Local Market Remains Insulated From Wobble in the Economy

SAN FRANCISCO—At the end of the third quarter, the overall vacancy rate dropped 40 basis points to 2.8% and overall availability dropped 70 basis points to 7.8%, while demand of 7.6 million square feet outpaced supply. Year-to-date leasing activity remained constrained, down 26.3% compared with the same period last year, according to a third-quarter report by Newmark Knight Frank. Despite the tight market, more than 1 million square feet was absorbed during the quarter, with more than half resulting from Dropbox’s move into 656,482 square feet at 1800 Owens St.

Of the 3.3 million square feet currently under construction, 84% has been pre-leased or is rumored to be in leases. Although the city granted Prop M allocations to several developments during the summer, these projects are not expected to break ground this year. As a result, vacancy is expected to stay low, and supply and demand will remain unbalanced until at least 2022 or 2023.

The restricted supply continues to push asking rates, which increased 8.9% year-over-year to $82.23 per square foot. Class-A asking rates increased 10.5% year-over-year to $91.22 per square foot, says the report.

“It would not surprise me if class-A office space surpasses the $100 per-square-foot mark by the end of 2020,” Andrea Arata, Newmark Knight Frank director of research for San Francisco, tells GlobeSt.com. “I also predict that Oakland will be a big benefactor of this robust cycle and that in five years, it will be as hip, cool and vibrant as San Francisco. Frankly, parts of Uptown already are.”

Despite the tight market, several landlords have noticed a slowdown in the time it takes to lease spaces of less than 20,000 square feet. One possible reason for this delay is that smaller tenants might hesitate at the longer-term lengths required and therefore seek alternatives elsewhere, whether in co-working spaces or nearby markets.

Another factor possibly affecting this size range is a change in venture funding during the past few years. The total number of investments has dropped while the amount of funding has increased, resulting in fewer investments in smaller companies. If tenants are concerned about rent liabilities on balance sheets, shorter-term or less expensive leases are a more favorable option.

Recent headlines featuring large San Francisco tenants have many people speculating what the long-term result will be if a company puts significant space back on the market. However, with 2.8% vacancy, this market has a lot of wiggle room, says Newmark Knight Frank’s Arata. If the amount of space that came back on the market during the eight quarters of recession were to come back on the market right now, it would result in a 6.7% vacancy.

Another historical transaction that factors into the equation is Jamestown’s purchase of Levi’s Plaza for $826 million from Gerson Bakar. It was one of the largest office deals in San Francisco history. The building portfolio includes an office footprint of five buildings totaling 931,160 square feet. The largest tenant, Levi Strauss & Co, has a lease until 2022.