San Francisco's Role in US Office Absorption

SAN FRANCISCO—A combination of lack of new supply, the strength of technology and energy tenants and a deep talent pool is responsible for strong absorption in the San Francisco office market, Maria Sicola, head of research for the Americas for Cushman & Wakefield, tells GlobeSt.com. A just-released C&W report shows Q1 US office-market absorption increases of 133% year over year, with San Francisco's occupancy gains coming in at 1.2 million square feet for the quarter, behind Midtown South New York (1.7 million square feet) and Chicago (1.4 million square feet).

As GlobeSt.com has reported recently, several large office leases have been signed in the market, including Salesforce.com's 714,000-square-foot lease at 415 Mission St.; significant new leases signed by Twitter, Dropbox, LinkedIn, Trulia and Practice Fusion; as well as Google's 372,000-sq. ft. renewal at Hills Plaza. In addition, as GlobeSt.com reported last week, 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,” according to Kidder Mathews' EVP of brokerage Reed Payne. The firm reported ±350,000 square feet in positive net absorption.

“The main thing that is really behind the activity in San Francisco is the nature of the industries and companies leasing large blocks of space,” says Sicola. “The recovery is largely driven by technology and energy, and this market in particularly has been one that has seen the benefits of those sectors' strength.” She adds that media and media-related firms are another industry driver for office space in this market.

Also, as opposed to the tech bubble we saw in the early part of this decade, the companies leasing large blocks of space and expanding are “all established, have good balance sheets and are looking to expand where the talent is,” Sicola says. “You have the talent here, plus what the environment and area offer that talent, and real estate is in effect following suit.”

Another reason why the absorption is so strong right now, Sicola says, is that lack of new supply from suppressed construction and limited subleasing has left vacancy rates lower and available space tighter than ever. “During the tech bubble, rents were spiking and companies were seeking a lot of space to lease and then went belly up, putting a lot of excess space on the market. Construction activity, while it has been up in the last two years, when you look at the 80s and late 90s, we're not going to see a return to that level of construction. While we're coming back with about 20 million square feet in the markets we track, it won't get to that previous level.”

It does seem contradictory, given what we've learned and heard about office tenants cutting back on space and seeking collaborative environments with higher densities, that absorption should be so high nationally and in a progressive market like San Francisco. “But we also haven't seen a lot of development, and what we do have is being absorbed rather quickly,” says Sicola.

Will the skyrocketing absorption rates continue into next year? “That's a great question,” says Sicola. “Looking ahead to next year, we'll see more significant employment growth. We're beginning to come of out this recession fully, with more people entering the job market. Others who have been unemployed for a long time are out of the job market, so we're not seeing unemployment rates go down dramatically, but we've seen significant employment growth in the last few years. In terms of the supply pipeline, it's on par with what we've seen over the last few years. Leasing fundamentals should tighten in 2014/'15, markets will become tighter—especially the energy and technology markets—and more traditional office tenants like law firms will become more active. We're at the beginning of this upcycle right now.”

Sicola adds that, stemming from an improving national economy, barring any unforeseen economic or geopolitical events, she anticipates continued progress as US businesses continue to expand and invest in private-sector jobs.

C&W also reports that the first quarter saw some significant movements in rents, and San Francisco's price per square foot per month rose 3.8% to $60.20. San Francisco also has the second-lowest CBD office-vacancy rate for Q1 at 9.28%, behind Midtown South, NY, at 7.85%.