Office Space

A Market in Near Equilibrium

by Greg Fogg

The fourth quarter of 2004 marked a successful closing to a year of positive transition for most owners of San Francisco office buildings. Consider that in 2004 the market posted a positive net absorption of approximately 1,405,165 square feet. Put in perspective, this is the largest amount of net absorption since 2000, and we finished 2003 at 203,006 square feet. Among the more compelling trends in 2004, there were several major companies within the Bay Area and in other parts of the country that chose to secure office space in San Francisco. These include: Gymboree at 500 Howard Street (164,250 sq. ft.), Olivia Cruises & Resorts at 434 Brannan Street (24,900 sq. ft.), Pappas Telecasting at 1700 Montgomery Street (20,600 sq. ft.), River Deep, Inc. at 100 Pine Street (13,006 sq. ft.), and Primitive Logic at 704 Sansome Street (10,784 sq. ft.).

As you would guess, this positive net absorption helped take a bite out of the office vacancy rate. Class A space located in the Financial District (north and south) saw vacancies decline to 17.0% at the close of 2004 from 19.6% at the close of 2003.
Similarly, Class B space in the Financial District (north and south) dropped to 14.6% from 16.7%. Perhaps even more surprisingly, vacancies outside the financial district fell to 16.5% from 21.1%. In Jackson Square and the North Waterfront, the trend continued with the vacancy rate lowering to 14.8% from 18.1%. In fact, the vacancy rate declined in every submarket of the San Francisco office market.

With the vacancy rate declining and solid leasing activity occurring, 2004 could be best characterized as a market in which owners selectively began to increase rents and limit concessions, and tenants began to move more swiftly to secure what they correctly perceived as a diminishing opportunity to negotiate historically favorable lease terms. Buoyed by improving fundamentals and pent up demand, sales of San Francisco office buildings reached a record volume. The following major Class A office projects traded hands in 2004:

555 California St. (1,800,000 sq. ft. at approximately $444 per sq. ft.), 425 Market St. (996,760 sq. ft. at approximately $149 per sq. ft.), Hills Plaza I & II (611,482 sq. ft. at approximately $322 per sq. ft.), 333 Market St. (596,000 sq. ft. with an undisclosed cost per sq. ft.), 1 South Van Ness (460,000 sq. ft. at approximately $109 per sq. ft.), Pacific Center (430,000 sq. ft. at approximately $428 per sq. ft.) and Hawthorne Plaza (418,668 sq. ft. at approximately $232 per sq. ft.).

In 2005, we expect to see a continued tightening of the office market, led by core Class A space. Our prediction is that 2005 will be as close to a market in equilibrium where both landlords and tenants have relatively even leverage. This market is one we have not seen for some time and such markets do not usually last long. With another decent year on the macro economic front, it is conceivable that San Francisco will post another 1,500,000 square feet of positive net absorption. At some point in the not too distant future, given market segmentation and the relatively high pricing associated with recently acquired assets, the upper quartile of San Francisco’s market stands to achieve significant rental appreciation.

The unemployment rate in San Francisco County dropped below 5% as of the fourth quarter of 2004 to 4.5%, 80 basis points lower than the third quarter of 2004 with a rate of 5.3%. In comparison, California recorded 5.8% unemployment for the same reporting period, while the U.S. average was 5.4%. The state unemployment rate has declined in each of the last three quarters, while the U.S. average posted no significant change from the previous quarter. All three unemployment rates are down from the same reporting period a year ago.

opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of SFAA or the San Francisco Apartment Magazine.Greg Fogg is a managing partner at BT Commercial, specializing in real estate representation of both landlords and tenants in negotiating office lease transactions. He can be reached at gfogg@btcommercial.com or 415-781-8100.