Tech Firms Continue to Drive San Francisco Office Market
Colliers Reports on Second Quarter
SAN FRANCISCO, CA, July 13, 2016 — San Francisco’s historic transformation from tourist mecca to Ground Zero of the nation’s new knowledge-based economy continued unabated during the second quarter of 2015, with office vacancy rates continuing to fall, absorption rates rising to record levels, and overall leasing levels eclipsing in six months what had been the city’s traditional annual average, Colliers International has reported in its latest quarterly report.
Led once again by technology companies occupying large amounts of available office space, the overall vacancy rate fell to 6.3 percent during the second quarter, compared to 6.7 percent in the first three months of the year, despite delivery to the market of 246,990 square feet of newly completed space during the first and second quarters, Colliers noted.
Despite the addition of the new space, much of which was pre-leased prior to coming onto the market, Colliers also reported that rental rates rose marginally in nearly every market, a reflection of the unprecedented demand being fueled by the voracious appetites of tech companies seeking office space in the City.
In one of the most compelling signs to date of the market’s continuing strength, net absorption, or the amount of space occupied after accounting for the movement of tenants in and out of space, reached 300,000 square feet in the second quarter, the 20th straight quarter of positive net absorption, the report disclosed. During the first quarter some 900,000 square feet of positive net absorption was recorded, bringing net absorption for the first half of 2015 to 1.2 million square feet, surpassing in six months what had been the historical annual average absorption rate of 1.1 million square feet, setting the market on a path to shatter all previous annual records.
“What this latest study does is confirm that San Francisco has further cemented its place as the center of the world’s technology-based economy and is growing at a pace rarely, if ever, seen in the nation’s history,” said Colliers Regional Executive Managing Director Alan Collenette. “Since this upcycle has continued, and each quarter shows better than the previous one, we have become like converts answering an altar call at a ‘Come-to-Jesus’ revival. Our faith has been strengthened as each quarter passes with more stunning news of another major tech firm taking hundreds of thousands of square feet. While we should take everything with a bit of caution, I now firmly believe that this seven-year cycle has at least 24 to 48 more months before we see it moderate at all.”
During earlier quarterly reports, Collenette, who oversees brokerage operations for Colliers in downtown San Francisco, Marin and Sacramento, variously labeled this period in the history of San Francisco as the City’s Golden Age or Glittering Age, labels he says are still accurate.
“I just can’t think of a better description than those,” he added. “With the tech companies and their employees continuing to desire to be located in San Francisco, there seems to be no end to how much space they may lease, buy or build. It is a sea change for this city and it is the proverbial rising tide that lifts all boats.”
However, as technology companies flood San Francisco’s office space and change the City’s basic economy -- and its culture -- from one that was largely dependent on tourism to one that is based on the solid financial footings of the technology industry with a full and thriving workforce, those who were part of the former economy have been jettisoned.
“This is the darker side of this change and it must be addressed if San Francisco is going maintain its new place as one of the most important economies in the world,” Collenette said. “As fast as it can be built, office space is being occupied and that puts San Francisco alone on the pinnacle of all other metropolitan areas not just in the state but throughout the nation. Only New York, with its grip on the international financial markets, can compare to what is happening here. But there are lessons to be learned from places like New York, where they have managed to maintain a diverse population despite its high prices and cost of living.”
Collenette added: “There simply is no other city on the face of the earth where so much knowledge and innovation is taking place. When scholars look back on this time, they will call it San Francisco’s Golden-Glittering Age and it will go into the history books as the center of the world when it comes to technology.”
Among the major lease transactions completed in the second quarter was online payment processor Stripe’s 300,000-square-foot commitment at 510 Townsend Street; wearable fitness-tracking company Fitbits’ 163,628 square feet at 199 Fremont; online money lender Lending Club’s 122,330 square feet at 595 Market Street; law firm Sheppard, Mullin, Richter & Hampton’s 72,000-square-foot renewal at 4 Embarcadero Center; SONY’s 63,000-square-foot renewal and expansion at 400 Second Street; web grocery delivery service Instacart’s 56,288 square feet at 50 Beale Street; NRB Energy’s 51,530 square feet at 100 California Street; and Slack’s 48,812 sublease at 155 Fifth Street.
The report showed approximately 5.2 million square feet of new office space under construction at the end of the second quarter, which was largely unchanged from the first three months of 2015 and reflects a total of 12.2 million square feet in various stages of planning, at the end of the second quarter.
On the sales front during the second quarter, the largest transaction was the $197,700,000 purchase by developer-investor Tishman Speyer of 160 Spear Street, which is comprised of 289,253 square feet of Class A office space. The seller was the investment firm of Legacy Partners.
“What this sale and others show is that San Francisco’s office market continues to attract investors from around the country and around the world,” said Collenette. “As the global capital investment markets continue to look for stability, both financially and politically, there are few places that compare to San Francisco and its booming office market, especially when it is being led by the technology sector.”
Overall market weighted rental rates reflected an increase of 3.2 percent for the second quarter, compared to 0.4 percent during the first quarter of the year, the report noted. Meanwhile, weighted Class B rents continued to climb and finished the quarter up 5.2 percent. This continued a trend from the previous year and the first quarter, resuming its normal pattern of rental increases that had only been interrupted in the fourth quarter of 2014 when rents briefly paused their growth.
After 2014’s banner year of over $5 billion and close to matching the peak years of 2007 and 2012, the investment sales market has tapered off slightly during the first half of 2015, but is anticipated to finish the year strong. As it did in the first quarter, the Financial District continued to dominate investment sales in the second quarter of 2015 with three major office properties changing hands. Tishman Speyer, the New York-based investment and development firm, purchased the 289,253-square-foot office building at 160 Spear Street for $197.7 million, or $683 per square foot. The seller was the investment firm Legacy Partners.
Trading at the highest price per square foot during the quarter was 143 Second Street, which sold to a private investment group for $816 per square foot, or $16.1 million. Owned by Market Street Real Estate Partners, the property was acquired by the firm two years ago. Market Street Real Estate Partners also disposed of another property when it sold 580 Market Street, a 33,656-square-foot landmark office building for $716 per square foot. The buyer was Paragon Real Estate Fund LLC.
“Although the volume of sales has ticked downward slightly during the quarter, per square foot prices have risen to new highs,” said Collenette. “While both the capital to invest and the products to invest in are both here, there is stiff competition for the available properties. This is perhaps the most competitive investment market in the City’s history, and I just don’t see it slowing down any time soon.”
Other factors helping San Francisco’s burgeoning economy is a job market that continues to be one of the top performing metropolitan areas in the country, the report said. Bolstered by the large number of technology firms moving into the City, and the many support industries the tech industry spawns both directly and indirectly, unemployment levels in San Francisco stood at a near-record low of 3.5 percent, according to the California Employment Development Dept.
“When unemployment rates fall below about 4 percent, most economists believe that signals full employment, or, put another way, whoever wants to work can work,” added Collenette. “Fueling this, like the rest of the local economy, is the fact that San Francisco is now home to more technology companies and the industries that support them, than Silicon Valley, so-called Silicon Beach in Southern California, and the Route 128 Corridor near Boson. Again, only the New York borough of Manhattan rivals our unemployment rate, but that’s based on a different, older financial services economy.”