Sacramento’s Aging Office Buildings Could Become Apartments

The reduced office demand in Sacramento could spell an opportunity for a big change. A new report from Marcus & Millichap suggests that challenges in the office market and a dearth of apartments could create an opportunity for apartment redevelopment.

The office market across the country has been severely impacted by the pandemic, and Sacramento is no different. The market has a record level of sublease supply—driven even higher in the second quarter by Sutter Health, which placed 200,000 square feet of sublease supply on the market. So far, there has been limited demand for the sublease stock, and Marcus & Millichap notes few executions of subleases since the start of the pandemic.

Looking ahead, the report expects office vacancy in the market will increase another 100 basis points this year, pushing it up to 14.5%, the highest level since 2016. However, the market also expects office rents to increase .4% this year. This is largely due to the delivery of new office buildings, which could help to seal the fate of older office stock. With increasing sublease supply and limited demand, older privately owned offices could become residential redevelopment opportunities.

Government agencies are also playing an outsized role in the trajectory of the office market. While the market is reopening and most private sectors are returning to the office, state government workers are planning to continue to work from home or on a hybrid schedule. As a result, many of these agencies are planning to reduce their current footprint. This could drive office vacancy up, particularly in the downtown area.

While the office market is suffering, the multifamily market is just the opposite. In fact, a multifamily report from Yardi Matrix in March showed that the Inland Empire in Southern California and Sacramento were leading the nation in multifamily gains with rents up 7.6% and 6.4%, respectively. The markets are also among the top three for occupancy growth year-over-year, with occupancy in the Inland Empire ticking up 2.2% in January and Sacramento showing a 1.2% increase. They also showed strong rent growth thanks to limited new supply coming online. This activity makes a good argument for why office space could become a residential redevelopment opportunity in Sacramento.

The market has also attracted noteworthy investments. At the end of last year, for example, the 293-unit Alira Luxury Apartments sold in the Natomas submarket for $92.3 million. Stockton-based multifamily development firm AG Spanos Companies sold the property to San Rafael-based real estate investment firm Oakmont Properties in an off-market transaction.