Demand for office space continues unabated as the region’s economic engine churns
Demand for office space in the Bay Area continues to rise to monumental heights, particularly in San Francisco, Silicon Valley and the Peninsula. According to 2018 Q3 reports released by Colliers International for the five major regions in the Bay Area, each region has experienced increasing amounts of leasing volume as the technology industry continues to boom.
While the leasing market remains relatively healthy, answers for limited supply remain in question. One aspect of positive growth that is symbolic of the state of the market is positive net absorption, especially in San Francisco and the Oakland Metropolitan Areas. Commercial real estate is in high demand, despite housing costs driving workers further from urban cores making commutes longer. Spaces are pre-leased faster than they are built, according to industry experts, continuing the trend of the industry evidenced in the last few years.
It is incredibly brisk. The preleasing that has gone on over the last 24-36 months has been absolutely unfathomable. It’s unprecedented.
Each region excels in some areas and falls short in others. Looking into factors such as average asking rents, overall vacancy rates and most notable transactions of the year, one can determine the Bay Area is and will continue to be a dynamic player in both the state and national leasing market fields.
San Francisco remains at the head of the game with almost 2.3 million square feet of leasing transactions closing by the end of the third quarter, according to the 2018 Q3 San Francisco Office Market Research & Forecast Report by Colliers International.
Some of the biggest transactions involved household names like Twilio, SoFi and Amazon, the latter of which leased 143,000 square feet at 525 Market Street. Added to their current footprint in San Francisco, Amazon now accounts for more than 600,000 square feet of office space.
Other notable leasing transactions include Unity Technologies and Regus (Spaces), which leased 144,924 and 77,999 square feet, respectively.
Because of the high demand for commercial real estate in San Francisco, vacancy rates continue to be very low. Though they have not reached the level achieved in 2002 at 5.1 percent, San Francisco is currently sitting at sub 6 percent at 5.8 percent, dropping 110 basis points since the end of 2017 as a direct result of positive net absorption for Class B assets, according to the report.
Just over 900,000 square feet is expected to be delivered before year end, which may play a role in slightly increasing vacancy rates going into 2019, depending on whether or not the space has already been leased.
Another reason behind the low vacancy rates could be the unprecedented amount of preleasing San Francisco has seen in the past two to three years.
“We’re in uncharted waters, there’s no question about it,” said Nick Slonek, principal and managing director for Enterprise Solutions Office Leasing Sales & Leasing at Avison Young, based in San Francisco. “It is incredibly brisk. The preleasing that has gone on over the last 24-36 months has been absolutely unfathomable. It’s unprecedented. It’s a fable: You build it and they will come type of situation.”
San Francisco ended the third quarter with 341,000 square feet of positive net absorption, according to the report, for a total of year-to-date absorption at more than 3.6 million square feet in the core Central Business District (CBD) submarkets.
“It used to be that 1 million square feet of absorption a year was the norm,” Slonek said. “We’ve eclipsed that.”
Despite the tech boom in San Francisco, Silicon Valley remains the crown jewel in California’s, and the nation’s, technology industry.
Demand for space continues to be extremely high, which has led to a steady increase in asking rents across the board. According to the 2018 Q3 San Jose/Silicon Valley Office Market Research & Forecast Report by Colliers International, average office asking rents rose to $4.38 for full service space, up $0.05 from the previous quarter.
Vacancy rates have risen from 5.2 percent in the second quarter to 5.4 percent in the third quarter, with net absorption falling to a -515,000 square feet in the third quarter.
According to the report, third quarter leasing activity in the office sector reached 2.4 million square feet. The largest leasing deals in Silicon Valley for the third quarter have been projects that have not yet reached completed construction, the most notable of which came from Roku, based in Los Gatos, Calif., which took 472,319 square feet at Coleman Highline in San Jose, most of which has not yet broken ground, according to the report.
Other transactions include Nokia leasing 227,220 square feet in Sunnyvale, Calif., expected to break ground next quarter, and Splunk leasing 301,000 square feet at Santana Row in San Jose, Calif., currently under construction.
Going into 2019, Phil Mahoney, executive vice chairman at Newmark Knight Frank, suggested that lenders could be acting more cautiously because of construction costs, and while construction activity in Silicon Valley has been hot and demand remains high, the market could be uncertain.
“The biggest wild cards are not real estate related,” Mahoney said. “They’re White House related, interest rate related, given growing debt. Companies left to themselves would be fine. [Tariffs] cause a big ripple. The semiconductor groups, they’re not sure just where they’re headed because of political turmoil. It’s very real and as much of an issue as I’ve ever seen it – uncertainty – and markets do not like uncertainty.”
San Francisco Peninsula
The Greater San Francisco Peninsula, which Colliers defined as covering the regions of San Mateo County, Palo Alto, Mountain View and Los Altos, has continued to show trends similar to much of the remaining Bay Area: high demand for leasing space and increasingly limited office supply.
Average asking rents have risen by 4.7 percent since the third quarter of 2017, according to the 2018 Q3 San Francisco Peninsula Office Market Research & Forecast Report by Colliers International, but while gross absorption levels have totaled 3,059,555 square feet leased since July (around 1,852,890 more square feet than the third quarter of 2017), net absorption has seen a -388,857 square feet decrease in the third quarter.
Overall vacancy rates for the Peninsula hover at around the same levels as its Bay Area counterparts at 5.4 percent, which is up .3 percent from the previous quarter, according to the report.
Most notable transactions from this quarter have been Adaptive Insight’s 54,863 square foot Palo Alto lease, Poshmark’s 50,237 square foot lease in Redwood City and Versartis’ 34,464 square foot long-term lease in Menlo Park, as stated by the report.
Oakland Metropolitan Areas
Oakland Metropolitan Areas have experienced a tumultuous few quarters in terms of vacancy, as a number of completed office developments caused a vacancy spike, according to the 2018 Q3 Oakland Metropolitan Areas Office Market Research & Forecast Report by Colliers International. After settling down in the third quarter, Oakland Metropolitan Areas still have a slightly higher vacancy rate than the rest of the Bay Area, moving down from 6.4 percent in the second quarter to 6.2 percent in the third quarter.
Overall asking rates continue to slide downward, from $3.95 in the previous quarter to $3.92 in the third quarter, though asking rates are picking up in submarkets.
Leasing demand in Oakland Metropolitan Areas, while not as robust as in the remainder of the Bay Area, still remains consistent with trends, and the presence of start-ups based in the Oakland area has paved the way for smaller tenants seeking flexible terms in co-working spaces, according to the report. Significant leases include UC Berkeley with 244,000 square feet in the city of Berkeley and Dynavax Technologies Corp. with 75,662 square feet in Emeryville, Calif.
More than one million square feet currently remains under construction, with no new projects completed since the second quarter at 986,500 square feet.
Oakland Metropolitan Areas hover modestly in terms of net absorption at 86,404 square feet this quarter, according to the report, nearly 10,000 square feet more than the second quarter.
New construction projects going into the fourth quarter include the CIM project Uptown Station, a total of 365,000 square feet of Class A office space that is located at 1955 Broadway Ave.
The Tri-Valley falls far behind its Bay Area counterparts in terms of vacancy rates but has experienced a vacancy decrease overall, from 12.3 percent to 10.7 percent in the third quarter. According to the 2018 Q3 Pleasanton/Tri-Valley Office Market Research & Forecast Report by Colliers International, the Tri-Valley has experienced a continued softening market over the years, with weighted average rent asking rates decreasing and net absorption to date still negative.
Looking particularly to the third quarter, however, things are looking up. Net absorption for the third quarter was 334,812 square feet, according to the report, and the Tri-Valley is still enjoying job creation from the tech industry boom in San Francisco, Silicon Valley and surrounding areas.
“It’s a simple formula: as long as you have job creation, there’s square footage leased,” said Edward Del Beccaro, East Bay Regional Manager at Tri-Commercial Real Estate Services, Inc.
Compared to previous years, the Tri-Valley is also enjoying a healthier market and can expect not too much of a difference going into 2019.
“We still have positive absorption in all sectors across the board,” Del Beccaro said. “The last quarter has slowed a bit in certain categories relative to four and five years ago. This is one of the longest extended business cycles. Overall market for 2019 is still very good and not as dramatic as it was two or three years ago.”
Prominent business transactions include Patelco Credit Union, which purchased the six-story, Class A, 209,120 square foot vacant 3 Park Place from TRT NOIP Dublin LP (Black Creek Group) for $55,100,000, according to the report. One Park Place also completed a deal with Crown Castle USA Inc. on the third floor of 1 Park Place, leasing 36,690 square feet.
The Bay Area remains to be a truly dynamic leasing market, where anything can happen in the next quarter that will determine the future of real estate. When speaking about San Francisco, Slonek added it was high anxiety and fast execution.
“[It is] the ultimate game of musical chairs, and who gets what is at the finish line first,” Slonek said.