The San Francisco office market continued to churn in the second quarter, building upon trends established in previous cycles. Lack of supply counteracted the pattern of high demand for space, both large blocks and otherwise, with continued low vacancy rates and steadily rising asking rates for Class A and B spaces, according to leading commercial real estate advisory firm Newmark Knight Frank Group’s recent 2Q 2019 San Francisco Office Market report.
Despite an extremely constricted market, several prominent lease and sale transactions populated the hot markets in the South/North Financial Districts and Showplace/Potrero submarket. Even markets with less activity, such as the Van Ness/Civic Center submarket, have very little available space to rent, as landlords continue to be aggressive in their attempts to lease what’s left in prime San Francisco real estate.
“You see the demand,” said Andrea Arata, director of research for NKF’s San Francisco Branch. “You’ve got these tenants. You’re trying to find them space and there’s just nowhere to put them. You’ve got several tenants competing for the same space so brokers are working like crazy to try and get their tenant in there, and only one tenant’s going to get the space.”
While the report mentions overall availability creeping from 8 percent to 8.5 percent in this quarter to a total of 7.1 million square feet, the reality is that demand consistently outpaces supply, which currently hovers currently at 7.9 million square feet.
“No matter what happens there’s still going to be a little bit of churn in the market,” Arata said. “We’re not talking a lot of space between 8 and 8.5 percent.”
Because the market is extremely tight in San Francisco currently, leasing activity has been constrained, decreasing 24.6 percent in the first half of 2019 compared to the first half of 2018. Already the entire 1.4 million square feet currently under construction with delivery dates through 2020 has been pre-leased, according to the report, which has pushed overall asking rental rates up by 9.2 percent year-over-year and Class A rates up by 9.7 percent year-over-year. One of the most expensive submarkets, and according to Arata one of the hottest, is the North Waterfront/Jackson Square area, which is currently going for $100.58 per square foot for Class A space, states NKF’s report. In comparison, the next highest Class A asking rate is SOMA at $90.83 per square foot.
“I think we’re going to continue to see rates go up and continue to compression,” Arata said. “That tends to happen as rates are going up.”
The largest property trade considering total price so far this year occurred this quarter with Juul purchasing the 28-story office tower at 123 Mission Street in the South Financial District for $397 million, or $1,149 per square foot. This adds approximately 363,000 square feet of additional office space to the company’s current corporate headquarters at Pier 70, which is owned by the city.
Other prominent trades this quarter included Beacon Capital Partners’ acquisition of 273,000 square feet at 655 Montgomery Street in the North Financial District for $191.5 million, or $701 per square foot.
A number of off-market transactions took place this quarter in the Showplace Square/Potrero submarket, with the Sobrato Organization acquiring 61,000 square feet at 808 Brannan Street from JMB Financial Advisors for $60 million, or $984 per square foot. This building is 100 percent leased to Pinterest, according to NKF’s report. In addition, the Swig Company purchased 41,745 square feet at 945 Bryant Street for $42 million from Bridgeton Holdings, or $1,005 per square foot. This building is 100 percent leased to the City and County of San Francisco.
Also notable this quarter was Boston Properties gaining 100 percent ownership in Salesforce Tower at 415 Mission Street with its $210.9 million payoff to Hines for its 5 percent equity stake in the building.
The report also listed several marketed and coming to market opportunities, which included 123 Townsend Street, 650 Townsend Street, 350 Rhode Island Street, 555-575 Market Street and Park Tower at Transbay.
“There are certainly brokers who are being forward-thinking and seeing where might there be space coming available that’s not on the market yet,” Arata said. “They’re constantly looking at what are other potential upcoming opportunities.”
Arata said landlords have been more aggressive as the market continues to grow tighter in San Francisco, with vacancy bottoming out, rental rates increasing and pre-leasing becomes more common than not.
“[They] know the market is hot and put stuff on the market as available much earlier than in other cycles,” she said.
Pre-leased space this quarter included 1 De Haro Street, 633 Folsom Street, 1515 Third Street and the GSW Event Center Complex at Blocks 29-32 within Mission Bay.
Technology firms looking to expand their footprints in San Francisco continued to drive leasing activity in Q2, with four companies leasing 100,000 square feet or more. Sony leased 130,000 square feet at 303 Second Street in SOMA East in the largest transaction, followed closely by Autodesk and Glassdoor at 50 Beal Street at 117,673 square feet and 116,688 square feet, respectively. An undisclosed tenant leased 116,037 square feet at 1 De Haro Street in Showplace/Potrero, with Workday following up with 74,430 square feet at 160 Spear Street in the South Financial District.
Even with the amount of transactions for large blocks of space that happened in Q2, the quarter ended with at least 15 tenants looking for at least 100,000 square feet of space, according to the report. Looking ahead to the future, vacancy rates will remain low and demand will continue to outweigh supply until new developments come online beginning in 2021 and continue to do so throughout 2023, which will further drive rental rates across the board as the market becomes more constrained.
“The market seems quiet, but it’s really, really crazy,” Arata said.