San Francisco’s Office Market Continues to Glitter

High Tech Equals High Growth as San Francisco Continues to Witness Office Market Trends During the First Quarter of the Year, Colliers Reports 

SAN FRANCISCO – Technology companies have continued to feed their unrelenting appetite for San Francisco office properties, pushing vacancy rates to record low levels and creating an unprecedented level of net absorption, as their frenzy for Class A office space continued unabated in the first quarter of 2015, Colliers International has reported.

In its latest study of the San Francisco office market, Colliers reported that office space leasing take-up (absorption) rates reached 900,000 square feet in the first three months of 2015, compared to 257,000 square feet in the fourth quarter of 2014, setting a voracious pace if the trend continues. The first three months of the year also equated to the 19th consecutive quarter of positive net absorption, a streak that places the City among the healthiest office markets in the world.

Vacancy rates fell to 6.7 percent, the lowest level seen in a decade for all classes of office space, despite delivery to the market of 185,000 square feet of newly constructed office space, much of which was pre-leased prior to coming on the market.

With 900,000 square feet already recorded in the first quarter, San Francisco is on pace to again eclipse the historical net take up average of 1.1 million square feet, the report noted. (In 2014, the City witnessed 2.8 million square feet of net growth).

“San Francisco, today, simply has no peer; it is the urban epicenter of the world’s knowledge-based economy, whose currency is innovation,” said Regional Executive Managing Director Alan Collenette, who oversees Colliers’ operations in downtown San Francisco, Marin and Sacramento. “This, truly, is San Francisco’s Glittering Age. Typically, well before this point in a real estate up-cycle (now 6 years old), you look for reasons to question the sustainability of the upward momentum. We have looked, diligently, but the evidence of a near term peak is not just hard to find, it is completely absent.”

Collenette continued: “For example, the first sign of a slowdown is often sublease space – from ‘starburst’ companies – those who have expanded into office space without the business model to support the growth habit. Yet today, vacant sublease space is virtually non-existent. At 0.6 percent, it has been below 1 percent for over four years.”

Despite a healthy level of new construction, the vacancy rate continued to plummet due to the almost immediate occupancy, through either long-term leases, or the outright purchase of, newly completed buildings.

Among the major lease transactions completed in the first quarter was Uber’s newly signed commitment for 172,838 square feet at 555 Market St., giving it one of the largest footprints of tech companies in the City, the report noted. Other notable lease signings during the first quarter included First Republic’s 132,474-square-foot renewal at 388 Market St., Advent Software’s renewal at 600 Townsend Street for 129,491 square feet, and Cooley’s renewal of 100,765 square feet at 101 California St. Filling out the largest leases signed in the first quarter were Mixpanel’s 60, 593 square feet at 405 Howard St.; AON Corp.’s 53,180 square feet at 425 Market St. and WeWork’s 45,738 square feet at 995 Market St.

The report showed over 5 million square feet of office space currently under construction with nearly another 11 million square feet either proposed or in various stages of planning.

“What we are seeing.” added Collenette, “is that as soon as an Uber, for instance, leases a major building, it immediately starts looking for more and more space, based on financial fundamentals that its backers truly believe are sustainable. Right now, there is no end to this growth.”

On the sales front during the first quarter, the largest transaction was Salesforce.com’s $640 million purchase from TIAA-CREF of 50 Fremont St. with total square footage of 817,412 square feet. That was followed by the $219,150,000 purchase by CPPIB of a 45 percent interest in 1455 Market St.; and Emmes Asset Management’s purchase for $200 million from Embarcadero Capital Partners of 301 Howard St.

“San Francisco’s office market continues to be one of the world’s strongest real estate investment markets,” said Collenette. “This is no accident, nor is it an anomaly. Globally, capital is looking for refuge from uncertainty, both political and economic. Against a background of very low interest rates, acceptable risk- and inflation-adjusted yields are hard to find in the bond and equity markets or elsewhere. Commercial real estate in San Francisco provides both safety, current yield and the possibility of capital gains. This is a matchless combination for domestic and global investors alike.”

The underlying strength in the San Francisco office market is generated by the number of new jobs created by the high-growth, high-tech firms, and the service sectors that support them, the concurrent rise in occupancy levels and the natural rise in rents that always follow.

According to the report, there was a total of 10 office sale transactions during the first quarter for a combined value of $1.3 billion, compared to 14 sales of office properties in the fourth quarter of 2014 for a combined value of $1.9 billion. For the full year 2014, Colliers recorded 50 sales of office properties for a total of $5 billion, the report noted.

Overall market weighted rental rates for assets reflected an increase of 0.4 percent for the first quarter and annualized rents continued to climb and finished the quarter up 5.7 percent, the study revealed. This continued a trend from the previous year, resuming its normal pattern of rental increases that had only been interrupted in the third quarter of 2014 when rents briefly paused their growth.

Prices continued to rise for Class A assets this quarter, as the average increased to $717 per square foot during the three-month period from $603 per square foot in the fourth quarter, the study found. Conversely, prices for Class B assets rose to $602 per square foot from $508 per square compared to this time last year, the report noted.

The Financial District continued to dominate investment sales, accounting for $864,500,000 of the investment sales during the first quarter. The two largest sales that closed were in the south Financial District, where 50 Fremont St. sold for $640 million, or $783 per square foot, and 301 Howard St. sold for $200 million, or $651 per square foot. At year end, Colliers cautioned that sales prices would continue to climb well into 2015, although it expects that sales volumes may slow. That is a prediction it is standing by, officials of the company stated.

“With the capital and opportunities both here, we are finding that both institutional and individual investors are all searching for opportunities where they can put their money to good use,” said Colliers Executive Vice President Tony Crossley. “But they may end up chasing few opportunities if the volume of sales does slow.”

Other factors helping San Francisco’s burgeoning economy is a job market that continues to be bolstered by the large number of technology firms moving into the City. This was reflected in the latest employment numbers from the California Employment Development Department (EDD) that showed the number of employed in San Francisco grew from 481,900 to 520,500. The overall unemployment rate in the first quarter fell to 3.8 percent, compared to the already low 4.3 percent recorded in the fourth quarter. That compares favorably with California’s overall unemployment rate of 6.7 percent. Nationally, the unemployment rate edged down to 5.5 percent.

“All of the new space coming onto the market and all of the renovated space that is being put back into the inventory is likely to be pre-leased due to the outsized demand we are seeing,” said Colliers Executive Vice President Mike McCarthy. “With so much new space projected to be coming on the market through the year 2017, we are fortunate that this is where the tech firms have decided they want to be. It gives us a decided advantage when compared to so many other office markets in the country that don’t have the benefit of such a powerful growth industry.”

About Colliers International
Colliers International is a global leader in commercial real estate services, with more than 16,300 professionals operating out of 502 offices in 67 countries. A subsidiary of FirstService Corporation, Colliers International delivers a full range of services to real estate occupiers, owners and investors worldwide, including global corporate solutions, brokerage, property and asset management, hotel investment sales and consulting, valuation, consulting and appraisal services, mortgage banking and insightful research. Colliers International has been recognized and ranked by the International Association of Outsourcing Professionals’ Global Outsourcing 100 for 10 consecutive years, more than any other real estate services firm. For the latest news from Colliers International, visit Colliers.com, or follow us on Twitter (@ColliersIntl) and LinkedIn.

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