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SAN FRANCISCO-The San Francisco office market saw vacancy, rental rates, absorption and leasing activity all worsen over the second quarter, according to the latest report from Colliers International. Vacancy now stands at 17.4%, up from 16.8% in the first quarter, according to the report.

“With the current state of deteriorated market fundamentals, a substantial improvement in rental rates appears years out,” says Colliers Research Director Brad Van Blois. “The freefall in rents over the past two-and-a-half years is astonishing, but when analyzing what’s transpired over the past four quarters the picture doesn’t appear as bad as it might seem. There are two stories being played out that must be viewed separately: direct rents are stabilizing while sublease rents continue to plummet.”

Despite 10 million sf of vacant space, office landlords have been holding firm on asking rental rates, according to the report. The lure for tenants to move to class A buildings during the market downturn remains very prevalent and has kept direct rental rates in check, says Van Blois. Class A Financial District direct rents were virtually unchanged in one year’s time, from $32.92 at third quarter 2002 to $32.89 at the end of last month. Direct space in class B buildings has firmed up as well, according to the report, as the majority of lease transactions during the second quarter were done at rates between $21 and $24 per sf per year.

The rate at which sublease space is being added to the market has slowed but the desperation of sublessors continues to grow, spiraling rents down to new lows, says Van Blois. In class A Financial District buildings, for example, sublease rents have dropped 63% in one year’s time, from $33.84 at the end of the third quarter 2002 to $20.74 at the end of last month.

“While we have avoided a double-dip recession, the inconsistent momentum has failed to restore healthy business conditions or most importantly, reduce unemployment,” says Van Blois. “As a result, the office market has experienced negative absorption of 237,256 sf year-to-date, with financial service companies such as Morgan Stanley, Montgomery Assets, ABN Amro, Merrill Lynch, Price WaterhouseCoopers accounting for a large portion of this.”

Looking ahead, it’s more of the same. “Wells Fargo, DHL, Matson Navigation, Delta Dental and Bank of America are expected to return large blocks of space during the second half of 2003, resulting in a roughly 300,000 square feet of negative absorption,” Van Blois said. “We just don’t see much in the way of encouraging news for San Francisco at the moment.”

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