didn't used to say it. They used to say no housing. Now they say yes, housing. It's just hard to do it. And the market hasn't quite caught up yet, but I think it will. And there's a lot of entitled property in the area now. So looking down the road three years, a real negative could be we forgot to build the housing we said we were going to build, and now the rents are so high or the opportunity is so low, it's hard for people to come in. So we have to stay really focused on the mission of getting housing built in San Francisco and in the Bay Area. We have to accept the fact that people want to be safe. We've got to get our transportation systems in shape. We’ve got to fix BART. BART delivers people in large number from the rest of the region into San Francisco. We created BART back in the 1950s. That was a creation of the Bay Area Council, as we created the ferry system later on. We've got to have a transportation system. CBRE points this out in the work that you did. I think it's very, very important not to forget these great regions, these mixed, what do you call them, mixed-major require these older infrastructure systems to actually function well. And for a while, they did. And lately, not as much. But we're really focusing now on that. So these are things we need to do. We actually have to do some big projects that can't be done by government alone. Private interests cannot accomplish them without government cooperation. So joining hands on those things, I think, is going to be really, really big in the future.
Joe Wallace
One other thing. We have the resolve, the capital, the institutions to do it. We need the resolve to do it. But one of the things that we have to solve housing affordability is we have land inventory, which most people don't really think of. You know, the population density of the nine Bay Area counties, which, by the way, encompass three of the top 25 cities in population. San Francisco, San Jose, and Oakland are all the top three in terms of population of the city. If you take those nine counties, the population density of those counties is half of the population density of L.A. County. One in four Californians live in L.A. County. And let's go back to New York City. If you take New York City and all five bureaus, the population density of the nine counties of the Bay Area is 1/30 of the population density of New York City. Not just Manhattan. I'm talking about all five boroughs. Like we have the land. What it takes is a new perspective and a new sense of urgency around this. And that's why my faith in the future of San Francisco is way up.
Spencer Levy
And on behalf of The Weekly Take, what a great conversation with Jim Wunderman, the CEO of the Bay Area Council. Jim, great job. Thank you so much for coming out today, and thanks for all the great work you do in the Bay Area.
Jim Wunderman
Well, thank you. Thanks for thinking of us. And, you know, next time you come out, Spencer, we'll have to hit a couple of restaurants that you might miss otherwise. It's great when folks come from other places to San Francisco and get to see this and then go back home and talk about it because we need that. We need to recharge our tourism industry. That reputational challenge that we've developed is hurting us economically. So we have to get people to hear the story that San Francisco's actually safe again and that it's fun again. So thank you very much for having us.
Spencer Levy
Looking forward to that. And Joe Wallace, my old friend, our President of the Northern California Division. Great job, Joe.
Joe Wallace
It was a pleasure. Spence. Any time. And I want in on that dinner that Jim talked about, so I'm counting on that.
Spencer Levy
Talk about a San Francisco treat. Thanks for joining us in the Golden Gate City. For more, and to explore other chapters of CBRE Shaping Tomorrow's Cities series, please visit our website, CBRE.com/TheWeeklyTake. And for additional research, such as the tech talent report that we touched on, check out the CBRE Insights page. Remember to subscribe, rate and review the show wherever you listen, and send us your feedback and suggestions. We'd love to hear from you. In the coming weeks, we'll widen our lens on the real estate world with a visit to Madrid and other cool places. We'll hope you'll join us. For now, thanks for listening. I'm Spencer Levy. Be smart. Be safe. Be well.
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