Fueled by the unrelenting growth of the tech industry, the year ahead, like the year just concluded and the year before that, will be one of the most prolific and productive periods of office development in the city’s history and will be the cause of a historic, continental shift of the nation’s economic power center from East to West where an overwhelming majority of major tech companies are now based, including Apple, Google, Facebook, Pinterest, Twitter, and so many more, the report noted.
“I cannot stress enough that this, truly, is San Francisco’s Glittering Age,” said Colliers’ Regional Executive Managing Director Alan Collenette. “This is an era, not a short-lived boom. For the relatively few of us who truly study and parse the sometimes obscure and subtle leading indicators that underlie the economics of the office space market, it is plain to see that this time it is different.
“What is different from prior boom and bust cycles like the so-called Dot Com Bubble and The Great Recession,” he continued, “is that the entire world economy has shifted to a knowledge-based economy, where innovation is the commodity. The world has chosen San Francisco as its capital city, and the rush of inbound, VC and inbound employees has built to a crescendo. Like Rome or Florence or London in their golden eras, San Francisco is the undisputed epicenter of the world’s knowledge-based economy. Worldwide serious technology companies today cannot not be in San Francisco.”
That’s why, for the first time in history, office rents are higher in San Francisco than they are in Manhattan -- $72.26 versus $71.26 on a per square foot and per annum basis, Colliers reported. Meanwhile, vacancy rates, the oft-quoted indicator of an office market’s strength, are much lower in San Francisco than they are in Manhattan -- 7.2% versus 9.6%, respectively. A lower vacancy rate translates into stronger demand and would be one factor among several leading to the cost disparity of the two office markets.
Meantime, sublease space, the traditional canary in the mineshaft for market health, stood at just 0.7% of San Francisco’s 90 million-square-foot office market at year-end, the report revealed. This compares with a high of 5.1% in the aftermath of the dot com bust of 2002 and 1.6% during the depths of The Great Recession in 2009. Sublease space is defined as surplus space offered for lease by tenants.
Additionally, Colliers reported, the proverbial “Help Wanted” sign is becoming ubiquitous throughout the Bay Area. Unemployment is 5% or less, a number that effectively equates to zero, according to the UCLA Anderson School of Management’s latest survey of the Bay Area. In the municipality of San Francisco itself, the jobless rate was even lower at 4%, according to the federal Bureau of Labor Statistics most recent report, which equates to the fact that anyone who is able to work and wants a job, can find one in the Bay Area, according to every available academic, government and business study.
“There is much discussion here of the cost of housing, the cost of living, the shortage of office space and the dearth of employees,” said Collenette. “Despite these factors, still they come, this extraordinarily well-educated and motivated workforce who have, in many cases, fled the dreadful winters back East or in the Midwest, left the parched cultural and geographic desert states of the southwestern U.S., or escaped hardscrabble lives in India and Asia, and are willing to work around any hurdles to get a piece of the action.”
Collenette noted that there is no meaningful pressure release valve, either, since even nearby Oakland, which made news recently by attracting Uber to its office market, cannot oblige because its office vacancy rate is 3.5%, it has no pipeline of housing or meaningful commercial construction, and new office buildings and other structures simply cannot be built due to local economics.
“As I have often mentioned, we are the most discussed and most sought-after office market in terms of vacancy rates, absorption levels and investment sales in the U.S. for a variety of reasons,” Collenette added, “all of which have conspired to create a ‘perfect storm’ in our office submarkets.”
Reflecting Collenette’s statement, according to the Colliers report, overall vacancy levels at the end of the fourth quarter 2015, as previously mentioned, stood at a low 7.2%, rising higher than the 6.1% recorded in the third quarter. However, that number was skewed by the completion of four major pre-leased but not-yet-occupied office properties coming on the market at year’s end. When figuring occupancy levels, Colliers counts only space that is physically occupied, not pre-leased, which was the case with the four new pre-leased buildings that came on the market in the fourth quarter.
Those four buildings – 350 Mission Street, 222 Second Street, 333 Brannan Street and 345 Brannan Street – delivered over 1.2 million new square feet to the market and are expected to be occupied in the first half of 2016, which will then drop the vacancy levels back to the 7% or lower range, which for most major metropolitan areas is effectively a net-zero vacancy rate. When that happens, the market will tighten its ranking as one of the strongest in the nation, the report noted, and will be far below the “10 percent tipping point” that would signal a balanced market. In lockstep with that declining vacancy rate, rental rates inexorably will rise as demand continues unabated for less product, the report predicted.
“When compared to other urban office markets around the West and the entire country, San Francisco is the strongest office market in the nation, pushed largely by the creative office space requirements of high-tech companies,”
said Collenette. “When you have tenants like Apple, Salesforce, Twitter, Google, AirBnB, Pinterest and Udemy, to name only a handful, eating up large blocks of space in the City, along with the law firms and other service-related companies affiliated with the high-tech industry, the overall office market can be best described as a boom town.. This is where most of the major tech firms want to be.”
To underscore the strength and diversity of the market, which has witnessed a profusion of tech firms filling empty office space this year and last, the fourth quarter ended Dec. 31, 2015, was dominated by firms that utilize technology to serve clients in fashion, law, health care, and office suite rentals.
In some of the largest lease transactions of the fourth quarter, The Gap, the clothing and accessories retailer, renewed its lease, but downsized to 243,000 square feet at 550 Terry Francois Blvd.; Stitch Fix, the online personal fashion shopping site, leased 95,000 square feet at 1 Montgomery Street; Collective Health, an employer health-care consultancy, pre-leased the entire building of 53,000 square feet at 85 Bluxome Street; and Under Armour, the national chain of high-performance sportswear retail outlets, relocated to 51,895 square feet at 135 Townsend, Colliers reported.
“Ironically, I am sure that many visitors and others who have little, if any, knowledge of the City, still think of our conurbation as a quaint tourist mecca instead of the mega-metropolis it is and are ignorant of the fact that we have evolved into what is now ‘Ground Zero’ of the new knowledge-based tech economy,” Collenette said.
Two other notable lease transactions were Regus, the Luxembourg-based company that leases individual suites of offices on a temporary basis, which renewed for 43,000 square feet at 1 Market Street and the law firm of Severson & Werson, with offices throughout the nation, leasing 41,500 square feet at 1 Embarcadero Center.
Absorption rates, meantime, or the amount of net space occupied , totaled a healthy 179,736 square feet in the fourth quarter, the 22nd consecutive three-month period of positive net absorption, the reported noted. For the 12-month period ended Dec. 31, 2015, total absorption for the year was a strong 1,569,532 square feet.
“What this does not indicate, however, is the amount of space brought to market that was pre-leased but not yet occupied and the amount of new space that is in the pipeline for delivery in 2016, including some 637,000 square feet slated for delivery in the first quarter of the new year,” Collenette said. “Overall, there is nearly 5 million square feet total now under construction with 36% of that pre-leased.”
According to the Colliers report, the South of Market (SOMA) submarket experienced the largest spike in absorption during the fourth quarter with a total of nearly 225,000 square feet of newly occupied space. Major tenants occupying space there included Pinterest, with some 120,000 square feet at 651 Brannan Street, followed by Udemy, which occupied nearly 40,000 square feet at 600 Harrison Street, and AirBnB moving into 48,000 square feet of expansion space at 888 Brannan Street.
On the investment sales front, there were a total of 36 office sale transactions closed during the year for a combined value of nearly $3.7 billion. By comparison, during 2014, Colliers recorded 50 office sales for a total of $5.0 billion.
“This is above the historical averages of $2 (billion) to $3 billion seen in San Francisco over the last 16 years and we are chasing the historically strong years of 2007 and 2012, which had $9.8 billion and $6.0 billion in sales, respectively,” said Collenette.
With nearly 180,000 square feet absorbed in the fourth quarter, the market has experienced nearly 1.6 million square feet of growth in 2015, the report noted. Class A assets continue to benefit from the large leasing volume in the market, accounting for approximately 100 percent of the positive absorption in the market year to date.
Meanwhile, overall weighted Class B rents increased in the fourth quarter by 3.9 percent, to $73.26 per square foot. Weighted Class B rents have surged by 53 percent over the past two years.
“Despite many large tenant requirements being filled this past year, demand in this market continues to remain strong with over 5.8 million square feet of office space in play among 156 tenants,” said Collenette. “If all of these tenants’ requirements were met, this would equate to a net absorption of over 2 million square feet. While the likelihood that 100 percent of these tenants will secure their stated space requirements is doubtful, this does provide an indicator that there will be robust leasing activity well into 2016 and, perhaps, beyond.”
While overall weighted rental rates for Class A assets reflected an increase for the quarter, annualized rents are up 11.8 percent, Colliers disclosed. Leasing activity continued to be strong during the fourth quarter with nearly 1.2 million square feet of gross leasing volume. The San Francisco market experienced 13 leases over 100,000 square feet closed in 2012 and recorded 14 leases totaling over 100,000 square feet in 2014.
For the year 2015, the report noted, the City experienced a strong year of leasing activity with nearly 6.3 million total square feet leased. In terms of transactions sized larger than 100,000 square feet, in 2015 the City recorded 13 such transactions greater than 100,000 square feet with over half of those completed in the first half of the past year.
Most notable among these was Stripe leasing 300,000 square feet at 510 Townsend Street, JP Morgan renewing 201,000 square feet at 560 Mission Street and The Gap’s renewal and downsizing of 243,138 square feet at 550 Terry Francois Boulevard.
Prices continue to rise for both Class A and Class B assets. Class A prices rose to $675 per square foot in 2015 compared to the $615 one year ago. Class B prices per square foot also rose to $573 in 2015, compared to $508 in 2014.
The notable Class A sale that closed during the fourth quarter of 2015 was Tishman Speyer paying $378.5 million for the 546,182-square-foot building at 333 Bush Street, Notable Class B sales included a $25 million purchase by Market Street Capital of the 47,031-square-foot building at 1340-1370 Mission Street, or $552 per square foot; and Workday’s acquisition of a 34,500-square-foot office property at 2650 Eighteenth Street for $14.25 million, or $413per square foot.