San Francisco’s economy continues to add jobs at a healthy clip. Total employment grew by 2.3% in the last 12 months with the addition of nearly 25,000 new jobs, according to Moody’s Analytics, well ahead of the U.S.’s average of 1.8% during this same period. The metropolitan area’s unemployment rate declined to 4.2% as of May 2014, below the state’s level of 7.1%.
FLURRY OF ACTIVITY
Second quarter brought a flurry of activity for San Francisco’s office market. Not only did leasing reach new cyclical highs, but a number of move-ins pushed the vacancy rate down in the non-CBD submarkets to new lows, and the investment market surged with both a number of assets trading hands as well as a large number of new properties brought to the market. With the record-setting Salesforce lease at the start of the quarter, leasing activity Citywide was a robust 3.1 million square feet (msf), the highest level since the first quarter of 2000. This brought year-to-date leasing up to 5.4 msf.
The other noteworthy trend was that a number of the sizable tenants that previously signed deals finally moved into spaces during the second quarter, causing the overall vacancy rate in the non-CBD submarkets to drop to 8.6%, a 240 basis point (bp) decline in just one quarter. This drop in the non-CBD submarkets caused the overall vacancy rate Citywide to decline 90 bps during the quarter to 8.9%. In fact, all of the activity in the non-CBD submarkets resulted in the non-CBD overall vacancy rate finally dipping below the CBD’s vacancy rate—the first time since 1999 that this has happened. The CBD recorded a less dramatic decline of only 30 bps to 9.0%.
Asking rents increased modestly during the quarter and continued to post strong growth year-over-year. Direct class A rents Citywide increased 2.4% quarter-over-quarter and 9.6% year-over-year to $60.07 psf and direct class A rents in the CBD rose 1.7% quarter- over-quarter and 9.6% year-over-year to $61.25 psf.
ROBUST SALES VOLUME
Approximately one-third of the buildings within the CBD, or 13 msf, have traded hands in the past 24 months totalling more than $7.5 billion and another 10% are either in contract or currently being marketed. The torrid pace of leasing and rising rents, combined with the large amounts of capital chasing San Francisco assets, are encouraging current owners to harvest gains, as prices have risen to $600 to $700 psf, with well-leased assets trading close to $800 psf. Given strong pricing, even owners who purchased assets two years ago with plans for a longer term hold are contemplating selling their properties.
With the rising amount of new development under way, the concern of whether we will bump up against the Prop M cap is growing. As for now, we do not believe that we are going to hit that threshold, but we are closely watching it. The amount of new space pre-leased increased during the quarter to two-thirds of the available space, with the sizable commitments by some tech firms including Salesforce and LinkedIn. Even with a total of 3.3 msf of new space under construction, given the projected employment growth of 2.5% per year through 2016 translating into solid demand, we forecast the Citywide overall vacancy rate will decline to the low-8% range by 2017 with class A rent increasing by more than 25% over the same period.