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BAY AREA NEWS
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San Francisco Office Vacancy Rate Decreases in First Half 2019 Even with Over 1 msf of New Inventory

7/11/19

This report provided by Jerry Holdner, Director of Research, Kidder Mathews

The first half of 2019 saw San Franciscoís office market add over 1 msf of new inventory. Despite over 200k sf being added in 2Q, the direct vacancy rate declined 9 basis points quarter-over-quarter, according to the latest research from Kidder Mathews. The tight office market has forced an increasing number of tenants to pre-lease projects without a final approval to secure large blocks of space. Sales volume is already over $2.24 bil for 2019, and average price per square foot is at a new historic high for the second straight quarter. Asking lease rates also increased to a new historic high, and year-over-year the market is tied for third in average rental rate growth. Forecasts show no signs of this trend stopping, and the market is expected to continue to push rental rates, occupancy, and sales prices to new heights throughout the rest of 2019.

New Construction

The only delivery in 2Q was the Van Ness & Geary Medical Office Building at 1100 Van Ness Ave, which added 234k sf of medical office space to the Van Ness Corridor submarket. Nine buildings spanning 3.9 msf still remain in the development pipeline. First Street Tower at 50 1st St is the largest property still in the pipeline, but more capital will be needed if the owner, Oceanwide Holdings, aims to complete it by 2023. Oceanwide has stalled construction on its Oceanwide Center in Los Angeles, and some observers fear that if the Chinese developer cannot source new capital soon, the San Francisco project will also stall.

Asking Rental Rates

Due in large part to the shrinking amount of available space, direct and total annual asking lease rates ended 2Q 2019 at new historic highs of $66.13 FS and $64.15 FS, respectively. Year-over-year direct rates jumped 14.25%, while total rates increased 6.16% in that same period. Class A direct asking rents are up 10.02% on a year-over-year basis, while direct asking rents for Class B properties climbed 7.09% in that same timeframe. The Van Ness Corridor had the strongest quarter-over-quarter rental rate increases, climbing 9.5%. While most direct space is taken up, sublet space remains very sought after in Mission Bay/China Basin, finishing 2Q at $95.00 FS. San Francisco tied Charlotte, NC for third largest growth in rental rates year-over-year, despite it already being one of the most expensive office markets in the nation. This trend appears set to continue into 3Q.

Absorption & Vacancy

The first half of 2019 has started off strong with nearly 900k sf of positive net absorption. Net absorption finished above 400k sf for the second consecutive quarter, and is projected to be even higher in 3Q. The South Financial District was again the leading submarket in terms of leasing activity. The two largest leases of 2Q were both in a South Financial District building at 50 Beale St. Autodesk ended up taking 117.7k sf in June, while Glassdoor Inc took 116.7k sf in May. Samsara took the third largest lease of 2Q after they signed on to occupy 116k sf at 45 Fremont St in May. Despite rising rents, companies like Glassdoor have decided to move from more affordable markets (Glassdoor started in Mill Valley) to take advantage of high-skilled labor in San Francisco.

Both total and direct vacancy rates for San Francisco fell 9 and 10 basis points, respectively, quarter-over-quarter. Despite 234k sf of new inventory added, vacancy rates remain very low. Year-over-year direct vacancy rates are down 32 basis points, while total vacancy is down 20 basis points. The San Francisco office property market is so tight now that industry titans seeking large contiguous blocks of space, such as Pinterest and Salesforce, are signing on to occupy space that hasnít even broken ground yet. In 1Q Pinterest signed on to occupy over 400k sf of space at a proposed development at 88 Bluxome St that may not be able to break ground for a long time due to legal disputes over the Central SOMA plan. Going forward it is likely this market remains tight, even when more of the development pipeline delivers.

Investment

Investment in office property has been very strong through the first half of 2019 with dollar volume reaching $2.24 bil. After just two quarters, the sales dollar volume is already at 89.44% of the sales dollar volume posted all of last year. Average per square foot price continued to rise, hitting $1,110.90 by the end of 2Q. The average per square foot price is up 18.44% quarter-over-quarter, and an extremely impressive 68.32% year-over-year. The sale of the Salesforce Tower from Hines Securities to Boston Properties completed in 2Q 2019, with Boston Properties taking the final 5% stake for $210.9 mil. The total sale finished at $4.218 bil ($2,969/sf), which is record setting for San Francisco. E-cigarette giant Juul completed the second largest purchase of 2Q when they bought 123 Mission St. for $397 mil ($1,149/sf) from Northwood Investors LLC. JLL Income Property Trust sold the Montgomery Washington Tower in the Financial District to Harbor Group International, LLC for $191.5 mil ($701/sf), which ended up being the third largest purchase of 2Q. San Francisco office property continues to provide incredible returns on investment, as demand for premier rental space continues unabated, driving sales prices even higher.

Spotlight

After 17 months of proposals, negotiations, and revisions, the Presidio Trust has decided that they will go it alone in redeveloping Fort Winfield Scott in the Presidio. WeWork, the World Economic Forum, New Energy Nexus, Lela Goren Group, Equity Community Builders, and Elon Muskís Open AI created a formidable group to put forward a proposal to partner with the Presidio Trust to turn the 30-acre former army base into a multifaceted office site that would also include the Epicenter for Climate Solutions that would have focused on solving issues related to climate change. The staff of the Presidio Trust signed a letter rebuking the proposal, despite revisions that would have provided many concessions to public uses from WeWork. The Staff contended that the proposal was still too focused on providing return on investment for private interests rather than dedicating the majority of redevelopment for the public good, and recommended that the board abandon the redevelopment effort for now. The board agreed and in mid-June rejected the plan. For now there are no plans to restart the redevelopment effort.

Source: RCA, CoStar, San Francisco Business Times, The Registry
*Figures and information for this report look only at industrial buildings larger than 15,000 s.f.




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