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6/16/15
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Demand for San Francisco’s trophy office towers exceeded demand for all space in the market during the first quarter of 2015, as absorption for space in these buildings jumped 4.5% in the period, compared to an increase of 0.6% for the Class A market overall, according to JLL’s 2015 Digital Skyline report.
The Trophy market is typically considered to be core office buildings that consistently achieve rents in the Top 10% of a given marketplace. Trophy inventory excludes owner-occupied properties.
The City by the Bay’s trophy buildings boasted the third highest net absorption behind New York and Chicago in the last year and the city’s office market places high nationally among major markets in several other benchmark categories including rent growth, which at 49.9 percent growth since 2010 is the highest nationwide among skyline office markets tracked by JLL. Currently, San Francisco also has the nation’s third highest office skyline occupancy rate (behind Bellevue and Pittsburgh, PA) at 92.6 percent, according to JLL.
Average asking rental rates in San Francisco Trophy buildings in the first quarter of 2015 were also among the highest in the nation at $68.75 per square foot. Only New York and Washington DC’s Trophy buildings commanded more and San Francisco rents are significantly ahead of the national average asking rent for Class A office of $42.30 per square foot.
Much of this demand for space has been driven by the ever expanding creative and technology community in San Francisco, but more traditional office users like financial and professional services firms are also growing. Financial services and law firms accounted for more than 41 percent of total leasing in 2014 compared to 22.9 percent for the technology sector.
“We’ve seen a generally strong office market in San Francisco since the last recession but in the last 12-18 months we’ve seen a significant flight to quality among a variety of office tenants, particularly in the technology sector, and that has pushed vacancy to historic lows in many of the city’s highest quality office buildings, while also pushing rents steadily higher,” said Amber Schiada, vice president, JLL Research. “Looking forward, we see further tightening among Skyline buildings as many tenants continue to place a greater emphasis on a building’s location and amenities as the keys to their location decision,” she added.
Trophy tenants can expect little relief in rental rates in the immediate future, since the city’s appeal as a headquarters location for a broad range of tenants in technology as well as professional and financial services continues to deepen, creating a competitive leasing environment. Meanwhile, only 800k sf of new Trophy space was built in 2014 and 2.29 msf is currently under construction. Of that, 2.2 msf, more than 50 percent is already leased. This is increasing the appeal of future Skyline projects.
“New office developments now underway in San Francisco are being designed from the inside out with the modern headquarters user in mind. These will be the modern workplace communities of the future with appeal to a wide range of tenants from creative and technology-related ventures to hedge funds and other financial and professional services firms that want to be in a creative space with views, and access to a wide range of amenities in an urban setting close to major transportation,” said Chris Roeder, an international director with JLL in San Francisco.
If demand for space and office rental rates is fierce, the price tag to buy an office building in San Francisco is even more so. Economic growth, business expansion and improving market fundamentals have resulted in a second consecutive year of pricing gains, pushing average pricing for San Francisco’s Skyline buildings to $651 per square foot so far in 2015, a more than seven percent increase over 2014 average pricing and just $28 per s.f. below the peak achieved in 2008.
Around the country, abundant foreign capital chasing Skyline office deals is having a major impact on pricing, and San Francisco is at the top of almost every international investor’s target list. A recent influx of capital from mainland China into San Francisco has added another deep pocketed group of buyers to an already crowded field. Recent notable office transactions involving Chinese capital include the sale of 225 Bush to a mainland Chinese developer for $350 mil and the recapitalization of a speculative office development at 350 Bush Street by Gemdale, a Shenzhen-based developer.
Mainland Chinese investors have also purchased or capitalized a number of large scale residential and mixed use development projects in San Francisco including Lumina, a 655-unit condo project being developed by a JV partnership between China Vanke and Tishman Speyer, and First & Mission, a development site upon which China Oceanwide is planning a 2 msf, Norman Foster-designed foot mixed use development.
“San Francisco is a very desirable destination for international capital due to its global connectivity and thriving economy. Competition for trophy office assets and prime development sites is intense, to say the least. With upwards of $50 bil projected to flow into U.S. commercial real estate in 2015 from international capital sources alone, we expect the influence of foreign capital on San Francisco’s commercial real estate market to continue to grow,” said Rob Hielscher, a San Francisco-based managing director in JLL’s Capital Markets Group.
Hielscher continued, “This influx of new capital will continue to drive prices up, and domestic institutional investors will be forced to evolve their strategies, increasingly partnering with foreign investors and diversifying into non-core and non-CBD assets.”
JLL’s proprietary 2015 Digital Skyline identifies and tracks micro-segments of 47 city centers across North America. The Skyline features Trophy and Class A buildings where tenants and investors alike focus demand for office space in a flight to quality and efficiency.
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