Colliers: San Francisco Peninsula Research & Forecast Report Q3 2014

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Positive Momentum in a Performing Market

OFFICE OVERVIEW
At the close of this quarter, leasing activity in San Mateo County remains strong, with dramatic rent increases and a wave of speculative development not seen in years. The vacancy rate for the Greater San Francisco Peninsula ended at 8.64 percent, a fairly substantial drop from last quarter’s rate of 9.39 percent, which is also the lowest level seen since the Dot-Com days. San Mateo County, which is more heavily impacted by the slower Northern Peninsula submarkets, closed the quarter with a 10.74 percent rate, only a nominal improvement from last quarter’s 11.11 percent, but the sixth consecutive quarter with declining rates.

Registering a milestone not seen since the Dot-Com days, the monthly average asking rate per square foot for office space on the Greater San Francisco Peninsula has surpassed the $4.00 mark; the $4.10 full service (FS) average asking rate represents a 2.76 percent increase over the past quarter. Without the influence of the especially high rents in the Palo Alto and Mountain View submarkets, the average asking rate for San Mateo County checked in at a still record-breaking $3.80 FS, which increased by 2.98 percent from the previous quarter.

The gross absorption (a measure of all leasing activity) for this quarter quantified just how strong leasing activity has been over the last several months. The 1,719,881 square feet of gross absorption recorded on the Greater San Francisco Peninsula is the highest figure for any quarter in the last three years. Gross absorption for San Mateo County alone is 1,267,094 square feet, advancing the year-to-date total to 2,982,677 square feet. The gross absorption recorded for this quarter is the highest in San Mateo County since the first quarter of 2011 when it was 1,933,894 square feet. Not a part of this notable total is the 334,000 Box.net pre- lease at the Crossings/900 development that is currently under construction in Downtown Redwood City (new developments are not included in Colliers’ statistics until building completion).

While the headline grabbing Box.net development was the most significant lease of the year in San Mateo County, other large transactions played a role in the very solid quarter too. Activity includes Machine Zone’s 222,087 square foot commitment to Sand Hill Property’s Page Mill Road project (largest in Palo Alto since 2011), Ring Central’s 84,416 square foot lease at 20 Davis in Belmont, Conviva’s 34,764 square foot move to 989 East Hillsdale Boulevard in San Mateo, and Yelp’s commitment to the under construction 45,472 square foot project at 2100 El Camino in Palo Alto.

Perhaps the most interesting trend at this current stage of the market cycle is the newfound interest in speculative building development. The above mentioned Crossings/900 project broke ground long before securing a tenant, and Wilson Meany recently announced plans to begin construction on their first building of 210,000 square feet at the massive transit- oriented Bay Meadows project. Several other significant projects are expected to fill the queue as well.

A remarkable feature of a current market snapshot is just how broad the strength is deployed across the region. Heavy vacancies are concentrated in just the most remote and challenging submarkets, while rent growth is seen consistently in virtually all submarkets. Combine that with the lack of volatile sublease inventory, and we have expectations of continued strength in the market.

R&D/INDUSTRIAL OVERVIEW
Once again the R&D and industrial sectors in San Mateo County did not disappoint in the third quarter. Both product types boasted positive net absorption with an increase in overall average asking rates. The market is still showing all-around positive signs and we expect the same throughout the balance of the year.

As we look at the R&D market the initial indicator that jumps out is vacancy. We are currently at only 6.37 percent vacancy, which is the lowest since the fourth quarter of 2007 when it was barely above this level at 6.40 percent. Vacancy has dropped nearly in half since this time last year when the County was still running a vacancy rate of 11.57 percent. Compared to last quarter, vacancy dropped a total of 262 basis points from 8.99 percent down to 6.37 percent. With this drastic drop in vacancy comes a spike in monthly average asking rates to $2.11 NNN per square foot this quarter, versus $1.87 NNN in the third quarter of 2013. The R&D market absorbed a healthy 84,472 square feet of net absorption and 322,508 square feet of gross absorption. This charge has been led by the South San Francisco/Brisbane biotech market, which now has an average asking rate of $2.93 NNN.

While the North County has driven this resurgence, the largest R&D/industrial sale was on Constitution Drive in Menlo Park with Facebook purchasing a mix of R&D and industrial buildings on approximately 59 acres. While this site is anticipated to eventually be converted to office space for Facebook’s use, the existing tenants will remain on a sale lease back structure locking this product type in place for the time being.

Shifting to the industrial sector, there is an even stronger market with extremely limited available space. Vacancy is at 3.32 percent, which is a 61 basis point decrease from the previous quarter, and the lowest recorded rate since before 2006. Average asking rents increased to $0.85 NNN, a slight uptick from $0.83 NNN last quarter. The Burlingame market now has an average asking rate of $1.01 NNN, which is the highest in San Mateo County.

Another key aspect of the statistics to address is sublease vacancy; this quarter the sublease vacancy is merely 0.31 percent and has been under 1.00 percent since the fourth quarter of 2013. This lack of sublease inventory indicates that tenants are utilizing all their space and oftentimes are looking to expand if they can find new availability. In regards to deal velocity, it is also important to note this is the seventh consecutive quarter for positive net absorption which totaled 132,986 square feet. Gross absorption for the quarter is also at a thriving 591,607 square feet bringing the year-to-date total to 1,893,500 square feet.

While no large industrial sale transactions were completed this quarter, Colliers was involved in two of the largest lease transactions on the Greater San Francisco Peninsula. Classic Party Rentals expanded its footprint in DCT’s building at 1635 Rollins Road in Burlingame to approximately 97,000 square feet and Roadex Cargo Service, a freight company, leased approximately 47,000 square feet at Prologis’ site at 401 East Grand Avenue in South San Francisco.

As the data unfolds, all indicators show strong growth going forward in both the R&D and industrial markets. While the R&D sector still has product available, industrial product is scarce and has begun to force tenants to the East Bay or further south towards San Jose. Unfortunately, the scarcity and price of land is not conducive to new development for industrial so both landlords and tenants are compromising to work with existing product.

West Coast Commercial Real Estate News