Vacancy: DOWN from 9.5% to 9.2%
Net Absorption: UP 367,259
Average Asking Rental Rates: UP from $38.17 to $39.02
New Office Construction: UP
Notable Lease Transactions
- 101 Spear, Salesforce.com, 228,721 s.f.
- 1455 Market, Square Inc, 85,111 s.f.
- 760 Market, Obvious Corporation, 75,000 s.f.
- 60 Spear St, Rodan+Fields, 62,524 s.f.
- 1 Market, McKenna, Long & Aldridge, 42,288 s.f. (sublease)
Notable Sales Transactions
- 100 Spear Street $100M, $492/s.f.
- 116 New Montgomery Street $57M, $402/s.f.
- 450 Sansome Street $51M, $388/s.f.
The San Francisco office market is still the hottest in the country and one of the hottest around the world. The thriving technology sector continues to power the local real estate economy. The economies of agglomeration that have driven technology growth in Silicon Valley over the past 30 years have expanded into San Francisco. Established tech giants and new startups are looking to base their operations in, or expand into, San Francisco. At the same time, San Francisco remains a draw for companies from across the spectrum of other industries.
EMPLOYMENT. San Francisco’s reliance on the tech and tourism industries has allowed it to weather the Great Recession better than most cities. Moody’s, in their most recent projections through 2018, expects San Francisco to outpace the nation in the recovery as well. San Francisco’s unemployment rate in January was 6.8%, up from 6.5% in December. California’s unemployment rate is unchanged since December at 9.8%. Nationwide the unemployment rate in January was 7.9%.
SALESFORCE. The global enterprise software company Salesforce, which shelved plans to build a new campus in Mission Bay in early 2012, changed its strategy to leasing major office spaces in downtown San Francisco. At the moment, Salesforce occupies over 700,000 square feet, but they have already committed to leases that will push their total over 1.5 million square feet by 2015. 1.5 million square feet would equal almost 3% of the entire financial district market.
NEW OFFICE CONSTRUCTION. As the season changes from winter to spring, San Francisco will see construction begin on its first significant new office developments in years. Tishman Speyer is breaking ground on a 450,000 square foot tower at 222 Second Street. Boston Properties will begin work on a 27-story building at 535 Mission Street and Kilroy Realty will soon begin building a 30-story tower at 350 Mission (already 100% preleased to Salesforce). There was also a ceremonial ground breaking for the Boston Properties/Hines Transbay Tower (1.3 million square feet) on March 28, 2013. These projects will join Tishman’s Foundry Square III (over 286,000 square feet) which is due to be delivered in December 2013.
Asking rental rates for Class A, B, and C buildings average $45.38, $36.24, and $31.75/square foot, respectively. From the first quarter of 2012, Class A building rents are up 7%, Class B building rents are up almost 14%, and Class C building rents are up close to 24%. These asking rents come from a survey of landlord representatives and, thanks to the strength of the current office market, many spaces are coming onto the market unpriced; many landlords are letting the market set the price. Therefore, the asking rents above will generally be on the low end of the scale in the most sought-after parts of the city.
Net absorption (the change in occupied space) for San Francisco was a positive 367,259 square feet in the first quarter. This increase was driven by the tech sector with AirBnB, Salesforce, Amazon, Pinterest, and New Relic all moving into new space.
The most expensive rent this quarter was signed by the Malaysian Sovereign Wealth Fund on the 45th floor of 101 California. At $70/square foot start NNN, that rate is equivalent to around $92/square foot, FS.
After a very active December 2012 which saw 8 office buildings sell for over a combined $1.6 billion, finishing off a record-breaking year, the investment sales market has begun 2013 slowly. The increase in the capital gains tax that went into effect January 1, 2013 drove many sellers to offload their properties in the fourth quarter of 2012, therefore, not many properties have come to market since January 1.
Despite the dearth of product, institutional buyers looking for long-term holds have shown willingness to put down money and then put in the capital expenditures to improve the quality of their assets. A recent example of this is Invesco/Hines (JV) purchase of The Rialto Building at 116 New Montgomery for $57 million ($407/square foot ). It is reported that the building will require an additional $9-$10 million in capital expenditures and TIs.
While most people think that rents will continue to increase significantly over the next few years, the rate of growth each year will most likely not be as substantial as that experienced in 2012. The depth and breadth of the current recovery seem to be a strong foundation for sustained rent growth over the long term. This means that investors looking for long-term holds will remain focused on San Francisco even though many of the sellers looking to exit did so in 2012.
Spotlight: Mid-Market Changing Bay Area Dynamics
The Mid-Market has exploded in the past year driven by Mayor Ed Lee’s payroll tax exclusion zone. This attracted Twitter and other tech companies, making Mid-Market one of the most sought after areas of the city. A great barometer for the health of Mid-Market has always been the Warfield Building on the corner of Market and 6th which, as this report is going to print, has only one vacant floor after sitting almost half vacant for an extended period of time.
While Mid-Market is booming, there are ripple effects of its growth being felt throughout the Bay Area. Many of the areas that used to benefit from ‘spillover’ from San Francisco, Oakland and the North Peninsula, have seen little growth, especially compared to the tech boom of 2000. In downtown Oakland, average Class A asking rents are $30.41/square foot, and in the North Peninsula, average Class A asking rents are $33.63/square foot. This compares with over $45/square foot for Class A space in San Francisco. Therefore, there are opportunities to move into spaces in Class A or B buildings just outside San Francisco, where rents that are more than 30% lower.
In 2000/2001, Class A asking rents in Oakland were almost $45/square foot and asking rents on the North Peninsula were almost $60/square foot. The lack of rent growth during this tech expansion in these areas shows the power Mid-Market has had to absorb this new tech growth.
The new construction mentioned above may help to slow the rent growth in San Francisco, but as the cost discrepancies continue to widen, many companies that are not part of the technology cluster will start to look outside of San Francisco proper and get locked into lower rates in equally nice spaces elsewhere.
***Figures and information for this report were obtained using 4/1/2013 as the cutoff date for the 1st Quarter.