The longest economic downturn of the postwar era has shown some signs of easing. The S&P 500 has surged 70 percent since its bear-market low in March, 2009 and the US Economy, as measured by GDP, began growing again in the third quarter, 2009.
While several positive indicators are fueling renewed optimism in the overall marketplace, commercial real estate fundamentals remain depressed. Employment in office using industries, the primary driver of demand, has declined at unprecedented levels and continued to contract, locally and nationally, in the first quarter of the year.
“Bay Area businesses continue to exercise caution, reducing spending and streamlining operations,” said Steve Barker, executive vice president and branch manager of Studley’s San Francisco office. “As a company’s two most significant expenditures are labor and real estate, it only follows that these would be the primary targets for reduction.”
While tenant activity has increased this quarter, on a trailing four-quarter basis, the uptick is due to excessive rollover. Lease expirations will be higher than normal in 2010/2011, due to the abundance of 10-year deals signed in 2001, 5-year deals signed in 2006, and recent short-term extensions. “However, the rise in activity stemming from lease rollover should not be mistaken for increased demand or absorption,” said Barker. “In fact, the activity primarily consists of tenants downsizing as they renew or move.”
According to the Studley Report, nearly 20 percent of San Francisco’s 80-million-square-foot office market is currently available for lease. In order for availability to fall to 10 percent—typically considered a market tipping point—and, consequently, for rents to begin rising, more than 7 million square feet square feet would need to be absorbed. “At an average allocation of 225 square feet per employee, this would still mean that 31,000 new San Francisco-based office jobs would need to be created, an unlikely scenario given current economic and market fundamentals,” explained Barker.
Leasing Activity Rises
Leasing activity continued to rise from historic lows. On a trailing four-quarter basis, approximately 5.2 msf has been leased, up 20% from the previous quarter, but 33% lower than the market’s 10-year historical average of 7.8 msf.
Asking Rents Soften
Overall asking rent averaged $28.35, down 2.1% from last quarter and 15.2% from last year. Class A asking rent, at $28.71, declined 3.9% from the previous quarter and 17.3% from a year ago. Asking rents have retreated to 2006 rates.
Availability Remains Near All-Time High
San Francisco’s overall availability rate, 19.7%, fell by 0.3 pp on a quarterly comparison but remained 1.5 pp higher than a year ago. Class A availability rate, 17.9% increased by 0.3 pp for the quarter and is 0.8 pp higher than a year ago.
Large Block Inventory Down Slightly
The number of available large contiguous blocks of space (50,000sf or more) declined to 48, compared to 50 last quarter, and 38 one year ago.
The downward pressure on the market may begin to alleviate, but tenants will retain the upper-hand in lease negotiations in 2010 and beyond. Most tenants remain focused on cost-cutting, and several planned consolidations will return office space to the available supply. Job growth will be muted, at best, and most likely negative as forecasted by the Association of Bay Area Governments, as well as Moody’s.