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PALO ALTO, CA-Overall Silicon Valley office leasing activity in the second quarter declined by more than 64% compared to the same year-earlier period, according to a new report by the tenant-rep firm Studley. Leasing activity totaled 426,717 square feet during the quarter, a 54.2% decline from the first quarter and a 64.3% drop from the second quarter of 2008.

Class A office leasing volume for the past four quarters totaled approximately 892,000 square feet, which is 64% behind the regions’ historic average of 2.4 million square feet, according to the report. All office leasing activity for the past four quarters totaled 3.5 million square feet, which is down 18% from the first quarter and 31% behind the total as of the second quarter of 2008.

“Given the region’s recent employment figures—Silicon Valley’s unemployment rate accelerated at an alarming pace over the past three months, closing midyear at 11.2 percent—the sharp deterioration in the office market was to be expected,” says George Fox, Studley senior vice president and branch manager of the firm’s Silicon Valley office.

The region’s overall vacancy rate reached 20% in the second quarter, increasing by 220 basis points from the first quarter, according to the report, while class A vacancy jumped 260 basis points to 30%.

Overall asking rents fell by 2% in the second quarter to an average of $2.47 per square foot. Class A asking rents fell faster, decreasing 4.3% to $2.78. Effective rents, meanwhile, fell even faster, declining by as much as an additional 20- to 30%, as landlords have begun to respond to market realities, according to the report.

That having been said, Fox believes the market has only begun to feel the impact of the recession. “We believe our region is still in a period of pricing discovery and expect that it will take several quarters to play out, with further declines likely,” he says.

With tenant demand low, Studley says building owners are demonstrating flexibility, offering short-term extensions for firms that face uncertainly and negotiating early restructures for those that can take advantage of current opportunities and lock in discounts for the long-term.

“The recent 240,000-square-foot Bank of the West transaction at Bishop Ranch in San Ramon underscores how flexibility can translate to opportunity for some landlords, particularly those that have owned their properties for some time and can afford to be more aggressive in pursuit of tenants,” Fox says.

Sunset Development Company, which developed the 9 million square-foot business park and still owns a goodly portion of it, told GlobeSt.com last month that it is relocating two existing tenants to make way for Bank of the West. In addition to having a large enough development to work such a deal, Sunset Development now has another big advantage: it has owned the development for 30 years and has maintained very low leverage on the properties, which allows it to offer the same or better space for less than more highly leveraged building owners. Now that values have fallen as much as 50% and occupancy has declined, those highly-leveraged owners have very little room to wiggle and still make their debt payments while Sunset can still wheel and deal.

Bank of the West signed a long-term agreement for Bishop Ranch 7, a class B office building. The bank intends to use the space beginning in late 2010 to consolidate its East Bay operations, which currently has 1,600 employees spread among seven buildings in Walnut Creek, Concord and Pacheco. While the negotiated terms were not released by the parties involved the annual full-service asking rate for the building was in the $26-$28 range and local brokers have speculated that the deal included a substantial amount of free rent.

Other significant transactions closed during the second quarter include Symantec signing 75,231 square feet at 466 Ellis Street in Mountain View/Los Altos; Google adding 36,900 square feet at 1824-1842 N. Shoreline Boulevard, also in Mountain View/Los Altos; and 3 Leaf Networks leasing 23,511 square feet at 2355 Scott Boulevard in Santa Clara.

Despite the current lack of activity, Fox says the core driver of the Valley’s economy, the technology sector, as well as emerging industries such as clean tech, biotech and nanotech, provides some underlying stability. “Overall, the sectors comprising the Valley’s economy are poised for long-term growth and, as such, the region is better positioned than many to achieve a full recovery,” he says.

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