The 91-million-square-foot San Francisco West Bay office market is strong but sane, according to Reis data. This market, including the City of San Francisco and Marin and San Mateo Counties, has the seventh lowest vacancy rate among the top Reis markets, but that rate is still above the single-digit level recorded in 2007, let alone the rock bottom rates in the late 1990s. It has the highest second quarter rent gain among the top Reis markets, but that increase is moderate compared with the wild rent spikes of the past. Other market watchers, however, report the madness returning to the City of San Francisco, and Reis has recorded a sudden spike in office building sales.
The vacancy rate was 13.8% in the second quarter of 2012 according to Reis, down 40 basis points from the prior quarter and 100 from a year earlier. The Class A rate is 13.2%, down 70 basis points over three months and 140 over twelve, while the Class B/C rate of 14.7% is unchanged for the second quarter and down 50 basis points year-over-year.
Cassidy Turley reports a 9.6% vacancy rate for San Francisco County, down 60 basis points from the prior quarter. In San Mateo County, this source reports a 14.1% rate, up 30 basis points, the second increase in as many quarters. In San Francisco County, Cushman & Wakefield reports an overall vacancy rate of 11.0%. The rate is also 11.0% on the peninsula, down 100 basis points during the second quarter. The mid- to late-2000s saw a much milder market swing than the dot-com boom and bust around 2000. In the more recent cycle, according to Reis, the vacancy rate ranged from a low of 9.3% in the second quarter of 2008 to a high of 15.6% in the fourth quarter of 2010, compared with year-end readings of 2.0% in 1999 and 22.1% in 2003. Reis predicts further moderation, with a slow but steady decrease in vacancy to 13.4% at year-end 2012 and 12.4% at year-end 2016.
SUPPLY AND DEMAND
Reis predicts a modest decrease in the vacancy rate despite an expectation of limited new supply. The financial crisis put a halt to what might have been a development boom, and as a result little new space has been added to the market since 2003—not even enough to fully offset the office to residential conversions during the housing bubble. The 72,000-square-foot 188 Spear Street, completed in May, is expected to be the only multi-tenant new supply this year—following no space added in 2010 or 2011.
Despite falling vacancy and rising rents just 405,000 square feet of new space are under construction in one project. While the planning pipeline is full, most of the planned and proposed projects are in San Mateo County, where vacancy is generally higher. The two planned projects that have development schedules are both located in the City of San Francisco, with 346,000 square feet. Reis predicts 912,000 square feet will complete construction in 2013, with even lower totals in the following three years.
The firm expects the vacancy rate will remain in double digits because office demand is forecast to be limited. The 407,000 square feet of net absorption recorded during the second quarter brought the year-to-date total to 861,000, more than the 788,000 square feet absorbed in all of 2011. While this is a solid record, it pales in comparison with the more than 3.4 million square feet absorbed in both 2005 and 2006, let alone the decade of consistently positive net absorption in the 1990s. Reis predicts that 1.3 million square feet will be absorbed in 2012 all told, but the forecast for each subsequent year through 2015 is progressively lower—and not more than the limited new supply expected to come on line. Even though San Francisco’s occupancy losses during the Great Recession were modest, it will take until 2016 for the occupied inventory total of 2007 to be matched.
Office rent gains are restrained nationwide, as San Francisco’s top asking rent increase for second quarter was just 1.0% to $40.26 psf. The average effective rent rose 1.1% during the period to $33.27 psf. The year-over-year gains are strong but not spectacular at 6.6% asking and 7.9% effective. The average asking rent for the Class A segment is $45.12 psf, up 1.2% for the second quarter and 5.6% from a year earlier. The Class B/C asking average of $32.92 psf is up 0.5% over three months and 4.7% over twelve. Rent gains for the West Bay as a whole are moderate according to Reis.
But they are spiking in the City of San Francisco according to some other market watchers. “Today’s average asking rent of $44.70 psf is up over 30% from the $36.52 per-square-foot rate of one year ago,” according to Cassidy Turley, although this source reports a leveling off in the second quarter. “Citywide, direct Class A asking rents rose 10.4% in the first half of the year to $50.58 psf,” according to Cushman & Wakefield, which reports a 23.3% year-over-year increase in direct asking rents for all office space in the city. Tenant rep firm Studley, Inc., on the other hand, reports a 0.8% decrease in San Francisco’s overall asking rent to $39.52 psf, “reversing a trend.” Cassidy Turley, meanwhile, reports a $39.84 psf asking rent for San Mateo County, and rising despite increased vacancy. Cushman & Wakefield reports a 6.9% second quarter increase in overall rents on the San Francisco Peninsula to $39.00 psf.
Reis predicts the rent moderation will continue, as the asking and effective rent gains of 4.2% and 4.5% are little more than half the gains of 7.3% and 8.6% recorded in 2011. The increases forecast locally for the 2013 to 2016 period, between 5.0% and 6.0% each year for the asking average and higher still for the effective average, will exceed both the inflation rate and the average increases for the U.S. and the West Region. But they would not constitute a repeat of the rent spikes of 2006 and 2007, or the late 1990s. These rent increases, however, may be more long lasting.