Office Report Q4-2004 NORTHERN CALIFORNIA
o f f i c e Colliers International Office We are pleased to present you with the inaugural issue of the Colliers Northern California Office. Our goal at Colliers is to be the premier source of market information for the San Francisco Bay Area Region and to provide our clients with the edge that comes from superior market knowledge. We are very proud of the fact that throughout the economic uncertainties of the past two years we have expanded our research capabilities. Our research is a team effort, guided by research professionals who work hand-in-hand with our entire staff of brokers to gather, analyze and publish independently verified market data in order to best assist you in your decision-making process. The simple fact is that if there is ever a time in which the importance of accurate market data is key, it is when market conditions are less than crystal clear. With that, we are proud to bring you the most accurate, comprehensive and current market information available. Bay Area Rollercoaster on the Way Back Up Extending from San Jose and the Silicon Valley to the south and eastward to California s capitol city of Sacramento, the San Francisco Bay Area Region is the fourth largest metropolitan region in the United States and the world s 24th largest economy. It boasts more Fortune 00 companies than any region in the United States except New York and features the highest density of venture capital firms in the world. We are home to the nation s largest concentration of corporate and independent research laboratories and leading research universities and that is reflected in the fact that we have the most highly educated workforce in the nation with the highest percentage of residents with graduate and professional degrees. San Francisco Bay Region boasts exports higher than all but one state, features the highest level of patent generation in the nation and boasts the highest economic productivity - nearly twice the U.S. average - of any metropolitan area. Despite its competitive advantages, the Bay Area Region s office market has been on a rollercoaster ride over the last four years of economic turbulence. Following the phenomenal growth that marked the late 1990s, the tech-wreck that began in 2000 marked the beginning of an economic decline that culminated in the recession of 2001 and sluggish growth in the years immediately following. Nowhere was the impact of these events felt more profoundly than in the San Francisco Bay Area Region. Being at the heart of the tech revolution of the 1990s, few office markets experienced as extreme a shift in market fundamentals than those in the Bay Area, particularly in the tech-heavy San Francisco and Silicon Valley markets. In San Francisco this was demonstrated by a drastic swing in vacancy levels from a low of just 3.6% at the high peak of the dot.com boom in 2000 to 16.9% by 2003 as conditions reached their low-level mark. San Jose and the Silicon Valley fared even worse. Less than four percent of all Silicon Valley office space was available as of the third quarter of 2000. This amount soared to nearly 2.0% of all space by the mid-year 1 2.0% 20.0% 1.0% 10.0%.0% 0.0% SAN FRANCISCO Regional Office Vacancy Rates VACANCY RATE PENINSULA SILICON VALLEY EAST BAY SACRAMENTO mark of 2003. Even more striking is the shift in asking rates during that time. When office space was at a premium there were deals inked for new Class A space in Downtown San Francisco at rates of $.00 per square foot annually (on a full service basis) or more. That rate dropped to the high twenties within just twelve months. Some landlords actually opted not to market vacant space and simply wait for better market conditions to prevail rather than attempt to lease unoccupied space at such low rates. Other major region office markets such as Oakland and the East Bay were not quite as hard hit as their neighbors across the Bay, but they were certainly impacted. Vacancy increased, rents decreased and sublease availability in all Bay Area markets soared. The sole exception to this trend was the Sacramento office market where a large government user presence combined with strong recent population growth lent some measure of stability with vacancy rates staying in the low teens. But the good news is that since that time the Bay Area Region has been on the mend. Vacancy in San Francisco and Oakland now stand in the mid-teens. Increased interest in Bio-Tech space has helped to send vacancy in the San Mateo/Peninsula office market on a downward trajectory. While vacancy there still stands in the 20.0% range, this market has recorded five consecutive quarters of growth. San Jose, meanwhile, has recorded rental rate growth for the first time in four years and also is on the road to recovery. Once again, the sole exception to these trends is Sacramento where the State budget crisis and significant new construction have sent office vacancy upward as the rest of the region is firmly in recovery. However, it is vital to note that vacancy in the Capitol City still remains below 1.0%. Employment Growth Equals Increased Demand While the Bay Area Region has faced some challenges over the last four years, the worst is over and the local economy has recorded substantial growth over the past 2
Colliers International o f f i c e twelve months. Employment growth, the largest single determinant in office space demand, is on the upswing. According to a December 8th USA Today article, temporary agencies are seeing not only a 10.0% increase in temporary hires over last year, but also a strong increase in their transition to permanent status. All anecdotal evidence aside, the numbers bear this trend out. As of November 2004 unemployment rates for San Jose stood at.0% down from 7.3% a year ago. The trend was the same in the East Bay where rates stand at 4.7% down from.8%. Unemployment also dipped in San Francisco from.1% to today s rate of 4.1%. All of these stand below the California rate of.6% and the national unemployment rate of.2%. Employment growth equals increased demand and all indicators point towards this trend continuing into 200. Will Construction Declines Lead to Rental Growth? Another positive sign for the Region in 200 is the fact that with the exception of Sacramento--very little speculative office construction is planned for delivery. This should give the market time to absorb currently vacant space as it moves closer towards equilibrium between supply and demand. That being said, most individual markets within the Region still have some way to go before equilibrium is reached. Vacancy levels within the ten percent range generally ensure enough available space for economic expansion, but not so much as to depress rental growth. All of the Region s markets are at least a year or two away from this mark. It differs from market to market, but the Bay Area Region will likely not reach equilibrium prior to 2007. In the meantime, look for the market to continue to post occupancy growth as it continues a gradual recovery. The good news for landlords is that the freefall in rental rates is over. Rates have stabilized over the past eighteen months and in some select markets and specific property types they have actually begun to show signs of life. Again, this varies from market to market within the Region, but don t expect significant rental growth in the immediate future. Landlords in those markets with vacancy above the high teens will certainly struggle to raise rents in the face of stiff competition. However, certain property types in select markets may find themselves situated for increases by later in the year. San Francisco Recovery Strengthens in The City The San Francisco office market experienced almost 700,000 square feet of positive net absorption in the 4th quarter of 2004, and surpassed 1.2 million square feet for the year. This marks a massive increase over 2003 when just under 10,000 square feet of occupancy growth was recorded and illustrates the fact that the San Francisco office market is firmly on the rebound. A steady stream of leasing activity and a shrinking office inventory due to the conversion of a number of buildings to residential use has tightened the San Francisco office market. The overall vacancy rate decreased to 1.4% during the fourth quarter of 2004, down basis points since last quarter and down 10 basis points since 2 San Francisco Office SAN FRANCISCO Direct vs VS Sublease Space 1,791,9 SF 10,491,488 SF the fourth quarter 2003. There is also a considerable tightening in Class A properties. The vacancy rate for Class A properties decreased from 17.7% to 16.8% for the quarter. The conversion of a number of secondary properties to multifamily residential and other uses has also helped to tighten the market and force vacancy rates downward. Office buildings representing almost 900,000 square feet are proposed, planned, or already in the process of becoming residential projects. This has resulted in the market experiencing something that has not occurred since 2000; rental growth for some of San Francisco s prime office properties. The market continues to favor tenants, but rising rental rates and tightening supply levels in the most desirable submarkets, is leading to a more substantial rent appreciation among top-of-the-line Class A properties, particularly the Financial District. The average effective direct Class A rent in The Financial District was $34.9, up from $30.36 at the close of the third quarter. Investment activity is also on the upswing in the City by the Bay. Seemingly unending amounts of capital have been placed into commercial real estate this year. Overall, more than $2.8 billion traded hands in sales of commercial buildings, exceeding 2000 s record total of $2.4 billion. Multiple interest rate hikes by the Fed in 2004 had minimal impact on the already increased investment demand for office properties. Strong competition among lenders has been a factor in this, but most investors recognize the strong economic fundamentals of the local economy and have been anxious to ride the next wave of local growth. San Francisco Peninsula Bio-Tech Fueling Peninsula Growth In 2004, the San Francisco Peninsula experienced early stage development activity spurred by the long anticipated accelerated growth in the biotech industry. Just as the tech revolution fueled record 3
o f f i c e Colliers International growth here in the 1990s, the biotech industry is again creating immense optimism for commercial real estate. The San Francisco Peninsula is already one of the world s leading biotech centers and is wellpositioned for future growth from this sector. Most of the activity was concentrated in proposed developments with some activity impacting the net absorption figures. The immediate impact on net absorption was nominal, although activity in the general office sector continued to moderately rebound resulting from seed money driving smaller start-up and early stage companies. Leading the way in the biotech sector is South San Francisco s Genentech. Responsible for the largest transaction of 2003 a 141,000 square foot lease at 611 Gateway Genentech expanded an additional 108,000 square feet in June at the same location. They followed this with two other major moves over the last half of 2004. They acquired a 114,000 square foot warehouse at the Cabot & Forbes Industrial Park at 43 Forbes Boulevard for future development and, in December, signed a $40 million blockbuster lease agreement with Slough Estates for an eight building phase-in over the next few years. This deal alone will account for over 7,000 square feet of occupancy growth over the next few years! 3 PENINSULA Peninsula Office Direct vs Sublease Space 2,217,39 SF 7,24,39 SF Overall vacancy in the San Francisco Peninsula office market dropped half a percentage point over the final quarter of 2004 to its current level of 23.3%. This marks a solid drop from the 29.3% rate that was recorded at the close of 2003, but clearly indicates that the market has a long way yet to go. A number of large blocks of space still account for the vast majority of local vacancy, but what is interesting is that demand is firmly on the upswing. In fact, despite current vacancy rates, finding quality space in the 3,000 to 10,000 square foot range has become increasingly difficult over the past year. Smaller space users are returning to the marketplace and the market recorded just under 700,000 square feet of total YTD net absorption There may be a local business mood shift as the biotech sector continues to generate momentum. Even though there are dire predictions of the impact in the offshoring of professional jobs, there is a concentration of intellectual and financial capital throughout the San Francisco Peninsula that will launch new businesses and should continue to generate increased demand locally. Oakland/East Bay Oakland Emerges Unscathed Despite a rough start, 2004 was a year of continued recovery in Oakland as vacancy declined and occupancy grew by the close of the year. The Oakland Metropolitan Area s Class A market is slowly starting to slough off some of the available space that came onto the market at the beginning of the year. Nearly 830,000 square feet of accumulated leasing activity in 2004 has helped lower the overall Class A market s vacancy rate down to 16.8% from 17.6% at the same time last year. Downtown Oakland s Class A vacancy has also made a slow descent down to 13.4% by the end of the fourth quarter 2004, since spiking up to 1.6% during the first quarter. The fourth quarter accounted for over 3,000 square feet of positive net absorption overall, reversing many of the setbacks that occurred during the first half of 2004. There has not been much of a change in the area s Class B/C and Flex market, with the overall vacancy rate for this sector staying at 17.8%. The explanation behind this seeming spate of inertia lies in nearly equal amounts of space being leased as well as coming back on the market. So, while we recorded an increase in leasing activity for this product type, much of the activity was churning with occupancy gains and losses effectively canceling each other out. This market sector s woes and triumphs are closely connected to those of the Class A market, so we expect the Class B/C market to improve as the Class A market makes a more significant recovery. Investment activity was a bright spot for Oakland in 2004. Two major Class A buildings, 1 Grand Avenue and 2101 Webster Street, closed escrow early in the fourth quarter. California State Teachers' Retirement purchased 1 Grand Avenue, while Prentiss Properties Acquisition bought 2101 Webster Street. Local investment trends have mirrored that of the Region as a whole. For the most part the number of available buildings is far exceeded by the number of potential buyers in the marketplace. Interest rate hikes, meanwhile, have done little to stem the tide of demand. The anxiety over Oracle s acquisition of Peoplesoft and its 1.1 million square foot 4 EAST BAY East Bay Office Direct vs Sublease Space 1,899,690 SF 7,66,81 SF 4
Colliers International o f f i c e campus in Pleasanton has been relieved. Lower than anticipated layoffs and potential employee relocations to Pleasanton from the Redwood Shores campus look to minimize any impact on the region s office market. San Jose/Silicon Valley Year Ends On Bright Note The Downtown San Jose availability rate at the end of final quarter of the year stood at 22.3%. This marks a decline of just over half a percentage point throughout 2004. While availability of over 20.0% far from reflects a market anywhere near equilibrium, this year s declines do reflect the gradual trend of stabilization and recovery that are beginning to take hold in San Jose. All told, the San Jose/Silicon Valley market recorded over 830,000 square feet of positive net absorption throughout 2004 a radical contrast to the over 2.3 million square feet of occupancy losses it recorded in 2003. The Downtown San Jose office market competes with three other major office markets in the Silicon Valley; the San Jose Airport area, the Santa Clara Marriott area and the city of Palo Alto. The San Jose Airport office submarket area remains one of the stronger suburban trade areas, with an SILICON VALLEY Silicon Valley Office Direct vs Sublease Space 1,082,367 SF 7,989,087 SF availability rate of 17.3%. This marks a decrease of 1.4% from the beginning of the year. Despite the fact that properties within the Santa Clara Marriott area offer free parking, availability there stands at 30.1%. Yet, this market posted the largest turn-around this year with availability decreasing 1.3% since the close of 2003. The Palo Alto market also recorded gains with availability currently standing at 22.1%, down 10.1% from 2003. Local landlords had reason to feel upbeat as the year came to a close. Leasing activity ticked up considerably over the final quarter of 2004. Yahoo! leased 184,000 square feet of space while the Silicon Valley Bank leased over 213,000 square feet in the Santa Clara Marriott area. Meanwhile, Sivault Systems leased over 34,000 square feet of space in San Jose s suburban market. Throughout the final three months of the year, the Silicon Valley office market experienced at least fifteen lease transactions in the 10,000 to 20,000 square foot range and eleven deals in the,000 to 10,000 square foot range. But perhaps the strongest reason for optimism within the San Jose office market is the fact that during the fourth quarter of 2004 the Silicon Valley office market recorded a slight increase in quoted asking rents. This had not occurred since 2004 and is a strong sign of returning confidence. While the trend is still minimal, this illustrates that landlords believe the Silicon Valley office market is beginning to turn around. Sacramento Capitol City Finally Feels Pinch The past year has been one of ups and downs for the Sacramento office market. Ironically, the economic downturn that began in 2001 and impacted most major metropolitan office markets never really hit the Capitol City. Just two years ago while Bay Area vacancy was approaching 30.0%, Sacramento vacancy remained in the low teens. Yet in 2004, the local outlook became decidedly less sunny. Employment cutbacks by major local employers such as Bank of America, Hewlett-Packard and Intel as well as the California state budget crisis finally began to impact the local office market. As the third quarter of 2004 came to a close we reported to you that vacancy within the Sacramento office market had topped the 1.0% mark. Yet, while the market may have recorded the highest vacancy levels experienced since the recession of the early 1990s, tenant interest and leasing activity were actually on the upswing. Space users were finally returning to the marketplace after two years of sluggish demand. The only problem was that developers were also returning and that this surge in demand could not keep pace with an even greater surge in new development. Over 1.2 million square feet of new product was delivered throughout 2004. The good news is that as of the close of 2004 it appears that these trends have begun to reverse themselves. Just over 22,000 square feet of new product was delivered in the fourth quarter, down from nearly 470,000 square feet of new office space that came online in the third quarter. Meanwhile, a flurry of leasing activity resulted in over 67,000 square feet of occupancy growth in the fourth quarter alone. As a result, vacancy within the Sacramento office market now stands at 14.6%. The trend throughout 2004 had been one of increasing vacancy but thanks to a 6 SACRAMENTO Sacramento Office Direct vs Sublease Space 689,963 SF 9,110,711 SF
o f f i c e Colliers International strong finish, the Sacramento office market ended the year with over 760,000 square feet of positive net absorption and vacancy not too far from where it stood at the beginning of the year. Looking forward, the good news is that demand continues to increase from the private sector and overall market fundamentals remain strong. The question is will it keep pace with our developers. Looking Ahead Economic fundamentals within the Bay Area Region remain strong and the ongoing recovery continues to gather steam. Lease activity is on the increase throughout the Region and tenant demand - which had virtually vanished during the upheaval of 2001, is returning. Look for occupancy growth to continue to post increases in all of the Bay Area Region markets in the near future. Also look for landlords to remain competitive and for tenants to remain in the drivers seat even as the market continues to recover. The market has a way to go before it reaches balance between supply and demand, but after four difficult years, growth has returned and the pendulum is finally beginning to swing the other way. 7 Fourth Quarter Office Statistics Market Total EXISTING PROPERTIES ABSORPTION CONSTRUCTION RENT Class Bldgs Total Direct Direct Sublease Sublease Total Total Total Net Net Net New Under Ask FS Inventory Vacant Vacancy Vacant Vacancy Vacant Vacancy Vacancy Absorp Absorp Supply Const Rent SF SF Rate SF Rate SF Current Prior Current YTD SF YTD SF Current $/SF Period Period Period SF Period SF Annual SAN FRANCISCO A 163 48,168,074 6,768,893 14.1% 1,302,89 2.7% 8,071,788 16.8% 17.7% 3,2 61,922-83,000 $32.13 B 241 24,117,26 2,9,343 12.3% 416,042 1.7% 3,371,38 14.0% 1.0% 261,3 703,24 - - $23.06 C 121 7,277,414 767,22 10.% 73,043 1.0% 840,29 11.% 10.0% (11,12) (82,096) - - $20.89 Total 2 79,62,744 10,491,488 13.2% 1,791,9 2.3% 12,283,468 1.4% 16.2% 699,843 1,237,30-83,000 $30.1 PENINSULA (SAN MATEO / PALO ALTO) A 244 23,87,041 4,494,69 18.8% 1,633, 6.8% 6,128,20 2.7% 2.9% 0,400 233,966 - - $27.38 B 34 16,013,41 2,612,288 16.3% 69,63 3.6% 3,181,941 19.9% 20.3% 102,0 462,691 - - $22.89 C 34 70,31 147,412 19.6% 14,187 1.9% 161,99 21.% 22.2% - - - - $23.16 Total 632 40,638,7 7,24,39 17.9% 2,217,39.% 9,471,790 23.3% 24.2% 12,4 696,67 - - $2. SILICON VALLEY A 328 2,63,262 3,832,029 14.9% 709,929 2.8% 4,41,98 17.7% 18.% (10,697) 833,96 - - $26.27 B 83 23,429,842 3,144,901 13.4% 303,01 1.3% 3,448,402 14.7% 1.4% - - - - $21.9 C 61 8,90,243 1,012,17 11.8% 68,937 0.8% 1,081,094 12.6% 11.4% - -,840 - $20.13 Total 1,742 7,6,347 7,989,087 13.9% 1,082,367 1.9% 9,071,44 1.7% 16.6% (10,697) 833,96,840 - $23.90 EAST BAY (OAKLAND / PLEASANTON / WALNUT CREEK) A 211 33,48,979 3,12,889 9.3% 1,213, 3.6% 4,339,469 13.0% 14.3% 263,40 340,717 - - $23.98 B 44 22,228,877 2,87,312 12.9% 466,10 2.1% 3,323,822 1.0% 16.0% 227,979 188,811-114,000 $20.18 C 36 11,87,997 1,682,614 14.% 219,600 1.9% 1,902,214 16.4% 1.8% (111,064) (48,401) - - $18.44 Total 1,120 67,27,83 7,66,81 11.4% 1,899,690 2.8% 9,6,0 14.2% 14.9% 3,36 71,127-114,000 $21.6 SACRAMENTO A 16 17,44,913 2,477,868 14.2% 343,22 2.0% 2,821,093 16.2% 17.2% 242,12 634,141 479,99 1,68,071 $2.20 B 602 23,749,188 3,669,811 1.% 216,9 0.9% 3,886,370 16.4% 17.2% 31,327 96,699 747,978 433,04 $21.00 C 1,40 26,326,623 2,963,032 11.3% 130,179 0.% 3,093,211 11.7% 11.8% 121,049 29,998 - - $18.60 Total 2,172 67,30,724 9,110,711 13.% 689,963 1.0% 9,0,674 14.% 1.3% 678,888 760,838 1,227,937 2,001,12 $21.4 MARKET TOTAL A 1,111 148,92,269 20,699,374 13.9%,203,184 3.% 2,902,8 17.4% 18.2% 1,099,467 2,68,342 479,99 2,403,071 $27.86 B 2,94 109,38,614 1,239,6 13.9% 1,972,26 1.8% 17,211,920 1.7% 16.% 906,914 1,41,72 747,978 47,04 $21.78 C 2,486 4,32,92 6,72,467 12.1% 0,946 0.9% 6,916,814 12.7% 12.7% (10,27) (10,499),840 - $19.07 Total 6,191 312,663,47 42,11,496 13.6% 7,681,39 2.% 0,031,292 16.0% 16.7% 1,900,84 3,99,68 1,233,777 2,90,12 $24. QUARTERLY COMPARISON AND TOTALS Q4-04 6,191 312,663,47 42,11,496 13.6% 7,681,39 2.% 0,031,292 16.0% 16.7% 1,900,84 3,99,68 1,233,777 2,90,12 $24. * San Francisco Rents are Effective Weighted 6
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