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7/05/23
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This report was provided by real estate services firm Kidder Mathews
MARKET HIGHLIGHTS
Total Vacancy climbs to 26.8%
Sublease Vacancy increased by 80 bps quarter-over-quarter to 5.8%.
There is a large discrepancy between pricing across Trophy, Class A, Class B, and Class C offices.
Market Drivers
The San Francisco office market is reporting its seventh consecutive quarter of negative net absorption, with roughly negative 2.85 msf year-to-date. At this rate, the city is on track for similar—if not more negative net absorption than was reported in 2022 (4.9 msf). Total office vacancy continues to climb and currently sits at 26.8%. Many firms continue to reassess their office needs, which can be seen in the uptick of 80 basis points (bps) quarter-over-quarter to 5.8% in sublease vacancy. Year-over-year sublease vacancies increased by 140 bps.
Despite the year’s negative net absorption, leasing activity totaled 952.4k sf, resulting in a year-to-date total of 2.2 msf of activity. Roughly 60% of this quarter’s leasing activity was in Class A offices spaces, clearly demonstrating the ongoing “flight to quality” trend. Throughout the market, average rental rates continue to decline, albeit at a slower rate as prices hold relatively steady. There is an extreme bifurcation in pricing. Class B and C buildings have been hit the hardest, reporting average asking rates of $48.97/sf full service and $36.11/sf full service, respectively. Class A office properties are faring much better with an average lease rate of $61.01/sf full service. Premier Class A offices with desirable amenities and views remain competitive and have asking rates well over $80/sf full service, with the very best buildings commanding, and getting north of $100/sf full service.
Economic Review
The unemployment rate throughout San Francisco dipped to 2.7% in April, 30 bps lower than the previous month. Despite the widespread tech layoffs earlier this year, year-over-year unemployment rate has only risen by 30 bps, indicating a stable labor market.
There is very little investment sales activity throughout the market; this quarter only 50.7k sf of office traded hands. Amidst climbing interest rates, buyers and sellers have not yet found a middle ground on pricing. According to a recent article in the San Francisco Business Times, 350 California is currently under contract for a steep discount and is expected to close between $120-$130/sf. This is just one of a handful of office properties that are currently testing the market though all seem to be generating little demand, to the extent there is demand, at substantially lower prices than were seen pre-pandemic.
In the past year, the Federal Reserve has raised interest rates ten (10) times to combat inflation. After the most recent hike, the Federal Reserve announced its plans to not raise rates further for the month of June. According to a recent article by Reuters, policymakers anticipate two more 25-bps hikes this year.
Near-Term Outlook
The San Francisco Office market’s outlook remains unpredictable with record high vacancies, hybrid work models, notable companies downsizing their office footprint, and looming loan maturities for landlords. As an example, prior to the pandemic, the block surrounding Salesforce Tower at 415 Mission Street was considered one of the most desirable locations within the city and had a low vacancy rate of 5.3% (4Q 2019). Quarter-to-date the same area now has a total vacancy of 24.8%. More recently, Westfield has announced its departure from Union Square as the city’s continuing struggles have begun to make its way into the retail sector. That said, record high vacancy and lower pricing opens the door for ample opportunities for investment, expansion, and relocation. Despite the economic uncertainty, this may be one of the best times for companies to position themselves before the market picks up again.
Source: KM Research, CoStar, U.S. Bureau of Labor Statistics
This update was prepared by Kidder Mathews Director of Research Gary Baragona
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