By Guest Blogger Derek Daniels
Senior Research Analyst,
Entering Correction Territory
A combination of slowing labor force growth and a rise in the ranks of the employed pushed the unemployment rate down to 2.8% in May, its lowest figure since December 2000. Total private sector positions climbed to 950,600, up by 32,100 or 3.5% year-over-year. Jobs that require the use of an office workspace have increased 4.0% over the past 12 months to 404,100. The subsector of professional services led the way, followed by financial activities, and information.
CRE & Tech
The San Francisco commercial real estate market has soared along on its longest “up-cycle” in decades, but there were signs of easing back on the throttle in the second quarter of 2016. The single most influential contributor to this local economic expansion has been the rapid rise of the “tech sector” which has become a rather ubiquitous term covering all businesses that have a significant technology focus or component.
Slow or No Growth?
However, recent changes in the tech sector have begun to affect the local office market. Slow or no growth policies have emerged among start-ups as well as some more established firms, resulting in a significant increase in new, vacant sublease space.
M&A activity is also on the rise, with two transactions involving local companies announced before the close of the second quarter. While M&A activity has yet to make a material impact on the market, it is certainly an important activity to monitor as it could lead to more sublease space.
The increase in sublease vacancy and several larger blocks of direct space hitting the market has propelled the Citywide overall vacancy rate to 7.3% in the second quarter of 2016, up 160 basis points (BPS) from the first quarter of 2016 and the largest quarterly increase since the first quarter of 2009.
The overall Citywide asking rent continued to climb, (this metric being slow to adjust in a quickly changing market), closing at a record high of $69.30 per square foot (PSF). Sublease vacancy stood at 1.5 million square feet (MSF), up from the 822,000 SF reported one quarter ago, with tech accounting for 48.0% of the latest figure.
CBD overall vacancy landed at 8.0% in the second quarter of 2016, up from both the 6.5% reported last quarter and the 7.4% reported one year ago. Non-CBD vacancy increased 180 BPS over the quarter to 5.9% from 4.1%.
The North Financial District Class A submarket recorded the highest negative net absorption: -386,245 square feet (SF). However the Class A average asking rent still recorded an increase of +1.1% to $71.42 PSF.
Completed Office Projects & Construction
There were four office buildings completed in the second quarter, all of which were delivered 100% pre-leased: Kilroy Realty Corporation’s 444,000 SF building at 350 Mission Street in the South Financial submarket delivered in May with Salesforce occupying the entire building; Dropbox’s HQ at 333 & 345 Brannan Street; and Splunk’s building at 270 Brannan Street.
As of the end of the quarter, there was 3.8 MSF of space under construction Citywide of which 25.0% was pre-leased. There is one building scheduled to be delivered in 2016: the 55,000 SF boutique property located at 500 Pine Street that is 100% available.
New Leasing Activity
New leasing activity totaled 1.3 MSF in the second quarter of 2016, down from 1.4 MSF last quarter and the lowest second quarter figure since 2009. Tech continued to drive transactions.
The largest deal of the quarter was Fitbit’s sublease at 215 Fremont Street in the South Financial submarket. The wearable tech manufacturer will occupy all of Charles Schwab’s former building to be phased in over 36 months.
There were two significant transactions signed at China Basin Landing (185 Berry Street) in the East SOMA submarket: Lyft took 206,000 SF in a mix of direct and sublease space and Stripe subleased 102,000 SF. Both sublease blocks were originally occupied by Dropbox which moved into its new headquarters.
There were 3.6 MSF of active tenant requirements at the close of the second quarter; down from the 5.5 MSF reported one year ago. Technology users currently account for 65.0% of those tenants in the market.
While uncertainty (China, oil, BREXIT fallout, US election, etc.) continues to be a major theme in the capital markets, the San Francisco office market is still viewed as an attractive investment for institutional, high net worth, and foreign capital.
Cushman & Wakefield tracked seven sales in the second quarter of 2016 totaling $1.3 billion with an additional five sales totaling $1.2 billion expected to close by the end of August. While many investors believe that the market has peaked and may be cooling, they still consider San Francisco to be a great long term investment.
Some of the more notable transactions included Blackstone’s purchase of 555-575 Market Street (one of the largest sales transactions in this cycle) and Pembroke Real Estate’s acquisition of 140 New Montgomery Street. Given where we are in the cycle, we could see cap rates creep up an additional 25-50 BPS in the second half of the year as investors are now requiring cash flow (as opposed to appreciation) to make up a material portion of their overall return.
Though new leasing activity will likely remain subdued compared to the past two years, the market is not dead. Several leases greater than 100,000 SF are expected to close before year-end with some of these pure expansions.
Rents will likely flatten in the second half of the year after reaching record levels.
Only one new building (500 Pine) will enter the market in the second half of the year ahead of four major projects delivering in 2017 (Salesforce Tower, 181 Fremont, The Exchange on 16th, 350 Bush).
THE INCREASE IN SUBLEASE VACANCY AND SEVERAL LARGER BLOCKS OF DIRECT SPACE HITTING THE MARKET HAS PROPELLED THE CITYWIDE OVERALL VACANCY RATE TO 7.3%.
Derek Daniels is a Senior Research Analyst with Cushman & Wakefield, based in the heart of San Francisco’s booming Financial District. With nearly a decade of eclectic research experience in the Bay Area commercial real estate market, his career includes a wide variety of work ranging from local market research to advising tenants and landlords in the lease and sale of office and industrial space.
As an avid social media participant, Derek is an active commercial real estate guest blogger for blog.cushwake.com and engages with the online stratosphere on a consistent basis.