By Meghan Hall
While suburban office markets have generally fared better than their more urban counterparts, the challenges of COVID-19 remain. In Sacramento, hopes of recovery were dashed when the Delta variant emerged, further delaying returns to the office and a subsequent need for commercial office space. While full recovery is still in the works, there are a few positive signs in the market, according to a third quarter report released by Colliers International.
“While our office market has been hit hard since the start of the pandemic, market fundamentals and rental rates have not been as adversely affected like our neighbors in the Bay Area,” explained Colliers’ Bob Shanahan. “Many of the large vacancies we have seen in our market over the last 18 months were not COVID-related with companies or government agencies consolidating into new construction from leased space.”
At the end of the third quarter, vacancy sat at 16.5 percent, an increase of 340 basis points since the first quarter of 2020, and up from 13.5 percent during the third quarter of 2020. Colliers estimates that since COVID-19 began, the Sacramento office market has shed 1.9 million square feet of occupied office space as tenants reevaluate their needs. Vacancy, Colliers predicts, is expected to continue rising into 2022.
Colliers notes that office occupancy continues to “fall deep into the red” and annual net absorption is on track to post its lowest annual total since 1998. Absorption during 2021 has also been 2.5 times lower than 2020’s annual total. Absorption during the fourth quarter is also likely to be negative, as the California Department of Conservation will vacate 180,000 square feet at 801 K Street as it prepares to move to a new building.
Other companies are given back space via sublease; during the third quarter, Sacramento’s sublease market also continued to rise, reaching 1.28 million square feet. Companies, including public sector tenants, are continuing to give up space. FI$CAL returned 75,000 square feet in Point West, while Centene gave up 63,000 square feet in the Highway 50 East submarket. Dignity Health also returned 51,000 square feet to market.
While vacancy does continue to increase, occupancy losses slowed for the first time during the third quarter, and leasing and sales volumes have reached their highest levels since the beginning of 2020. Recent lease transactions include Penumbra’s decision to take 97,000 square feet at 620 Roseville Parkway, and General Dynamics 31,000 square foot lease at 105 Lake Forest Way in Folsom. The Mental Health Services Oversight & Accountability Commission (MHSOAC) also signed up for 28,000 square feet at 1812 9th Street in downtown Sacramento.
However, there is one caveat to leasing activity occurring in Sacramento: it is mostly the result of companies looking to downsize or consolidate. While tenants recognize they need some office space, they are also realizing that they may have too much. Law firm Wilke Fleury, notes Colliers, signed a lease for 13,000 square feet at 621 Capitol Mall, a decrease of 7,000 square feet from its current offices at 400 Capitol Mall, representing a 35 percent reduction in space.
“Companies and public sector tenants are continuing to reevaluate their office space needs in the Sacramento market. While the overall occupancy trend continues to be negative, we are beginning to get more clarify in terms of demand moving forward,” said Shanahan. “…We are still far from seeing a full recovery this year, but the overall trend is heading in the right direction with leasing activity increases and occupancy losses moderating.”
On a more positive note, even as vacancy climbs, rental rates have remained relatively stable. Over the past year, rental rates have held, increasing just $0.01 to $2.06 per square foot over the past 12 months.
Colliers also looked to other fundamentals to get a sense of the office market’s health. The brokerage firm notes that while the commercial real estate industry continues to lag, other economic fundamentals are improving, and that hopefully CRE will follow suit. Real GDP, for example, has increased 8.5 percent year-over-year. Unemployment has decreased to 6.4 percent as of August of 2021, while unemployment growth reached 4.8 percent year-over-year.
The pandemic has also spurred population growth in the region, which resulted in a 3.3 percent net migration change between March of 2020 and February of 2021. Colliers notes that companies may be prompted to open new offices to accommodate recently relocated residents. Additionally, Sacramento has experienced a dearth of new, speculative office supply over the past decade. As demand returns, this will only serve to bolster the local market in the long-term.
“With a glaring lack of speculative development delivered over the last decade, the Sacramento market should recover much quickly from this downturn than it has in previous downturns,” Shanahan noted. “Our market is continuing to receive new residents and as companies return to the office, we should see overall demand pick up.”