Overall, the San Francisco office leasing market continues to soften, according to a report from Colin Yasukochi of Grubb & Ellis, but the decline has slowed. Downtown class A rents are down 3.77% to $69.19 per sf and class B rents are down 5.66% to $55.41 per sf. Vacancy is 17% higher and rents are nearly 30% lower in the dot-com heavy area south of Market Street.
The vacancy rate jump north of Market Street, which added a full percentage point last week, is a "harbinger of things to come," says McComb. The class B market, comprised of buildings built before 1960, is a leading indicator of the future of market rents because they provide an acceptable alternative to class A buildings at more affordable rents. The market doesn't tolerate an 11% to 13% vacancy rate for more than a few months before property owners are forced to make concessions.
The vacancy rate had been at zero during November and December of last year, says McComb, and shot up to 11% in a couple of months mainly due to the "dot-com shakeout" and a migration due to high rents of mid-level businesses into their areas. Rental rates shoot up fast when the vacancy rate is below 5%, says McComb, because most properties operate with an expected occupancy level of 95%.
Once a high occupancy level is reached, owners can afford to test the market for higher rents. Class B rent raises last year sent many businesses into other markets seeking lower rents in order to maintain their 15% to 20% profit margins.
Vacancy rates on property offered directly by owners are at 5.93%, exceeding sublet vacancy rates at 4.84%. McComb says that's an indication that the core tenant base has already begun to erode--that tenants are willing to wait until the last minute to renew or relocate in an effort to wait and see where market rates settle.
Starboard Commercial Real Estate is among those tenants who can pull off a last minute move quickly. Starboard's lease on 3,500 sf at 311 California St. expires in June and McComb says he will wait until from 45 to 60 days before the lease expires to see if the owner is willing to negotiate.
"If the vacancy rate remains in the 11% to 13% range for just a few more months," says McComb, property owners will begin to get a little more realistic. Owners tend to try to hold the line on rates by using bargaining techniques like free rent, bonus commissions, above standard tenant improvement contributions, moving allowances or move-in bonuses.
"The big-boom cycle has blown out now and it is gone," says McComb. The market is returning to the traditional tenant base in the 4,000 sf to 7,000 sf range. The days of brokers running with several larger tenants are past for now. Brokers will have to do more deals to make it.
There is about 3.3 million sf available now in the core financial district area. Owners with larger blocks of space will be forced to reconfigure their spaces to meet the market. The larger institutional owners will concede to the market more slowly, but owners with one or two buildings could be coming around by June.
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