Tenants in San Francisco's office market are now in the market for more space than is currently available, a first since the late 1990's dotcom boom.

 

SAN FRANCISCO—After a strong fourth quarter, leasing activity here in San Francisco in the first quarter of 2014 has been red hot, with ±350,000 square feet in positive net absorption. That is according to a recent report from Kidder Matthews.

According to the firm’s EVP of brokerage, Reed Payne, for the first time since the late 1990′s dotcom boom, tenants are now in the market for more space than is currently available, leading to a game of “musical chairs.” Payne notes that “Tech and biotech companies continue to be major players in the market, however, all industries in the region are looking strong and will play a role in leasing going forward.”

Direct asking rental rates for class A, B and C office buildings average $51.89/square foot, $40.97/square foot and $36.63/square foot, respectively, according to the firm’s report. Year-on-year rental rates for class A buildings are up $6.64 (15%), while year-on-year rental rates for class B are up $4.85 (13%), and class C buildings are up $4.86 (15%). “There are no obvious signs that this rapid rental growth, which started in 2011, will stall anytime soon,” says Payne.

Net absorption (the change in occupied space) for San Francisco overall was a positive 238,735 square feet in the first quarter, says the report. The North Financial District buildings recorded a negative 278,179 square feet while the South Financial District recorded a positive 212,747 square feet. Mission Bay recorded a positive 223,417 square feet and Rincon/South Beach recorded a positive 154,571 square feet.

“This shows the continuing southward movement of the center of gravity in San Francisco,” says Payne. “Tenants have been drawn to the new and creative spaces South of Market.”

The most expensive lease signed this quarter was UBS, a Swiss financial services company on the 36th and 46th floors at 555 California at the equivalent of $96/square foot/per year full service, says the report. The vacancy rate in the first quarter remained consistent with the fourth quarter at 8.2%.

On the investment side, San Francisco continues to attract capital investment from around the world and the strong leasing and preleasing market has been driving investments into the city, says Payne. The first quarter of 2014 saw a slight drop from $1.6 billion in transactions in the fourth quarter to $1.2 billion. While the first quarter of 2013 was extremely slow; the first quarter of 2014 did not see the same slowdown. Some major buildings sold in the first quarter include: 101 Second for $297M or $769/square foot, 1550 Bryant for $90M or $494/square foot, and 808 Brannan for $35M or $632/square foot.

During the first quarter there was $1.21 billion in deal volume comprised of 20 San Francisco office properties, says the report. A total of 3.4 million square feet transacted with an average price of $434/square foot, compared to $406/square foot in 2013, which is a 7% increase in average dollars per square foot

“Correspondingly, the average cap rate for San Francisco office investments decreased to 4.8% from 5.1%,” says Payne. For perspective on relative values, New York’s cap rate is similar, at 4.6%, while the national office cap rate average is 6.9% (35% higher). “These rates demonstrate how investors desire properties in premier markets, such as San Francisco, and are willing to pay more to acquire them.”

Institutions continue to be the predominant buyers, comprising 49% of the total 2013 transaction volume and 55% in the first quarter, says the report. Foreign capital investment is also above the national average, with Hong Kong and Singapore leading the offshore San Francisco office investors.

Check back with GlobeSt.com for an update on this story, with more on the area’s market drivers.