Office Construction Dip May Cause Heartburn

SAN FRANCISCO—San Francisco may face a shortage of available office space between now and 2022 when the next major office project will be completed. Space continues to dwindle, with Facebook’s lease of the last available office building in San Francisco taking all 750,000 square feet at Park Tower. Then a few weeks later, Facebook leased 1 million square feet of office space on the Peninsula and finally leased an additional 750,000 square feet in Fremont. And, Facebook recently sublet 456,760 square feet from WeWork, which in turn had sublet from LinkedIn. That’s a whopping 3 million square feet leased in 30 days.

And, at the end of July, Kilroy Realty Corp. signed a 12-year lease with a publicly traded multinational software company for 100,850 square feet of office space. The prior lease was scheduled to expire in 2019. The office space, located on Brannan Street in South of Market, is a three-story historic brick and timber building. It is blocks away from AT&T Park, the soon-to-be expanded Muni Metro T Third Line, and multiple restaurants and shops.

“San Francisco continues to have a huge demand for premium quality creative space with the majority of that demand coming from the technology sector,” Michael Brown, executive managing director, Newmark Knight Frank, tells GlobeSt.com. “We see that demand increasing as companies seek to remain in this technology hub.”

During the first half of 2018, five of the top 10 metropolitan markets for commercial construction starts ranked by dollar volume showed increased activity compared to a year ago, according to Dodge Data & Analytics. Of the top 20 markets, 11 were able to register gains.

At the national level, the volume of commercial and multifamily construction starts during the first half of 2018 was $101.4 billion, down 1% from last year’s first half, although still 2% above what was reported during the first half of 2016. Metropolitan areas showing decreased activity for commercial and multifamily construction starts during the first half of 2018 were Dallas-Fort Worth ($3.4 billion), down 23%; Los Angeles ($2.9 billion), down 38%; San Francisco ($2.8 billion), down 38%; Chicago ($2.7 billion), down 37%; and Atlanta ($2 billion), down 43%.

Commercial and multifamily construction starts in the San Francisco metropolitan area also retreated during the first half of 2018 from the elevated activity during last year’s first half. San Francisco had shown strong annual increases during the past two years, with activity up 95% in 2016 and another 30% in 2017. The first half of 2017 included the start of several very large projects, led by the $1.3 billion Oceanwide Center tower in San Francisco, with the following allocation by structure type–office building at $780 million, multifamily housing at $387 million and hotel at $95 million.

Other large projects that reached groundbreaking during the first half of 2017 included the $361 million office portion of the $1 billion Golden State Warriors arena complex and a $310 million Facebook office building in Menlo Park. The commercial building amount during the first half of 2018 was down 51% from a year ago, with declines for offices (down 81%), retail properties (down 62%) and garages (down 18%), while gains were reported for hotels (up 84%) and warehouses (up 110%). The hotel category was lifted by the start of the $225 million Grand Hyatt Airport Hotel at San Francisco International Airport, while the warehouse category was lifted by the start of a $107 million research and development complex in Fremont.

Multifamily housing during the first half of 2018 was down 19% from its first half 2017 amount, although there have been groundbreakings this year for such multifamily projects as the $173 million multifamily portion of a $200 million mixed-use development in Oakland and the $98 million multifamily portion of a $150 million Market Street mixed-use building in San Francisco.

The New York City metropolitan area, at $16.1 billion during the first half of 2018, held onto its number one ranking and comprised 16% of the US total, helped by a 44% jump compared to a year ago. Other markets in the top 10 showing growth during the first half of 2018 were Washington, DC ($5 billion), up 23%; Miami ($4.9 billion), up 34%; Boston ($3.7 billion), up 56% and Seattle ($3.2 billion), up 7%. Of these markets, the top four (New York, Washington, DC, Miami and Boston) showed renewed growth after the decreased activity reported for the full year 2017, while Seattle was able to maintain the upward track that was set in motion last year.

For those markets ranked 11 through 20, the six that registered first half 2018 gains were Austin, TX ($1.8 billion), up 15%; Kansas City, MO ($1.7 billion), up 52%; Orlando ($1.6 billion), up 4%; Phoenix ($1.6 billion), up 19%; Minneapolis-St. Paul ($1.3 billion), up 34%; and Portland OR ($1.1 billion), up 15%.  The four posting declines were Houston ($1.9 billion), down 13%; Philadelphia ($1.7 billion), down 13%; Denver ($1.6 billion), down 25%; and San Jose ($1.1 billion), down 37%.

At the US level, the 1% drop for the commercial and multifamily total during the first half of 2018 reflected an 8% retreat for commercial building that was essentially balanced by an 8% increase for multifamily housing.

“Multifamily housing has proven to be surprisingly resilient so far during 2018, following its 8% decline in dollar terms at the US level that was reported for the full year 2017,” says Robert Murray, chief economist for Dodge Data & Analytics. “With apartment vacancy rates beginning to edge upward on a year-over-year basis, banks had been taking a more cautious stance towards lending for multifamily projects.”

Yet, after some loss of momentum during 2017, several factors appear to be providing near-term support for multifamily housing, Murray says. The US economy is currently moving at a healthy clip, with steady job growth bringing new workers into the labor force. The demand for multifamily housing by Millennials remains strong, given a desire to live in downtown areas while the increasing price of a single-family home and diminished tax benefits may be dissuading some from making the transition to single-family home ownership. As shown by this year’s surveys of bank lending officers conducted by the Federal Reserve, the extent of bank tightening for multifamily construction loans is not as widespread as a year ago.