By Joe Gose
To say that office real estate investment trusts that own assets in San Francisco are bullish about the promise for rent growth would be a tad understated.
Dogged demand from technology companies and limited supply have inspired predictions that average rental rates will approach heights not seen since the first dotcom boom. Lease rates in the city hit an average of $59.28 in the second quarter, according to commercial real estate services firm CBRE Group, Inc., and office owners are already testing tenant limits.[contextly_sidebar id=”1ll0lVjSXP1ITVvPCyjZME12MTwf0tcg”]“With lack of inventory, landlords, including us, are really seeking to try and push rents, and we’re asking in excess of $80 a square foot for our best space,” said Douglas Linde, president of Boston-based Boston Properties, Inc., during the company’s second quarter earnings call earlier this summer. “We’ll see if we get it.”
Linde is hardly alone among REIT executives regarding his outlook for San Francisco, and that optimism has spilled over to office REIT investors who are reaping outsized returns amid the low interest rate environment coupled with modest economic growth.
Through the end of August this year, office REITs generated a total return of 20 percent, double that of the Standard & Poor’s 500 Index, according to the National Association of Real Estate Investment Trusts.
In San Francisco, the second quarter rent of more than $59 a square foot represented a year-over-year increase of 14 percent. Victor Coleman, CEO of Hudson Pacific Properties, Inc., told analysts during his company’s earnings call that he anticipated average rents to close in on the 2000-era level of $74 per square foot soon, even with the addition of 1.3 million square feet of office space over the next year.
“[The new space] is already more than 80 percent pre-leased and therefore not expected to significantly ease the current supply constraints,” he said.
The Los Angeles-based REIT owns 2.2 million square feet of offices in the city and has secured its share of technology-related leases this year. In June, the company announced that transportation company Uber Technologies, Inc. would occupy an additional 130,434 square feet at 1455 Market St. on top of the 88,134 square feet that it leased in 2013. In April, digital advertising service provider Rocket Fuel agreed to lease 24,438 square feet of the building for seven years with an option to double its space.
NerdWallet, a dispenser of financial advice to consumers, also agreed to occupy 45,739 square feet at Hudson Pacific’s 901 Market St. property for seven years beginning in the fourth quarter.
“Looking ahead at the second half of the year, we believe technology firms will continue to provide strong demand for office space in the San Francisco marketplace,” Coleman told analysts.
Executives with Los Angeles-based Kilroy Realty Corp., which owns 2.8 million square feet of offices in San Francisco, also see higher rents on the horizon. Proposition M, a law that caps the amount of office development in the city, virtually guarantees that demand will continue to outstrip supply, Kilroy COO Jeffrey Hawken told analysts during the second quarter earnings call.
Office brokers are searching for 7.5 million square feet of space on behalf of clients, and 15 tenants in the market were looking for more than 100,000 square feet each, he added.
To meet that demand, REITs are developing new space before Prop. M restricts the approval of future office projects. In May, Kilroy acquired a fully entitled development site of 3.1 acres in Mission Bay for $95 million, and it has a $450 million plan to build four mid-rise office structures totaling 680,000 square feet. The REIT also in July agreed to buy a 1.9-acre site at 6th and Brannan streets in the city’s South of Market district for $27 million.
Meanwhile, Boston Properties, which owns 5 million square feet of office space in the Bay Area, in 2013 began construction of the approximately $1 billion Transbay Tower, a 1.4 million-square-foot, 61-story building at 415 Mission St. It renamed the structure Salesforce Tower earlier this year when the customer relationship management software provider agreed to occupy 714,000 square feet. Additionally, the REIT is nearing completion of its $215 million, 307,000-square-foot office project at 535 Mission St.
Robust leasing activity in conjunction with limited supply is forcing technology tenants in the market to think about their space needs over the long term, Linde said during the earnings call. That’s a strategic shift for the firms, which have largely hunted for space only after the need arose, he suggested.