JLL: High Cost of Living Remains Biggest Office Market Limitation for San Francisco and Silicon Valley

Greystar Real Estate Partners, University of California, San Francisco, UC Hastings

By Jacob Bourne

JLL’s Q1 2017 Office Insight report shows San Francisco’s performance marked by a continued rent growth plateau, slow occupancy gains and the highest level of large space leasing activity since 2014. The city’s office market also experienced negative net absorption for the first time in 26 quarters, which researchers attributed to the reduced pace of leasing activity last year, given a climate of economic uncertainty. For much of the Bay Area, JLL’s data tells a story of negative net absorption during last quarter for all markets except the Mid-Peninsula. Double-digit office vacancy rates were the trend in Silicon Valley, Easy Bay and Marin-Sonoma. Oakland had the lowest vacancy of 5.2 percent that’s predicted to continue climbing as tenants are priced out of the urban core and new construction is delivered.

San Francisco and Silicon Valley remain the region’s largest employment hubs, however due to the chronic lack of housing supply, the high cost of living threatens the health of these markets as tech and other industry talent migrates to Oakland and other U.S. cities that offer a combination of affordability and competitive wages. Stricter federal immigration policies contribute to this threat as the Bay Area’s large immigrant population is a key element of the region’s historical economic vitality.

“Part of the negative net absorption in San Francisco was due to professional services and law firms putting space on the market,” said Christan Basconcillo, research manager, JLL. “There were also six, 100,000 square foot deals that landed in one quarter. So the demand is still there but San Francisco struggles with a lack of supply in what tenants are looking for because the supply is outdated. It’s the same thing in the Valley; old product is stagnant unlike the nice, shiny new buildings in walkable areas.”

In the Valley, walking the tightrope of retaining talent to maintain a competitive office market dominated by tech is exemplified by the first quarter’s increase in vacancy following M&A activity. JLL reported that 40-percent of sublease space available on the market resulted from M&A, indicating a correlation between tech industry subleases and layoffs over the past nine months. Within that timeframe nearly 7,000 Silicon Valley workers have been subject to layoffs as employers scale back operations. The brunt was borne by IT and networking professionals, whose sub-sector was downsized by 30 percent, representing 36-percent of total subleases. The semiconductor sub-sector was also affected with layoffs at 18 percent, reflected by 16-percent of subleases. Twelve-percent of software tech employees have been laid off, with 13-percent of subleases for that industry sector. Researchers anticipate that up to 300,000 square feet of sublease space will hit the Valley by the end of the year as companies may foresee an economic slowdown looming.

“The Valley isn’t completely immune to everything,” Basconcillo said. “The mortality rate is really high for start-ups. From an overall industry standpoint, there were a lot of consolidations in the networking and semiconductor industries. We’re in the seventh year of an economic boom, and I think that many companies are starting to look at where they can tighten their belts in preparation for if and when the market slows down. A lot of companies are starting to be more cautious in terms of real estate. The layoffs aren’t an indicator that those companies are failing, they’re actually performing well in the stock market, and they want to continue to do well.”

According to state records, some Silicon Valley companies that have recently had substantial layoffs include Cisco Systems, Ericsson, Marvell Semiconductor, NetApp and Hewlett Packard. Oracle, Verizon, Google and Intel have also scaled back on labor.

Basconcillo commented that core areas in the Mid-Peninsula have benefitted from the overheated rents in Silicon Valley. With new housing delivered in Downtown Redwood City and San Mateo near Caltrain, there’s been a migration to the area for similar quality spaces at a relative discount. This will cause the market’s total vacancy of 9.6 percent to tip downward this year and rents to stay stable. The Mid-Peninsula was also the only major Bay Area market that enjoyed positive net absorption for the quarter.

Oakland also had a strong quarterly performance with an uptick for Class B office product asking rents, while Class A rents have remained stable. Ground breaking on two projects at 601 City Center and 1100 Broadway mark the first deliveries of new Class A office space in about a decade. Researchers anticipate that these developments will ease pressures due to restricted supply in the city.

Oakland’s core business districts and areas in the East Bay with strong access to transit have been bolstered by the overheating of rents in Silicon Valley and San Francisco somewhat akin to the Mid-Peninsula’s performance. This spill over of activity has pushed rental rates up and created a justification for new construction.

“People are migrating away from the Valley but it’s not reflected in the numbers yet,” added Basconcillo. “Rents are a concern for tenants here, and it will be the tipping point if and when people earning six figures can’t afford to live here.”

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