While demand and leasing requirements on the Peninsula grow, so does its subleasing market
The San Francisco Peninsula has seen no shortage in investor interest when it comes to its commercial real estate market, which has been driven in large part by innovative and rapidly growing companies from all industries: technology, life sciences, medical and pharmaceutical, among others. Just as so many facets of the market continue to grow — demand, job growth, transaction volume, rental rates — so too has the submarket’s amount of available subleasing space. However, while subleasing inventory doubled from 451,112 square feet to just over 900,000 square feet from the end of 2018 to the beginning of 2019, pointing to a potential softening of the submarket, according to a Colliers Peninsula Report, local market conditions still remain strong.
The San Francisco Peninsula, which, according to Colliers, shares roughly the same geographical area as San Mateo County, includes the cities of Palo Alto, Mountain View and Los Altos and is home to Fortune 500 Companies such as Google and major institutions such as Stanford University. These employers have been some of the main economic and commercial real estate engines over the past several years, expanding rapidly alongside the region’s numerous start-ups. As a result, the Peninsula continues to outperform all other Bay Area submarkets in employment growth; as of the beginning of 2019, the unemployment rate for San Mateo County came in at 2.3 percent. The U.S. national unemployment rate, as a comparison, sits at about 3.8 percent.
When the market gets significant portions of space to sublease, that’s a sign these companies aren’t doing as well as they anticipate
Demand for space and developer confidence still remains high, however, with several major leases indicating continued, positive market momentum. The largest lease of the first quarter was Zuora’s, which took 101,938 square feet at 101 Redwood Shores Parkway in Redwood City. Zoox also inked a sizeable lease for 74,241 square feet at 4100 E. 3rd. Ave. in Foster City. Smaller leases included Enjoy Technology’s 27,032 square foot lease at the Stanford Research Park, while WeWork continued its Bay Area expansion by taking 40,000 square feet at 3101 Park Boulevard, a new, transit-oriented office development in Palo Alto.
In a significant sublease, Snowflake Computing will be moving into 208,994 square feet of space at 450 Concar Drive in San Mateo. Snowflake took over the new Class A space developed by Houston-based Hines and Chicago-based Pearlmark from customer experience management company Medallia.
In all, San Mateo County has 26,160,961 square feet of Class A office space and an additional 17,235,158 square feet of Class B office space for a total of 43,396,119 square feet. The South Peninsula, which includes Mountain View, Palo Alto and Los Altos, has an additional 12,268,345 square feet of total office space. Activity during the quarter was one of the strongest since 2015, with 986,326 square feet of gross absorption recorded.
Additionally, due to healthy levels of office space demand, the report notes that rental rates continue to rise. The average asking rate reached $5.77 fully serviced per square foot, up a modest one percent from the year before and three percent from the end of 2018.
However, the report also places careful emphasis on the large uptick in available subleasing space that occurred during the first quarter of the year, despite relatively low vacancy rates and consistently strong market fundamentals. The vacancy rate throughout the greater Peninsula rose from 6.1 to 6.9 percent during the first quarter; San Mateo County saw an even more dramatic increase to 8.1 percent, a 100-basis point rise from the end of 2018. It is the highest vacancy rate that San Mateo County has seen in four years.
The rise in vacancy, states Colliers, is “almost entirely attributable” to increasing levels of available sublease space. However, the firm also notes that there is not yet a cause for concern, and the report did not specifically outline the potential causes for the quarter’s uptick in subleasing availability.
“We monitor and determine if companies are leasing a lot of extra space and not utilizing it,” explained Rick Knauf, executive director at Colliers International’s San Francisco Peninsula branch. “Or are people leasing space with anticipated growth in mind? We’re not seeing lots of companies go out there and, as an example, lease 50,000 square feet, and after they occupy say, ‘Oh, we only need 10,000, so we’ve got to put 40,000 square feet on the market.’ If there’s a trend like that, that’s where we see problems.”
Within the amount of current vacant office space, 900,422 square feet can be attributed to vacant subleasing space. Previous quarters indicate that the amount of vacant subleasing space was significantly lower. At the end of 2018, there were 451,112 square feet of space available to sublet. Previous quarters were even lower. The first quarter of 2018 ended with 259,830 square feet of vacant space for subleasing, while the second and third quarters ended with 223,422 and 346,962 square feet, respectively. The Colliers report directly states this available subleasing space has nearly doubled in the past quarter, accounting for approximately 23 percent of the overall market.
The importance of tracking the subleasing market, said Knauf, is to determine trends in the market cycle and see if companies are over-leasing and not reaching their anticipated growth. Often, Knauf continued, companies make their commercial real estate decisions based partially on intuition.
“When the market gets significant portions of space to sublease, that’s a sign these companies aren’t doing as well as they anticipate,” he said.
For now, however, the Peninsula’s market continues to thrive, and the spike in subleasing availability is only a cause for concern if it becomes a more consistent trend. By Colliers’ account, subleasing availability at this point in time is simply an indicator to keep an eye on.
“The Peninsula market is very consistent with new construction and demand in the downtown cores and around Caltrain stations,” Knauf said. “There’s been some softness outside of those downtown areas, and this has been [happening] for some time.”