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10/03/24
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This report provided by real estate services firm Kidder Mathews
Market Highlights
• The availability rate rose YOY to 21.6%.
• Asking lease rates decreased YOY to $3.94/sf FS.
• Sale volume grew to YOY 872.3k sf.
• Total net absorption increased YOY to -851.3k sf
Market Drivers
• Since the last quarter, the office availability rate increased by 150-bps (basis points) to 21.6% in 3Q24. Likewise, the vacancy rate increased 90-bps to 17.1% in this timeframe. The increase in both areas highlight the continuing problems faced in the market where tenants continue to downsize and exercise work from home policies.
• Net absorption was -851.3k sf this quarter, a steep departure from the 714.4k sf last quarter. Overall, this year has been far less rough than last year, which had 1.9 msf less net absorption to this point.
• Average asking lease rates increased from $3.92/sf FS (Full Service) to $3.94/sf in the past quarter. Since the start of the pandemic, rates have stagnated, falling between $4.11 in 2Q20 and $3.92 at the lowest end last quarter.
• Despite the high interest rates, sales volume has reached 1.9 msf sold this year, more than all of 2023 combined. The price/sf these properties are selling for are significantly lower than the past, which opens these properties up for leases at lower rates to meet investment requirements. This coupled with lowering interest rates could open up the possibility for vacancy and availability numbers to being trending down, but there are still hurdles such as work from home policies to overcome before the market takes a full turn.
Economic Overview
• Unemployment in the San Jose-Sunnyvale-Santa Clara MSA jumped 60-bps to 4.5% quarter-over quarter. Conversely, California’s unemployment rate dropped 10-bps to 5.2%.
• The Professional Business Sector in the San Jose-Sunnyvale-Santa Clara Metropolitan Statistical Area (MSA) saw an increase both yearly and quarterly, reaching 249.1k this quarter.
Near-Term Outlook
• The Federal Reserve's recent interest rate cut has mixed implications for the office real estate market. While lower borrowing costs can unlock capital and spur refinancing, the office sector remains burdened by low demand and high vacancies, especially for Class B and C buildings in less desirable locations. Many office properties still face financial stress due to low occupancy and rising costs. While the rate cut may provide some relief, more substantial reductions and shifts in work from home policies are likely needed to stimulate significant office market recovery.
• One proposed form of relief is converting office buildings into residential buildings. Though this would help availability and vacancy problems, the feasibility has come into question. A study conducted by CommercialEdge concluded that 25.8% of properties throughout the San Francisco Bay Area would be viable candidates, and only 6.2% would be ideal. Although conversions would be beneficial, there isn’t much space that qualifies for these projects so it should not be seen as a savior for the market.
• The office market downturn has been costly for cities, and now some are turning to incentives to bring new deals and more people back to their downtown areas. One example is San Jose, which is currently voting on a plan that offers new downtown office tenants and owner-occupiers two years of free parking and no city-business tax. Although this doesn’t extend to current occupants, and the incentives go away after two years, it is nice.
The information in this report was composed by Gary Baragona, Director of Research, the Kidder Mathews Research Group.
Data source: Costar; data.bls.gov, www.bizjournals.com
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