West Office Market
San Francisco
The San Francisco office market has finally turned signs of improvement into positive market performance. Demand or net absorption was positive by about 100,000 square feet and it nudged overall vacancy down by 10 basis points to 24%. Gross leasing activity also maintained its healthy pace, surpassing the 1.4 million square feet of transactions posted last quarter.
This encouraging news kept rents fairly steady at $27.97 per square foot for class A and $20.56 per square foot for class B properties, a narrow decline of 0.5% and 1.2%, respectively, compared to last quarter.
In addition, the amount of available sublease space declined by about 9% or 400,000 square feet. The reduction was primarily attributable to spaces being leased, but there was also space taken off the market and returned to landlords.
Nevertheless, the pace of improvement must accelerate significantly to begin to make a dent in vacancy. It’s too early to declare that recovery is under way when fundamentals in the regional economy and job market have not yet shown meaningful improvement. More than likely, there is confirmation of entry into what is expected to be a long and bumpy plateau.
Expect flat rents and short-term movements in vacancy to be dictated by incremental demand generated from tenant movements until there is sustained improvement.
The pocket of strength continues to be in the market segment for high quality view space where tenants are once again competing for available supply.
Market Assessment
Now that demand or net absorption has once again turned positive and led to a decrease in the vacancy rate, one could suggest that we are now in the recovery phase.
Although Grubb & Ellis believes that it’s too early to declare that recovery is under way when fundamentals in the regional economy and job market have not yet shown meaningful improvement, this will likely be a unique and long-term recovery.
Why? There’s 15.1 million square feet of vacant space currently compared to 8.8 million square feet in 1987 when vacancy last peaked. The economic growth of the late 1990s was unprecedented and unlikely to repeat itself.
If the next few quarters once again show positive demand, then we can confidently say that we have entered the recovery phase. However, this eventual recovery may lead to a unique real estate cycle in the future,a very small to nonexistent expansion phase resulting from a bloated oversupply phase.
To use a common expression describing the current national economic situation, we could soon be entering a “new construction-less” recovery.
If you eliminate government space, the only foreseeable new construction in downtown San Francisco in the next decade is likely to be mixed-use projects where office space is required or where it can be targeted to the higher end segment.
What does this mean going forward? Well, short of major corporate relocations into San Francisco and another dot-com like economic boom, the recovery phase will be a very long part of the current real estate cycle.
