WESTERN SNAPSHOT, OCTOBER 2006

Sacramento Office Market

Boucher

The Sacramento area was no longer a national defense hub insulated from severe economic downturns in the private sector. Now, a decade later, the three bases are managed by private developers and more than two-thirds of the lost jobs have been replaced. As a result of the base closures, officials and business leaders in Sacramento have worked to develop a unique identity that highlights the area’s other strengths and advantages. Government is still a part of the market’s strength, but no longer a focus.

Today, Sacramento offers businesses a wide range of market choices including high-tech, Class A office developments that can confidently compete for the tenancy of national companies and regional stalwarts from other markets, where transportation, housing and economics have become inhospitable hosts. The city continues to field a strong Class B market to meet the demand across the various submarkets.

Market Conditions

The greater Sacramento area remains a relatively strong and stable office market. The city and the surrounding suburbs have reinvented themselves (and in some cases even invented themselves) over the last decade. In the process, this created fertile ground for businesses large and small looking for a place to grow and thrive.

Sacramento encompasses a diverse mix of interconnected yet independent submarkets. From West Sacramento and Natomas to the central business district downtown and to the eastern suburbs and surging communities of Roseville/Rocklin and Folsom, each part of Sacramento stands on its own and yet intertwines with its neighbors to create a web of communities with unique strengths and challenges. This dynamic structure creates flexibility that allows the Sacramento region as a whole to absorb market fluctuations that would impact the individual communities heavily and to balance them with significant growth and opportunity.

Trends

After a long run-up, Sacramento’s red-hot residential market appears to be cooling somewhat. So far, it seems that even this downturn has been contained within that market sector while other segments of the commercial market remain strong. While homebuilders are taking a wait-and-see attitude on plans for 2007, other businesses, primarily in the office and retail markets, continue to gear up to meet the needs of the consumers who rode in on the crest of the housing wave.

There has been an interesting shift in the trend of ownership. The wave of condominium conversions seems to have been inversely proportional to the level of interest rates. After a spike in the number of new office condominium projects in the area, there has been a moderate leveling of interest in building new owner/user developments. What remains to be seen is how interest rate changes will affect the remainder of the new projects available around the area. If rates stabilize, will it be enough to generate a resurgence of interest in this type of development? Or will owners begin to look to different uses?

Vacancy/Rental Rates

According to market research firm CoStar, the overall vacancy rate for office space in the Sacramento market continues to hover around 13 percent. The rate is up 0.3 percent from first quarter 2006, but down a full percentage point from first quarter 2005.

This stability provides interesting perspective on the perceived setbacks of several large tenants, including USAA and E-Trade pulling out of the market in recent months. In some cases, these large vacancies may remain but have been statistically offset by the commensurate absorption of a number of smaller spaces. This market is more flexible today, with greater depth and range than it had 10 or even 5 years ago.

In the last several years, rental rates have risen consistently, but well within the normal range. The average asking rates in the market for Class A and Class B property respectively are $2.11 and $1.70 per square foot. In contrast, contract rates for the area averaged $2.26 and $1.64 respectively.

Hot Spots

In terms of submarket growth, there are several hot spots in the region, many that continue to be among the fastest growing in California. Roseville and Rocklin continue to benefit from the broader growth and development of South Placer County as a whole as it fuels the success of these adjacent suburban centers. Of the other top suburban markets, Folsom is another that is clearly benefiting from the shift of regional growth away from urban centers.

Counterbalancing these continuingly strong performers, some submarkets in the area are experiencing an up tick in vacancies. Already flat absorption rates have tipped toward the negative in Elk Grove, South Sacramento, Watt Avenue and the midtown area.

Forecast

As the fourth quarter unfolds, several factors are brought to bear in Sacramento. The office market has yet to reveal a tangible response to an actively correcting residential market. What form of response, if any, will take place depends largely on the ability of other market sectors, not directly linked to the housing market, to compensate. In this respect, the diversity of the market will figure heavily into the equation. In a rapidly growing community, the building industry is a significant part of the economy. The question will be whether our economy has had time enough to mature beyond the point of growing just for the sake of growth and has moved on to a more balanced self-propagating cycle.

Jeff Boucher is a senior vice president for TRI Commercial /CORFAC International in Sacramento.

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