By Robert Sammons, Regional Director – Northwest U.S. Research
Hold the Rant for a couple of weeks and all hell breaks loose. This column was due to focus exclusively on the mid-year San Francisco office statistics and what they mean. And that will continue to be the primary objective. But it’s impossible to ignore Brexit. Quite frankly, the only thing we do know about what happens economically after the vote in favor of the UK leaving the European Union (EU) is that we don’t know. Certainly the markets are now all very shaky but that was the case even ahead of the vote. The coming weeks, months (and years) are likely to be volatile for the UK and all of Europe. Personally, I’m more concerned about our US presidential election and how that will shape the national and local economy moving forward. Truly an “interesting” political year and it’s far from over. In any case, Brexit is big news and impactful globally. For insightful analysis from Cushman & Wakefield on how Brexit may impact the economy and real estate, please click here.
Now on to San Francisco commercial real estate news. An overview of what happened in Q2 2016 and what can be found on this Infographic. But further analysis is warranted. The short and sweet of it? The statistics gave hardcore proof to what we’ve known since the beginning of the year – there is a fundamental shift underway in this office market.
The most glaring change was in the vacancy rate with the overall (all classes) citywide figure jumping 160 basis points in Q2 2016 to 7.3%. This is its highest figure since Q4 2014 and the first increase since Q1 2013. Digging deeper, it wasn’t just one block of space or one submarket but a much broader issue with 10 of the 14 submarkets recording increases and four submarkets recording no change. The submarkets with the biggest uptick in the vacancy rate were North Financial CBD (from 8.0% to 10.1%) and East SoMa (from 6.6% to 10.3%).
An ongoing issue since late last year has been the rise in sublease space which has been a significant contributor to the overall increase in vacancy (though direct vacancy has been headed higher as well). In Q2 2016, sublease vacancy nearly doubled to nearly 1.5 million square feet (msf) from just over 800,000 square feet (sf) last quarter.
To be clear, it’s not as if there is just an outright wholesale dumping of space happening. There are various reasons for the increase, such as relocations (within the City and to areas outside the City), downsizing and shutdowns as well. Additionally, much of the prime sublease space that has come to market has had a relatively short shelf life thanks to having a somewhat lower price point on average, being built out (little to no CapEx needed) and offering a shorter/flexible term.
Meanwhile, new leasing activity (direct and sublease transactions excluding renewals) was weak in Q2 2016 at just 1.3 msf, the slowest second quarter since 2009. For the first half of 2016, new leasing was down 32.5% from the first half of 2015. Of course, the market wasn’t completely lifeless nor was the tech sector, with significant new leases coming from major companies including Fitbit, Stripe and Lyft. These three large transactions were all subleases. In fact, 61% of the leasing activity in Q2 2016 was sublease space, up from 17% in Q1 2016.
Cushman & Wakefield added four new buildings to its proprietary database in the latest quarter – 350 Mission Street (Salesforce), 270 Brannan Street (Splunk), and 333 & 345 Brannan Street (Dropbox). These buildings went in as 100% occupied and were the reason that net absorption was still positive during the second quarter (+343,000 sf) as well as the first half of the year (+673,000 sf). Even so, midway through 2016 net absorption is down by 12.6% compared to the first half of 2015.
And now on to asking rents, which continued to rise in Q2, albeit generally at a slower pace. Seven of the 14 submarkets recorded increases and there are a couple of reasons for this trend even as the vacancy rate was climbing. First, landlords and sublandlords are generally slow to adjust rents in a changing market and second, the space coming to market was rather high-end which skewed the figures. The overall Citywide figure closed Q2 up 1.3% to a new record high of $69.30 per square foot.
So is this a tech bubble bursting or more of a correction? We believe we are certainly well within correction territory which will continue into 2017. The tech right-sizing phase will include both M&A activity along with some shutdowns. The market isn’t dead, however, as there are still some 3.6 msf of tenants in the market (65% of which are tech). Tech still wants to be here – it’s where the talent and the money are. A cooling down will help those tenants find the space they need at a potentially lower price point. Otherwise, the desire to look for a new or expanded home elsewhere, something that’s already underway, would rise even further. And it’s not solely the expense of being here – the San Francisco metropolitan division has a current unemployment rate of 2.8%. Let that sink in – that’s full employment people! But certainly a part of that miniscule figure is that our labor force has been flat or falling over the past few months likely because of the high cost of living. If San Francisco and the entire Bay Area could get a better grasp on housing costs, community, transport and infrastructure issues, then there would certainly be nowhere to go but up.
Check out our review of the San Francisco office market in Infographic format.
This post is guest commentary from the latest weekly edition of our Bay Area Research Rant, which you can subscribe to for free by e-mailing email@example.com.
Robert Sammons is a Research Director for Cushman & Wakefield. Based in San Francisco, Robert’s principal roles include working closely with the C&W research teams across the Northwest – including Northern California, Portland and Denver. Robert is author of numerous documents that delve into a wide variety of real estate and economic trends. He has been a quoted source for all manner of real estate and related economic information in many widely known media outlets across the country. Robert has 29 years of real estate experience as both an appraiser and researcher. He earned a BBA in Real Estate from The University of Georgia and an MS in Real Estate from Georgia State University. Robert is a member of the Urban Land Institute.