WESTERN SNAPSHOT, OCTOBER 2008

Sacramento, California Office Market

McGillivray

The metropolitan Sacramento office market is holding its own in turbulent economic times marked by a severe downtown in the housing market. In terms of commercial occupancy, the sector slowdown spiked in 2007 when numerous mortgage companies, residential real estate brokers, homebuilders and title companies returned space to the market. For example, Ameriquest Mortgage Co. returned 96,400 square feet in the Highway 50 corridor and K Hovnanian Homes released 30,000 square feet on Exposition Boulevard last year.

2008 began with the downtown office market approximately 13 percent vacant, suburban Sacramento nearly 16 percent vacant, Roseville about 15 percent vacant and Rocklin almost 25 percent vacant. By mid-2008, the total inventory, which exceeds 80 million square feet, is a little more than 13 percent vacant or about one point higher than a year ago. The overall vacancy rate is trending higher and should put downward pressure on rents during the next few quarters.

Now that the Sacramento metro market has digested most of the negative net absorption from homebuilding and the residential real estate sector, office brokers and commercial property owners are closely watching the other industries that drive the office market and hoping the other shoe or shoes will not drop. Preliminary indicators are not so sunny.

The biggest tenant in the Sacramento market, the state government, has signed new leases this year for later occupancy. At this point, however, it is hard to imagine the government expanding its footprint in the next 24 months. In August, Governor Schwarzenegger announced planned payroll reductions with news reports stating that most of the layoffs would be clerical and administrative. In other words, office workers are the most likely to be let go. Government leases signed in the second quarter include 55,000 square feet by the California Court of Appeals at the new U.S. Bank Tower at 621 Capital Mall and a 70,000-square-foot deal the California State Legislative Council Bureau inked at 925 L Street in downtown Sacramento.

The high-tech industry has historically had a one-step-forward, two-steps-back relationship with the area. In Auburn, officials fear Coherent Inc. will shutter its four-building plant by year’s end. The company has indicated it would lay off 144 people. The plant once housed as many as 800 workers. In other high-tech (downsizing) news, Santa Clara-based biotechnology company Affymetrix Inc. announced it would close its West Sacramento manufacturing plant by the middle of next year and would lay off more than 100 employees.

However, the largest office deal in south Placer County in the past year was recorded in the second quarter with Verifone Holdings Inc. leasing 40,000 square feet in Rocklin’s Stanford Ranch Corporate Center. The electronic payment systems company plans to move to the new Class A building owned by Kobra Properties in November. Verifone is consolidating from about 50,000 square feet after 10 years at the Atherton Tech Center. While Verifone is giving space back to the market, the fact that a major tenant was retained is significant.

The biggest and most elegant office building to come online this year is the aforementioned U.S. Bank Tower owned by David S. Taylor Interests Inc. At 25 floors with 365,000 square feet, the project is 64 percent leased, including the California Court of Appeals transaction that was signed in June. The owner is asking $3.45 per square foot on a monthly service basis, which is setting a high watermark in Sacramento. By comparison, asking rent is $3.10 per square foot at 500 Capital Mall, which is scheduled for delivery in early summer 2009.

Healthcare is expanding and providing opportunity for medical office building developers and investors. All of the major health service providers in the region — Sutter Health, Kaiser Permanente, UC Davis Health System and Catholic Healthcare West — are collectively growing by more than 3 million square feet. Granite Bay Ventures LLC has completed a 60,000-square-foot medical office building on the campus of Sutter Roseville Medical Center in Roseville that is 3,000 square feet shy of being fully occupied by doctors’ groups, which invested in the building.

The commercial condo market took a hit when the residential real estate industry began its slide, yet this niche is still experiencing pockets of success. As is often the case in real estate, location plays a role in determining a market. Jeff Kraft and his Habitat Construction Inc. project near The Fountains at Roseville sold six commercial condos earlier this summer with an offer pending on the remaining vacant building of 54,000 square feet. The Fountains is the lifestyle center that just opened with tenants such as Whole Foods Market, McCormick & Schmick’s restaurant and Sur La Table kitchenware.

The lifestyle retail, healthcare and government sectors cannot be expected to buoy the office market. Rather, the private sector bolstered by an improved national, state and regional economy will have to account for expansion. From June 2007 through June 2008, the Sacramento area lost approximately 10,000 jobs. During the same period, the state as a whole lost more than 58,000 jobs, according to the Sacramento Regional Research Institute, which monitors the economy of the six-county Sacramento area. Just when will the city begin to see recovery is anyone’s guess. Optimistic observers predict mid-2009, while the pessimists say it will be 2010.

Dennis McGillivray is senior vice president and regional manager for TRI Commercial/CORFAC International in Sacramento.

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