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SAN FRANCISCO-Office activity here, both leasing and sales, slowed considerably in the fourth quarter, stunting rental growth and values, according to year-end reports by Studley and Grubb & Ellis. When predicting 2008, however, the two begin to differ.

Studley, a tenant rep firm, paints a cloudy picture, with EVP Steve Barker calling market performance “lackluster” and accusing landlords of a “steadfast commitment to unrealistic asking rents.” Grubb & Ellis, a more landlord focused brokerage firm, says the slowdown is relative to an overheated market and that the changes are merely a shift toward a more sustainable growth pattern.

Studley’s Barker says tenants are adopting a ‘wait and see’ attitude in the wake of the credit crisis, opting to execute short-term transactions “with the expectation that asking rents will drop over the next six to nine months.” G&E acknowledges that tenants may be more conservative with their space commitments in 2008 but predicts that rent and occupancy gains will continue.

As for new construction deliveries, including renovations and conversions, Studley says they may create some “downward pressure on asking rents.” Grubb & Ellis says “strong demand should counterbalance the adverse effect of new and renovated construction deliveries” and “supply should continue to tighten,” but did temper its prediction.

“For those owners with upcoming availabilities in competitive areas, it may be a good time to button up deals before the competitive space hits the market,” states the report. “Those landlords with more coveted vacant space at the higher end of the spectrum may take their time in filling it to achieve higher rents, especially with anticipated rent growth, though at a moderated pace.”

In the fourth quarter, 92,752 sf of positive net absorption was recorded, 25% of the quarterly average over the past four years, but positive nonetheless, pushing the overall vacancy rate down to 11.2% in the 62-million-sf market, according to G&E. By class, class B space saw most of the positive net absorption but still has a much higher vacancy than class A space, 14.2% compared to 9.9%. Rent growth was flat, at 0.4% in the fourth quarter. At year-end 2007, city-wide rents stood at $48.09 per sf and $34.04 per sf for class A and class B space, respectively.

In the CBD, positive net absorption totaled about 42,000 sf in the fourth quarter, dropping vacancy in the 44-million-sf market to 10.1%–8.2% in the 19-million-sf South Financial District and 11.5% in the 25-million-sf North Financial District, according to G&E. Asking rents in the CBD averaged $50.12 for class A and $36.05 for class B. Average class A rents in the North Financial District specifically are about $3 above the overall CBD average and in the South Financial District they are about $3.50 below the CBD average.

During the first half of the year, office building investment sales reached a peak of $6.3 billion, pushing prices up 51% from 2006 to an all-time high of $512 per sf, according to G&E. During the same period, rents experienced the highest rate of growth since 2000 at 16.4%, and leasing activity pushed vacancy down 100 basis points.

The second half of the year ushered in a period of markedly slower growth, according to G&E. Reacting to the uncertainty in the capital markets, investment volume in the second half of 2007 was $1.4 billion, only 22% of the total volume in the first half of the year.

That having been said, the fourth quarter of 2007 represented the 18th consecutive quarter of positive net absorption, and year-to-date net absorption surpassed one million sf for the fourth consecutive year. Average rents increased 21% in 2007, the strongest year of rent growth in seven years, according to G&E.

Demand is being fueled in large part by the technology sector, according to G&E. Since 2004, over 475 technology companies have committed to approximately 5.6 million sf. In 2007, 36% of the total transaction activity is attributable to tech companies, up from 21% in 2006 and 17% in 2005. Looking ahead, G&E says another 40 plus tech tenants are looking to occupy over 850,000 sf.

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