Volatility is Much-Needed Medicine to Balance Market

Lumpkin emphasizes caution when looking at first quarter volatility.

SAN FRANCISCO—It appeared to be the same story for the first quarter as in the past few quarters: declining vacancy, increasing rents and positive absorption. However, the first quarter marks the end of one of the most volatile in the past five years, according to JD Lumpkin , San Francisco market leader for Cushman & Wakefield . “This volatility in the financial markets was reflected in our local real estate market as VC’s invested less, more sublease space hit the market, many larger lease transactions were ‘pulled’ or put on hold and many private companies have resolved to be more fiscally responsible under pressure to become profitable, says Lumpkin. Several factors are influencing the market and pointing to a cooling in San Francisco in the next 12 months: primarily over-blown valuations in the tech industry and a soaring cost of living. New sublease space has been hitting the market at an increasing level with more than half of that space originating from tech tenants. However, Lumpkin cites caution, telling GlobeSt.com: “The San Francisco office market and the tech occupiers that drive it are correcting, NOT collapsing.” He says, “While these factors have created palpable anxiety in the marketplace, particularly among investors and developers, this is a healthy dose of some much-needed medicine that will restore a more balanced market and allow for good companies to continue to grow in San Francisco. We should not be afraid of an 8 to 9% vacancy rate in San Francisco, as this would give tenants more room to navigate vs. just deciding to move or grow outside of San Francisco or even outside of California.” For year-end 2016, Cushman & Wakefield is forecasting the citywide overall asking rent to increase 1.5% from the current $68.44 per square foot with a vacancy rate up by 70 basis points to 6.4%. Essentially, slower job growth and increased inventory, even with most of the new product pre-leased, will lead to dispositions, particularly in non-class-A product. The $68.44 asking rent is a record high, representing a 9.9% increase during the past four quarters. The overall vacancy is 5.7%, a 20 basis point decrease since the fourth quarter of 2015 and below the 6.4% rate reported this time last year. The sublease vacancy is 822,301 square feet, which is up from 729,770 square feet in fourth quarter 2015. Overall net absorption was positive in the first quarter due to the LinkedIn move in at 222 Second St., otherwise, absorption would have been negative. There is 4.4 million square feet under construction, with 52% pre-leased. The pending moves are from SalesForce, Dropbox and Splunk . Robert Sammons , Cushman & Wakefield regional director, northwest research tells GlobeSt.com: “Sublease availability has continued to rise in the first quarter of 2016 but this is not necessarily a bad thing. Direct asking rents have been on such a sharp upward trajectory while direct availability has plummeted. This was threatening a number of price sensitive firms to push operations out of San Francisco. This built out “plug and play” space is coming to market at a somewhat lower price point with lease expirations that are several years out. It could, in fact, be just the breathing room San Francisco needs to hold onto its employment base–be that tech or non-tech.” This coincides with the national office report in which Cushman & Wakefield points out that tenant demand for office space slowed in the first quarter, dragged down primarily by continued weakness in the oil patch and a pullback in the tech sector. Kevin Thorpe , Cushman & Wakefield’s chief economist, says the slowdown mirrors the choppy performance of the US economy and was concentrated in certain markets. “The financial market volatility to start 2016 weighed heavily on the tech sector in particular. For the first time in years, we saw the venture capital faucet tighten, and certain tech hubs such as Silicon Valley and Boston began to pull back. The upshot is that conditions have stabilized after the first six weeks of the year, and US businesses continued to add jobs at a healthy pace. The US economy seems to be pulling out of this mini-Q1 slowdown, and given that job creation and consumer confidence have remained steadfast, we should see the office demand metrics pick up from here.” The highest office rents continue to be in Midtown Manhattan at $78.40 per square foot, but San Francisco, which has the lowest vacancy rate in the country at 5.7%, has closed the gap with asking rent averaging the aforementioned $68.44. As recently as the beginning of 2010, the difference between Midtown Manhattan and San Francisco was $30.30, while today it is just shy of $10.00. The top five markets in terms of rent growth were San Jose, with 22.1% year-over-year rental appreciation; Dallas/Fort Worth with 17.5%; San Mateo County with 16.5%; San Diego with 13.5% and San Francisco with 12.4%. “The biggest take away from the (San Francisco) report is that the market has slowed but we do not perceive this as a negative. San Francisco will benefit from a cool down as it was way overheated regarding the cost of doing business,” says Sammons.