WESTERN REGION OFFICE MARKET
SAN FRANCISCO
Leasing activity in San Francisco sustained the robust pace established early last year as tenants continue to take advantage of market conditions that appear to be moving even more in their favor.
During the first quarter, nearly 1.6 million square feet was leased, the highest quarterly total since fourth quarter 2000. And the average deal size has increased to 17,000 square feet from the 10,000-square-foot level seen for much of the past two years.
Despite the strong leasing activity, vacancy rates rose by 80 basis points to 24% and average asking rents slipped by 3.6% for class A space to $2.37 per square foot and 1.1% for class B to $1.76 per square foot.
The increased vacancy is a result of about 260,000 square feet of negative net absorption and the completion of 225,000 square feet of new, but vacant, office space.
The challenge going forward for landlords facing existing vacancy and near term lease rollover will be how they play the current game of tenant merry-go-round that is boosting leasing activity, but yielding very little new demand and pitting landlords against each other to produce the best deals.
Now that large tenants have entered the market in big numbers, rent levels will be truly tested. In addition, the amount of vacant space in the hands of landlords continues to increase and will provide further challenge,it now stands at nearly 69% of total vacancies, vs. 60% a year ago and 50% two years ago.
Economic uncertainty, persistent job losses and business cost cutting have created a bunker mentality that could lead to further upticks in vacancy.
Expect 2003 to be a defining year that sets the tone for years to come.
Tenants have tightened their grip on the leasing market as conditions move even more in their favor. And they haven’t been shy about throwing their weight around to get the best deals.
Landlords have responded by aggressively competing for what seems to be a growing pool of tenants entering the market ahead of their lease expiration.
Unfortunately for landlords, the current game of tenant merry-go-round is boosting leasing activity, but yielding very little new growth or demand.
The most significant hurdle for landlords is the retention of existing tenants and filling vacancies with new ones. Tenants have issues as well and are looking at their business bottom lines and seeing opportunities to reduce expenses through lower occupancy costs.
Landlords, then, would be wise to accommodate the needs of their existing tenants by being receptive to “extend and blend” proposals that reduce occupancy costs now, in exchange for a secure, longer term income stream.
Consequently, landlords are often faced with tough decisions that include sacrificing current “over-market” income to retain tenants or undercutting the competition to lure new tenants.
Despite poor market fundamentals, tenants are on the move and a full building usually produces more income than one with substantial vacancy.
Look for 2003 to produce a great opportunity for tenants and class A landlords to boost occupancy. It will take flexibility and creativity on both sides to make deals happen.
OTHER MARKETS
Albuquerque
The overall vacancy rate continued to trend slightly higher from the previous quarter and rose 30 basis points. Many companies moved into smaller spaces than they previously occupied resulting in decreased rents. An 11% rise in vacant sublease space was reported in the first quarter.
Honolulu
The negative absorption trend in downtown Honolulu continued during the first quarter,and at a faster pace than the previous quarter. A few large blocks of sublease space came on the market during the quarter and two or three more full floor subleases are set to hit the market next quarter.
Portland
The office market continues to feel the effects of the lagging national economy. Vacancy rates may have peaked this quarter at 16.9% with net absorption registering an insignificant negative 15,000 square feet. The results came from modest demand growth in some sectors, which was offset by the demise of the last of the unstable companies. Value hunters have caused a shift in the market with tenants upgrading to class A space with no increase in rental rates resulting in a disproportionate increase in class B and C vacancy rates.
Sacramento
Trends of note this quarter,mortgage companies and state contractors top our tenants on the move list, an informal survey of companies actively seeking space. Health and medical uses were also frequent seekers in the past three months. On locations, the Roseville/Rocklin submarket, and the city of Roseville, specifically, continues to be a sought after address. In fact, the current vacancy rate on Douglas Boulevard proper is a cool 10%. Lower vacancy rates continue to be the largest challenge facing Sacramento’s office market. Further, while contract rates are still up, concessions, primarily free rent, continues to be a drag on net effective rates.
Salt Lake City
The office market has seen little improvement since the end of the year. Construction is nearing completion on developments started in 2002. This has created a softening of rates and with the economy still waning, businesses are centralizing in an effort to cut cost, creating higher vacancy rates.
San Diego
The “tech wreck” that has compromised the economies and real estate markets of Silicon Valley and San Francisco has had a much milder effect on San Diego, despite the strong local presence of New Economy high-tech companies. Credit San Diego’s resilience to the diversification of its technology sector, which embraces computer technology, telecommunications, satellite communications, medical research, biotechnology and defense-related elements. While the area economy has not altogether escaped the recession, the effects have been relatively mild. The same applies to the local office market. Leasing has slowed as some high-tech companies have reduced their space requirements, modest quarterly bouts of negative net absorption have been recorded, and rents have weakened.
Seattle
Leasing activity continues to be mostly lateral moves as opposed to expansions as tenants are moving from older buildings into higher quality space. High vacancies and competing sublease space are putting downward pressure on asking rates and landlords are still offering concessions in most markets.
