Q4 Reports: Citywide Office Availability Tops 18%

The rapid increase in the availability rate--up nearly 65% from 11.1% in 2Q '07--has owners lowering their asking rates, which is pushing negotiated rates down even further. Owners of CBD class A properties dropped their asking rates by 7.7% during the quarter to $43.03, the steepest quarterly decline in more than five years, according to CBRE. "The delta between asking and signing rates appears to have widened further as owners trade lower rents for the stability of longer-term occupancy," states the report.

Indeed, a late December report by Colliers International based on 93 fourth quarter deals in the Financial District found that the weighted average class A office rent had fallen 26.4% to $41.34 per square foot per year, down from $56.17 in the third quarter and $53.14 in the fourth quarter of 2007.

"As Downtown landlords shift their focus from pushing rents to securing and maintaining occupancy, expect savvy tenants to seek lower rental rates in exchange for additional term on their existing leases," says Jay Sternberg, an SVP within Colliers who specializes in representing tenants.

Studley, a firm that exclusively represents tenants, a presented a more dire picture of building owners in its preliminary fourth quarter report, predicting that property values and rental rates for all classes of building will decline an additional 20% to 40%, with many of the buildings purchased in 2006/2007 going into some form of severe financial distress by 2010 or 2011.

"Over 60% of the commercial office buildings in San Francisco were sold between 2006 and 2008, and all of those buildings are worth less today--some have lost more than 50% of their 'value,'" states its report. "Since most of these buildings were financed with short-term debt there is tremendous pressure developing on both the equity and debt side of real estate (and) a tenant's lease decision can be the determining factor in whether an owner keeps or loses a building in the current environment."

Sources with two significant building owners in town did not immediately return phone calls seeking their take on the market. Presumably they would be more optimistic than tenant-rep brokers and tenant-rep firms who are hoping the dour outlook for owners will help generate some commissions.

CBRE, which represents tenants and building owners, is predicting that the first half of 2009 will feel much like the end of 2008. "Financial markets and the overall economy are still in a state of upheaval and several major commercial developers have now gone to Congress warning of further trouble due to their inability to refinance loans coming due in the next three years," the report states. "While a significant level of lease roll in the second half of the year may lead to increased activity, continued hesitancy on the part of tenants to commit to leases in the near-term will likely lead to a continued trend of increasing vacancy and negative absorption for at least the first half of the year."

In response, the development pipeline in San Francisco has been largely sealed off. While 1.8 million square feet of space was delivered this year--the busiest year since 2002--only 400,000 square feet of new space will be delivered in 2009, all of it for life sciences tenants, and only 210,000 square feet is currently slated for delivery in 2010, according to CBRE.