Same Office Supply and Demand Dilemma with No Great Surprises in Q4

SAN FRANCISCO—Office vacancy ticked up 40 basis points in the fourth quarter to 3.2%, while availability increased 180 basis points to 9.6%, according to a fourth quarter report by Newmark Knight Frank. However, demand also increased and still slightly outpaces supply at 8.1 million square feet.

While absorption was positive at 526,200 square feet, this amount included Facebook moving into 763,102 square feet at 250 Howard St., which is why there was an increase in vacancy despite positive absorption. Of the 3.3 million square feet currently under construction, 84% has been preleased or is rumored to be in lease. Another 4.4 million square feet are expected to break ground in 2020, and those projects are already 41.4% pre-leased or are rumored to be in lease. While some companies such as Uber are putting large blocks of sublease space on the market in preparation for a move into new locations, often that space is not available for a new tenant to move into for a year or more, according to the NKF report.

“There really aren’t any great surprises in this Q4 report. It’s the same supply and demand dilemma we have been dealing with since mid-2018,” Andrea Arata, Newmark Knight Frank’s San Francisco director of research tells GlobeSt.com. “Fortunately, the sublease space coming on the market will give us a little bit of much-needed wiggle room. Also, owners are getting more creative regarding the Prop M Small Allocation, and we are seeing more buildings under 50,000 square feet being proposed, such as the conversion of two floors from retail to office at the San Francisco Centre recently approved by the San Francisco Planning Commission.”

With all of that being said, vacancy is expected to stay low, and supply and demand will remain unbalanced until at least 2022 or 2023, according to the NKF report. The restricted supply continues to push asking rates, which increased 5.7% year-over-year to $87.22 per square foot. Class-A asking rates increased 7.7% year-over-year to $92.41 per square foot, the report says.

Moreover, the leasing volume in the fourth quarter was the lowest in more than three years, at 1.6 million square feet. In all, the tight market resulted in 2019 leasing dropping by 21.4% compared to 2018 and 33.9% compared to 2017.

Despite the slowdown, two leases greater than 100,000 square feet were signed during the quarter. The largest lease this quarter was Visa’s 350,000-square-foot lease at Mission Rock with Tishman Speyer, which will break ground in early 2020. Additionally, Nextdoor signed a 104,969-square-foot lease at 420 Taylor St. this quarter. The landlord Seven Equity Group will convert the garage of the 46,000-square-foot building to additional office space. Airbnb expanded this quarter with both a 61,000-square-foot lease at 808 Brannan St. and a 36,490-square-foot lease at 888 Brannan St. Lyft signed a 28,000-square-foot expansion and a 58,000-square-foot extension at 185 Berry St.

The largest renewal last quarter was Databricks’ 47,577-square-foot renewal at 160 Spear St. Other large leases during the last three months included EasyPost’s 51,156-square-foot lease at 345 California and Sentry’s 36,792-square-foot lease at 45 Fremont. Co-working companies have also slowed the leasing pace due to an abundance of caution both from the companies and potential landlords. The largest co-working deal this quarter was WeWork’s 44,341-square-foot lease at 475 Sansome with a tenant already in tow, Arata said.

“With CMBS as stable as we’ve seen it in years, life companies coming out with new allocations for 2020 and an abundance of debt funds continuing to aggressively pursue value-add opportunities, we expect debt markets to continue to be robust the first half of 2020 as the supply of competitive debt continues to benefit the capital markets,” Ramsey Daya tells GlobeSt.com. Daya is NKF vice chairman and head of the debt and structured finance team in Northern California and Pacific Northwest.