MARKET HIGHLIGHT, MARCH 2008

SAN FRANCISCO
Ryan Carmichael and Patrick Shiver 

Led by an active office sector, the San Francisco market continues to turn heads in the West.

Office

Despite several years of intense activity, San Francisco Bay Area office sector saw unprecedented investment sales in the first six months of 2007 – highlighted by major sales by Blackstone Group and Beacon Capital Partners. Since January 2004, 83 percent of the Class A office square footage in downtown San Francisco has changed hands and, in 2007, 49 downtown buildings valued at $9.3 billion traded.

The sector also showed very robust fundamentals. By the end of 2007, the San Francisco office market recorded 1.3 million square feet of overall positive net absorption, which included a significant take up of vacant sublease space in the downtown core and in some of the city’s submarkets thanks to companies such as Google, Myspace, Goodwin Proctor, Manat Phelps and Phillips. There was also significant leasing activity in the city’s peripheral office submarkets, particularly in the Presidio, where Babcock & Brown signed a lease last year for 155,000 square feet and plans to move its headquarters. This level of activity effectively lowered the overall citywide vacancy rate for all to 9.46 percent and reduced the sublease vacancy rate to just 1.11 percent by the end of the fourth quarter.

Construction activity was also quite brisk in 2007 with several major office projects slated for completion this year. These include the new Barclays Global Investors headquarters at 400 Howard Street, Lowe Enterprises’ 260,000-square-foot development at 500 Terry Francois Blvd. and Shorenstein Properties’ headquarters development for FibroGen at 409-499 Illinois Street, the latter two in the city’s rapidly evolving Mission Bay area. In addition, construction is underway on 555 Mission Street, Tishman Speyer’s 550,000-square-foot tower.

One trend that is only likely to deepen this year is that the city will see more office developments proposed to meet LEED standards of sustainability and energy efficiency. Just underway, for example, is Beacon Capital’s LEED-certified project at 535 Mission Street. With the city, as well as tenants and lenders increasingly demanding development of buildings conforming to green building principles, it’s difficult to see any new product coming online in the next few years that doesn’t have at least some sustainable design features.

The Mission Bay/China Basin submarket promises to be one of the most interesting markets in 2008. The growth of the Bay Area biotech research sector continued to fuel leasing activity in Mission Bay and last year saw four significant biotech venture capitalists — Versant Ventures, Novo Ventures, Arch Venture Partners and Column Group — all locate to 1700 Owens Street.

— Ryan Carmichael is an analyst in Jones Lang LaSalle’s San Francisco office.

Multifamily

The San Francisco Bay Area  multifamily sector had a reasonably successful year in 2007 despite a decline in overall occupancy to around 96.5 percent by the start of the fourth quarter. Bay Area apartment occupancy topped out at slightly more than 97.5 percent in third quarter 2006. Among the three largest Bay Area apartment markets — San Francisco, Oakland and San Jose — San Jose, at 97.5 percent, had the highest occupancy as of September 2007. San Francisco had the lowest overall occupancy at 96 percent, the first time since 2005 that the city experienced such a low.

San Francisco, Oakland and San Jose combined saw their total apartment stock increase by 4,433 units between October 2006 and September 2007 as 24 new developments came online. The multifamily construction pipeline in the area is projected to taper off quite considerably with 12 projects totaling 1,973 units slated to come online before September 2008 and only four projects totaling 1,135 units announced for completion after October 2008.

Oakland saw the most new apartment developments delivered between October 2006 and September 2007 with 10 new properties totaling 1,385 units. However, San Jose, with seven new properties built in that same timeframe added 1,776 units to its existing inventory. No new projects have yet been announced for the San Jose market after October 2008.

This decline in the pace of new inventory comes at a time when the markets are witnessing steady growth in apartment rental rates. In 2005, average rents in the South Bay were $1.56 per square foot or $1,287 monthly. In 2007, average per square foot rents were pushing $1.95 per square foot with monthly rents averaging $1,634. Rents on the peninsula during the same period increased from $1.87 to $2.15 per square foot. East Bay apartment rents also increased but not as dramatically. In 2005, monthly rents per square foot averaged $1.42 with monthly rents averaging $1,158; in 2007, per square foot rents had increased to $1.57 with monthly rents at $1,288.

As for investment activity, the San Jose and San Francisco apartment markets — like most markets in California — witnessed a significant increase in apartment sales in 2007, with totals of more than $1.4 billion and $1 billion, respectively. More than a hundred properties traded in San Francisco, San Jose and the East and North Bay markets combined last year. Most of the properties changing hands in 2007 were pre-1980 construction with 22 of those properties in the East Bay markets, which was the most active investment sales market in the Bay Area. 

— Patrick Shiver is vice president, multifamily sales and finance, in Jones Lang LaSalle’s San Francisco office.

Retail

At $485 per square foot, prime street-front retail space in San Francisco is second only to New York City in price and ranks among the most expensive retail markets worldwide, according to NAI Global’s 2008 Global Market Report.

In its economic overview, NAI indicates that prime downtown, ground-floor retail space in San Francisco County, excluding space in enclosed malls, averaged $154 per square foot and posted a 10 percent vacancy. Neighborhood service centers, ranging in size from 75,000 to 250,000 square feet, averaged $78 per square foot in rent and registered a 3.5 percent vacancy. Lastly, regional malls in the San Francisco market, classified as suburban or downtown properties exceeding 600,000 square feet with at least two major department store anchor tenants, averaged a rent of $99 per square foot and posted a vacancy of 3.5 percent.

While asking if consumers will stop spending in 2008, Grubb & Ellis notes in its Global Real Estate Forecast that markets offering the strongest defenses against faltering consumer confidence include the Bay Area in Northern California.

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