By Jacob Bourne
Analyses by local market researchers tell a story of health and stability for San Francisco’s office real estate market, despite data that indicates a leveling off in the aftermath of robust growth during the 2014 and 2015 peaks. Experts caution that comparing current activity with the extreme and unsustainable high growth of the past can easily skew perspectives on the present market outlook. The primary economic driver continues to be tech-related, however a more restrained industry is materializing as competition has squeezed start-ups in some saturated sub-sectors. Analysts maintain that the forecast is sunny for the remainder of 2016 and beyond, provided that structural challenges such as adequate housing and transportation infrastructure are prioritized.[contextly_sidebar id=”p5HNaLj7mTr1oYyNvZMNZ5ygjS2drNCf”]“The demand for completed office building space from investors is as high as it’s ever been,” explained Alan Collenette, regional executive managing director, Colliers International. “Prices are still at record levels. Investor interest has never been stronger for these buildings. The interested groups are looking for long-term stable investments. For foreign investors, San Francisco now places in the same league as London and New York as a center of the world’s knowledge-based economy. This has also spilled over into Seattle and Portland to a certain extent.”
Vacancy rates for office space in San Francisco ticked up this quarter, higher than a spike in Q3-Q4 in 2014, according to a recent, third quarter industry report from brokerage firm CBRE. JLL also issued its own set of Q3 data, showing the highest vacancy rate at 8.3 percent followed by 7.7 percent and 6.9 percent that Cushman & Wakefield and CBRE show, respectively. Yes, this is the quarter-end reporting season, and the top brokerage firms across the region are trying to capture the attention of the industry with their own way of data interpretation.
The Cushman & Wakefield report also indicated that the vacancy rate increase follows another one from the previous quarter, which is the first consecutive quarter-over-quarter increase since Q2 of 2009. In contrast, Q3 was the first quarter showing increased vacancy according to JLL data, which was influenced by Twitter putting 180,000 square feet of Mid-Market space up for sublease. The space is geared for 100-percent occupancy, but the lease deal had not been finalized prior to the publication of the reports.
“We’re going to end the year really strong for all markets,” said Amber Schiada, vice president, director of research, JLL Northern California. “We should be watching sublease space in San Francisco. Venture capital funding is a huge indicator for the tech industry. Things have been impacted by the housing shortages but with some new housing being created, that should ease the problems. We have some of the worst traffic in the nation — so it’s as if the economy is tripping over itself, which could potentially stunt the growth we’re hoping for.”
For Schiada and her research colleagues, this is the time where fine print is carefully vetted. The differences in vacancy rate values as well as other measures of the market are a function of different research methodologies each firm utilized. For example, JLL researchers call landlords directly to confirm whether spaces are physically occupied, however some firms calculate vacancy based on space availability, which would be applicable to sublease situations where an office may be occupied but also on the rental market. This distinction between true vacancy and availability also plays a role in how net absorption is calculated.
Asking rental rates show prices higher than 2014-2015 averages but quarterly performance has shown a slight decrease in rates, which researchers interpret as an overall plateau in rental rate growth for the periods ahead. Cushman & Wakefield highlighted Q3 as the first quarterly decrease since Q2 2010 at $69.21 per square foot, though the value is 4 percent greater than in Q3 2015. CBRE showed prices at $68.29, JLL $73.59, and Colliers $73.
JLL calculated 4.4 million square feet currently under construction while Cushman & Wakefield found 3.8 million square feet. Net absorption, one of the many indicators used to determine the health of the economy, showed positive figures from all four firms, although the figures varied wildly. For instance, for the third quarter alone CBRE indicated the lowest net absorption value at 29,000 square feet, followed by 185,000 for Cushman & Wakefield and 218,000 for JLL. In terms of year-to-date net absorption, CBRE’s value was the highest at over one million square feet, while Cushman & Wakefield and JLL’s numbers were above 700,000.
“We’re experiencing a healthy level of demand but at the same time the market is shifting towards greater balance,” offered Colin Yasukochi, director, research and analysis, CBRE. “Overall, tenants are seeing their leverage increase. Last year they had less leverage. When there is more demand than supply, the landlords dictate [terms], but when there’s more supply and less demand, tenants dictate [them]. Right now we’re seeing a higher level of supply, but I wouldn’t say it’s a tenants’ market because rents are not going down, but tenants are gaining ground.”
Though the increase in percentage points for the vacancy rate may indicate a slowdown, the rates are still below equilibrium levels and short of historic averages. Researchers expect a strong end-of-year market performance and agree that the current period is an aftermath of the 2014-2015 tech boom that brought an unsustainable level of growth. As a more balanced economy emerges, venture capitalists are closely scrutinizing start-ups, and companies are adopting more conservative growth policies. Challenges to the Bay Area’s structural economic growth such as the availability of tech talent, transit and housing will prove key factors in maintaining an active trajectory.
“This is still the glittering age of San Francisco — the most desirable city in the U.S. and one of a handful in the world,” expressed Collenette. “The city has come of age. Unless we think technology is no longer the fundamental driver of the modern economy, it is inconceivable that San Francisco employees and companies will do anything but flourish long into the future. Yes, there will be pauses, even dips, but we are not looking at any kind of repeat past booms and busts. We just need to get over that mindset and look at the real facts.”
Researchers foresee significant lease deals made in San Francisco and Silicon Valley by the end of the year. Companies such as Facebook, NerdWallet, Cisco and Google are reportedly seeking large expansion spaces in the city. NerdWallet is aiming to occupy 120,000 square feet of Twitter sublease space in San Francisco.
“The amount of demand in the market is lower than last year, but rent stability is an indicator that we’re headed towards a more stable market, which is a healthy thing,” said Yasukochi. “Supply and demand are constantly rebalancing. New construction will be starting, the bulk of which will be delivered in 2017.”