RACE TO BUILD

Developers are now in a race to build the next new addition to the San Francisco skyline. Over the past two years, strong tenant demand, especially from technology firms like Salesforce, Square and Twitter, has propelled San Francisco to outperform much of the US and global market. Vacancy rates have fallen below the 10% mark, the first time the rate has dipped that low since prior to the recession; rent growth has been robust, increasing more than 45% in the past two years.  Now, for the first time since 2008, developers have broken ground on projects that will have major impacts on the San Francisco market for years to come.

Before this focus on new construction, the influx of technology firms began to impact the local market with renovations of older buildings throughout the city. In 2011, the renovation began on 680 Folsom Street, formerly occupied by Pacific Bell, into a steel and glass building, as well as the renovation of the San Francisco Furniture Mart into the Twitter Building, which has become an  anchor in the city’s booming Mid-Market technology hub. The success of these high-profile renovations, along with the strong market, encouraged other owners and developers to begin transforming even more of the city’s older buildings into modern, open, technology-friendly spaces. Today, 2.6 million square feet of office space is currently being renovated. This includes notable renovations at 140 New Montgomery and 888 Brannan Street.

Alongside this focus on renovation, tight market conditions and rents approaching replacement cost levels have also spurred interest in constructing new buildings from the ground up.  In July 2012, Tishman Speyer began construction on Foundry Square III (505 Howard Street), the last remaining open site of the four properties that comprised the four-building Foundry Square “urban campus” development.  The developer jumped to take advantage of market conditions even ahead of lining up an anchor tenant and construction is underway with completion slated for the first quarter of 2014.  The owners of 350 Mission were set to begin construction around the same time as Foundry Square III, but at the last minute called an audible and rather than begin construction on the site, they sold it to Kilroy Realty in October 2012. Two months later, Kilroy lined up Salesforce to lease the entire building before the construction even began on the project, which is expected to come online in 2015.  The third building currently under way is Boston Properties’ development of 307,000 sf at 535 Mission.  Like Foundry Square III, this building is also under construction without a signed anchor tenant.  In total, more than 1.0 million square feet is presently under construction in San Francisco.

Developers are queued up to build an additional 2.4 msf during the next three to four years, including the Transbay Tower that will add 1.4 msf to the City’s skyline in 2016.  Tishman Speyer is also ready to start construction on another building at 222 Second Street.  In total, 6.1 msf of new space is expected to come online throughout San Francisco through 2016 of which 45% will be renovated space.  So far about 35% of it has been pre-leased.  Fortunately, San Francisco is projected to have strong employment growth of 2.7% per year during the next three years, far outpacing the U.S. average of 1.9%, which bodes well for the leasing of these new buildings.  Even with the higher levels of new construction expected over the next few years, we project the vacancy rate will stay below the 10% threshold with rent growth averaging 7.5% per year through 2016.

Caroline Green

Managing Director – Capital Markets | Northern California

Research

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